SAIB's SR and SRF reflect Fitch's view of a high probability of support for the bank, if needed, from the Saudi authorities. Fitch's assessment takes into account a long track record of support for Saudi banks, continued government willingness to maintain stability in the domestic financial system and a strong ability to support the bank, given large, albeit decreasing, external reserves, and increased access to external markets. SAIB's SR and SRF also reflect the bank's lower relative systemic importance compared with that of the larger banks we rate, due to the bank's smaller size, market share and franchise.
SAIB's Short-Term IDR of 'F2', the lower of the two options that map to a 'BBB+' Long-Term IDR, reflects Fitch's view of potentially simultaneous deterioration in the liquidity profile of both the sovereign and the bank in a stress scenario. The latter could impede the prompt flow of funds from the sovereign to the bank, reflecting the potential for the sovereign to pay its direct obligations ahead of providing support to the financial sector.
SAIB's VR reflects the bank's modest franchise, asset quality metrics that are weaker than peers', high asset and liability concentrations, albeit with some improvements, and an adequate, but less stable, funding profile than that of its peer group. The VR also incorporates reasonable profitability and capital ratios, the latter which, although at the lower end of the sector, are maintained with adequate buffers above regulatory requirements and are expected to improve following some recent one-offs. The bank's VR also reflects some pressures from the broader economic environment impacting asset quality and loan growth.
SAIB's company profile is modest considering the bank's small market share across both retail and corporate banking, which results in limited pricing power. SAIB's smaller size and higher cost of funding compared with peers' results in the bank focusing on higher-risk segments (including SME and mid-corporates) where competition from bigger banks is not as strong and returns are more attractive.
Underwriting standards have improved in recent years, supported by reductions in single-name concentrations, although in our opinion they are not as strong as peers', which is reflected in SAIB's weaker asset quality metrics. Stage 3 loans represented a high 4.8% of gross loans at end-1Q19, relative to peers', while total potential problem loans (stage 2 and stage 3) equalled 20% of gross loans. Reserve coverage of impaired loans is low (gross provisions/stage 3 loans of 63% at end-1Q19), reflecting reliance on collateral but exposing the bank to the risk of falling asset values.
Profitability is adequate for the rating, but weaker than larger peers', driven by a higher proportion of more expensive term deposits and higher-than-average loan impairment charges. Cost control is sound with a cost/income ratio at end-1Q19 of 42% while the bank's cost/assets ratio is one of the sector's lowest (1.3%).
Capitalisation is adequate and commensurate with the bank's risk profile with a Fitch Core Capital (FCC) ratio of 14.2% at end-1Q19 (end-2018: 13.3%), underpinned by sound internal capital generation and a low-growth environment. Dividend distributions have decreased recently, partially offsetting the impact on equity from several share repurchases and the recent settlement with the Saudi tax authority of the bank's extra zakat (an annual payment obligation under Islamic sharia) for years up to and including 2017, which has since been deducted from equity. The zakat settlement represented around 90bp of end-2018 risk weighted assets (RWAs).
Fitch expects SAIB's capitalisation to improve over the medium-term, mostly through sound internal capital generation and the absence of one-off negative capital hits. Leverage is healthy with a Basel leverage ratio of 13.7% at end-1Q19, at the higher end of the sector.
SAIB's loan book is predominately financed by customer deposits, which accounted for just over three-quarters of total funding, a large proportion of which is sourced from retail channels. We do not view SAIB's funding profile as strong as higher-rated peers' because of a lower proportion of stable current and savings accounts and a greater use of more confidence- sensitive short-term wholesale funding. Progress is being made to address this weakness with a gradually increasing share of demand deposits.
In line with peers', funding concentration is high although we view larger deposits as fairly sticky as the majority are sourced from government agencies. The bank maintains a large stock of high-quality liquid assets (29% of total customer deposits at end-1Q19), a large share of which comprise cash and cash reserves that largely placed with SAMA, plus SAMA securities and government bonds. The bank reported a liquidity coverage ratio of 186% at end-1Q19, comfortably above minimum requirements.
Credit growth in Saudi Arabia ticked up in 2018, albeit modestly, and we expect further growth in 2019 to be moderate. Banking sector asset quality metrics have deteriorated slightly, albeit from a strong base, due to some persisting pressures from the operating environment. Exposure to internal and external political shocks, as well as a concentrated economy, mean that there is a risk that asset quality could deteriorate suddenly. However, this is not our base case.
IDRs, SR AND SRF
As SAIB's IDRs are driven by sovereign support, they are sensitive to a revision of the bank's SRF. SAIB's SR and SRF are sensitive to a change in the Saudi Arabian sovereign rating. As the latter is currently on Stable Outlook, this is not our base case. A weaker propensity from the authorities to support the bank will also lead to a negative rating action, but this is not Fitch's base case.
Saudi Arabia is an FSB/G20 member country. Bankruptcy legislation has been introduced and resolution legislation is being finalised. If the legislation allows losses on senior creditor, and where we believe the authorities will use this rather than provide sovereign support, we will review the Saudi banks' SRFs, and this could result in downward revisions to the SRFs or even a 'No Floor'. However, this is not our base case.
SAIB's VR is sensitive to sharper-than-expected or prolonged deterioration in the domestic operating environment, which could result in deterioration in profitability, higher loan impairments, weaker asset quality, capitalisation and liquidity.
SAIB's VR could also come under pressure if asset quality indicators fail to stabilise at current levels as expected. The VR could also be downgraded if capital buffers are eroded due to weakening asset quality or prolonged rapid growth. Downward rating pressure would also build if capitalisation fails to improve as Fitch expects and if there is material deterioration in internal capital generation and profitability at SAIB. A weakening of the bank's funding and liquidity profile, which could be indicated by an increasing use of short-term wholesale funding or material deposit outflows, could also put pressure on ratings.
SAIB's VR could be upgraded if the bank makes material progress in addressing its lower proportion of stable deposits compared with peers', in turn supporting improvements in profitability and funding stability. An upgrade would also likely be contingent on evidence of improved and sustainable asset quality metrics commensurate with higher-rated peers'.
The rating actions are as follows:
Long-Term IDR affirmed at 'BBB+'; Outlook Stable
Short-Term IDR affirmed at 'F2'
Support Rating affirmed at '2'
Support Rating Floor affirmed at 'BBB+'
Viability Rating affirmed at 'bbb-'
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