KEY RATING DRIVERS
NBO's VR is at the same level as the SRF. The bank's Long-Term IDR is driven by its intrinsic financial strength (as measured by the VR) and underpinned by potential sovereign support.
NBO's VR reflects the tougher Omani operating environment, weak asset quality compared with peers', high loan book concentration, and only adequate capital ratios. The VR also reflects NBO's moderate franchise, a competent management team, reduced risk appetite, as well as a strong retail deposit franchise relative to peers'.
NBO 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 limited opportunities, a weakening of corporate balance sheets and consumer vulnerability.
NBO has a moderate franchise as the third-largest bank in Oman with an even split between corporate and retail lending. NBO's brand and sound domestic branch network underpin the bank's distribution capabilities. The bank's focus is primarily domestic, with limited and diminishing diversification into the UAE and Egypt. Fitch does not view the unsuccessful attempted merger with Bank Dhofar (BD) as negative for NBO, as the bank had continued to focus on its own strategy even while in talks with BD.
NBO's impaired loans ratio rose to 4.8% at end-2018 (2017: 4.1%), above the local average for Fitch-rated peers of 3.4%, still bearing the effects of the sharp deterioration of the bank's UAE exposures. However, the quality of Omani loans has been resilient so far despite some restructurings reflecting pressure from the local operating environment. Loan loss reserves fell to 92.8% of impaired loans at end-2018, compared with an average for local Fitch-rated peers of 109.5%. Fitch understands from management that this was because of expectation for high recoveries on the largest stage 3 exposures, which are adequately collateralised.
NBO's overall profitability (operating profit/ risk-weighted assets (RWAs)) returned to the local banking average of 1.8% in 2018, on lower loan impairment charges (LICs). Nevertheless, Fitch expects the bank's operating profit/RWAs to rise above market average as the magnitude of LICs caused by the UAE operations is viewed as one-off while the bank continues to benefit from a solid retail franchise that guarantees lower cost of funding than some of its competitors. Additionally, the bank's margins have narrowed through a combination of a higher cost of funding and the inability to re-price retail lending, which represents almost 50% of the loan book.
NBO is exposed to structural interest rate risk that cannot be effectively hedged because there is no viable local interest-rate swap market. Additionally, the bank's retail lending is subject to a long-standing regulatory lending rate cap of 6% that affects all local banks. Fitch believes that the Central Bank of Oman has little appetite to lift the cap despite a rising interest rate environment. NBO may suffer from some pressure on margins if interest rates rise. Foreign currency and equity/investment price risks are limited.
Capital ratios have demonstrated stability even in periods of high balance-sheet growth, but deteriorated in 2018 due to IFRS 9 implementation (43bps) and 6% loan growth in the year. NBO's Fitch Core Capital ratio (12.6% at end-2018) was below the local banking average of 15.9% at end-2018.
Similarly to peers, NBO's reliance on wholesale funding (corporates, financial institutions, government and government-related entities (GREs): 67% at end-2018) results in funding concentrations. However, the bank's branch network facilitates a strong Current Accounts/Savings Accounts and retail deposit base, which is reflected in a more stable and lower-cost deposit base than the local sector average.
An adequate stock of Fitch-calculated net liquid assets (equivalent to 5% of total assets and 8% of customer deposits at end-2018) underpins NBO's liquidity and offsets the bank's high gross loans/customer deposits ratio (119.9% at end-2018). The liquidity coverage ratio and the net stable funding ratio are comfortable.
SUPPORT RATING AND SUPPORT RATING FLOOR
NBO's SRF reflect Fitch's expectation of a moderate probability of support from the Omani authorities in case of need. Fitch views NBO as a domestic-systemically important bank (D-SIB) in Oman despite it not being officially designated as such. Its SRF is therefore equal to the Omani D-SIB SRF of 'BB'.
Fitch believes Oman has the financial flexibility to support its banking system despite the weakness in the country's fiscal policy framework. Despite a sharp increase in average oil prices this year, we expect Oman's budget deficit to narrow only gradually to 9% of GDP, still one of the largest deficits among Fitch-rated sovereigns. Fitch believes the Omani authorities' willingness to support domestic banks remains high, partly because of high contagion risk (small number and high concentration of banks in the system) and the importance of the banking system in building the local economy.
NBO's IDRs are sensitive to a simultaneous downgrade of its VR and downward revision of the SRF.
A downgrade of the VR would most likely be a result of a sovereign downgrade or a deteriorating operating environment. Weakening of NBO's liquidity or significant worsening of asset quality could also put pressure on the VR. An upgrade of the VR would be conditional on a sovereign upgrade or an improvement of the operating environment.
SR AND SRF
NBO's SR and SRF are sensitive to a change in Fitch's assumptions around the Omani authorities' propensity or ability to provide timely support to the banking sector or the bank.
The rating actions are as follows:
National Bank of Oman SAOG
Long-Term Foreign-Currency IDR downgraded to 'BB' from 'BB+'; off RWN; Stable Outlook
Short-Term Foreign-Currency IDR affirmed at 'B'
Viability Rating downgraded to 'bb' from 'bb+'; off RWN
Support Rating affirmed at '3'
Support Rating Floor revised to 'BB' from 'BB+'; off RWN
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