Fitch Ratings-London-May 23: Fitch Ratings has affirmed HSBC Bank Oman's (HBON) Long-Term Issuer Default Rating (IDR) at 'BBB' with a Negative Outlook. The bank's Viability Rating (VR) has also been affirmed at 'bbb-'. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
IDRs AND SUPPORT RATING
HBON's IDRs and Support Rating (SR) are driven by Fitch's expectation of a high probability of support from the bank's ultimate parent, HSBC Holdings (HSBC; AA-/Stable/aa-). This reflects HSBC's strong ability to support HBON, and HBON's manageable and negligible size as a share of total group assets. This view is supported by HBON's role in the group, providing products and services in a market identified as strategically important to HSBC. Fitch's view of support also factors in strong integration (including management, systems and risk practices), common branding and the high reputational risk that an HBON default would have for HSBC.
HBON's Long-Term IDR is capped by the Omani Country Ceiling, which captures transfer and convertibility (T&C) risk. If T&C considerations did not apply, HBON's Long-Term IDR would be notched down once from HSBC's 'AA-' Long-Term IDR, with a Stable Outlook. The Negative Outlook on HBON indirectly reflects the Negative Outlook on Oman, as a sovereign downgrade is likely to be accompanied by a downward revision of the Country Ceiling.
According to our criteria, a Long-Term IDR of 'BBB' corresponds to a Short-Term IDR of either 'F2' or 'F3'. We have assigned the 'F2' Short-Term IDR because we view the liquidity profile of HBON's parent as extremely strong.
Fitch does not assign a Support Rating Floor (SRF) to HBON, because in the agency's view the most likely source of extraordinary support for this bank is its shareholder and not the government authorities. SRFs are assigned to banks which in Fitch's opinion would receive extraordinary support from the government in the first instance.
VR
HBON's VR reflects HSBC's ordinary support, which underpins the bank's adequate domestic franchise, competent management, lower risk appetite compared with domestic peers, good risk controls, resilient loan quality, solid core capital ratios, stable funding and strong liquidity. It also considers the tougher Omani operating environment, profitability that is lower than peers, and high concentration risks, albeit lower than peers.
HBON operates primarily in Oman, a market that is less stable and resilient to economic shocks than it was previously. The undiversified and narrow Omani economy is highly correlated to government spending and initiatives. With the sovereign under pressure, this will reflect on the bank's intrinsic strength through corporate balance sheets' weakening and consumer vulnerability.
HBON has a moderate market share in assets, loans and deposits, and is generally a price-taker. However, HBON benefits from being part of the HSBC group, providing it with competitive advantages. This underpins the bank's good brand and client relationships, deposit collection, technical expertise and access to large lending tickets. The bank's universal banking business model is stable, oriented towards traditional commercial banking and geographically concentrated in Oman. HBON's organisational structure is simple and commensurate with its business model.
HBON's competent management, with a high degree of depth and stability and experience in the local and regional banking supports the bank's strategy implementation and benefits from being part of HSBC group. HBON's strategic objectives have been consistent over the years and well-articulated, with a key focus on maintaining a liquid balance sheet, cleaning-up all legacy credit exposures, achieving cautious organic growth and increasing group synergies. Fitch believes that the bank's execution may be more variable with changes in the domestic economic cycles and operating environment.
Similar to domestic peers, underwriting standards for lending are constrained by the undiversified and developing nature of the Omani economy and the lack of lending opportunities. This results in high and unavoidable concentrations that expose HBON to event risk. However, the bank's underwriting standards for lending are more prudent and conservative than the market, with lower exposures to volatile sectors and shorter-term and smaller-size lending tickets. HBON's underwriting standards for investments are also very conservative. The bank's risk controls and reporting tools are good and can support its cautious growth, although a weaker operating environment may impact their effectiveness.
In the current rising interest rate environment, Fitch believes that exposure to market risk is heightened given structural interest rate risk. However, HBON is technically better positioned than domestic peers to absorb interest rate adverse movements given the interest rate repricing gap and utilisation of better hedging techniques with international counterparties through HSBC group. Foreign currency and equity/investment price risks are limited.
HBON's loan quality is resilient, steadily improving over the last three years. The bank's impaired loans ratio (3.8% at end-2017) is in majority composed of legacy loans from Oman International Bank acquired in 2012. HBON is progressively writing off these legacy loans. Generation of problem loans is minimal and the stock of past due but not impaired loans is well-controlled. HBON's large securities portfolio supports the bank's asset quality. The bank's loan loss reserve coverage (126.4% of impaired loans at end-2017) is good and higher than domestic peers. Fitch believes this is necessary given the bank's concentration risk and pressures from the domestic operating environment. IFRS 9 provisioning is manageable for HBON given the high level of collective provisions already required by the Central Bank of Oman (CBO).
HBON's profitability benefits from the low cost of funding, good cost efficiency and stable loan impairment charges. The large non-interest bearing and low-cost current and saving accounts and retail deposits provide the bank with cheap funding and limit the impact of rising interest rates. However, HBON's lower penetration in retail lending, high quality borrowers and large good quality but low-yielding securities constrain the bank's net interest margins and net interest income. The bank also still suffers from the highest cost-to-income ratio in the country. HBON's profitability remains below peers, and Fitch expects it to improve on the back of lower costs relative to income. The bank's operating income may be variable over economic and interest rate cycles given the bank's high reliance on net interest income (72% of operating income in 2017). Fitch also expects a mild increase in impairment charges due to IFRS 9 implementation.
HBON has maintained a solid Fitch core capital ratio (16.6% at end-2017) and tangible leverage ratio (13.7%), which are above domestic peers, benefiting from high quality securities (US and Western Europe sovereign instruments), prudent growth and reasonable internal capital generation (albeit one of the lowest compared with domestic peers).
In 2017, the CBO required banks to risk weigh at 100% any exposures to non-Omani sovereigns and central banks, regardless of credit rating (including US treasuries) to promote local financing. Claims on the Omani government and the CBO (in all currencies) remained 0%-risk weighted. This greatly impacted HBON's capital ratios at end-2017 (by about 260bp-290bp). On 20 March 2018 (effective 1 April 2018), the CBO revised its decision. Disregarding these regulatory changes, HBON's capital ratios would have been the highest of its domestic peers at end-2017, with CET1 and AT1 of 18.6% and CAR of 19.8%.
The core capital structure (with 94% of the capital base composed of CET1 capital at end-2017) supports the capital's risk absorption capacity. Capital buffers over minimum regulatory requirements are high and steady and above the domestic peer average. As part of HSBC group, HBON has the ability to raise capital if needed. High concentrations will remain the main risk, although these are below domestic peers. The implementation of IFRS 9 has a manageable impact on HBON's equity and core capital from additional reserving requirements.
HBON is almost totally funded by customer deposits (98.2% of non-equity funding at end-2017). HBON's high reliance on wholesale funding, and particularly deposits from government-related entities and large corporates, results in high deposit concentration. This partially mitigates liquidity maturity mismatches. HBON's large retail deposit franchise benefits from HSBC's global franchise and good branch network, banking premier customers and high net worth individuals. HBON's non-deposit funding is minimal, shielding HBON from any refinancing risks. However, the bank has the ability to raise debt if needed, benefiting from HSBC's ordinary support. HBON also benefits from contingency funding from the group if required.
HBON has a strong liquidity position, supported by a low gross loans/customer deposits ratio (75.8% at end-2017). The high stock of liquid assets (equivalent to 33.0% of total assets and 39.9% of customer deposits at end-2017) underpins the bank's liquidity and mitigates its high deposit concentration. The liquidity coverage ratio and the net stable funding ratio are comfortable. HBON is a net placer on the interbank market.
RATING SENSITIVITIES
IDRS AND SR
HBON's Long-Term IDR and SR are sensitive to a change in Fitch's view of HSBC's ability or propensity to provide support. A one-notch downgrade of the Omani sovereign is also likely to result in a one-notch downgrade of HBON's Long-Term IDR as the Country Ceiling, which captures T&C risk, is also likely to be revised downwards.
VR
HBON's VR is mostly sensitive to material changes in asset quality and profitability metrics and to a sovereign downgrade.
The rating actions are as follows:
Long-Term Foreign-Currency IDR affirmed at 'BBB', Outlook Negative
Short-Term Foreign-Currency IDR affirmed at 'F2'
Viability Rating affirmed at 'bbb-'
Support Rating affirmed at '2'
Contact:
Primary Analyst
Redmond Ramsdale
Senior Director
+44 20 3530 1836
Fitch Ratings Limited
30 North Colonnade
London E14 5GN
Secondary Analyst
Gilbert Hobeika
Associate Director
+44 20 3530 1004
Committee Chairperson
Eric Dupont
Senior Director
+33 1 4429 91 31
Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com.
Additional information is available on
Applicable Criteria
Bank Rating Criteria (pub. 23 Mar 2018)
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