Fitch places Dukhan Bank on rating watch negative

Fitch Ratings - Dubai : Fitch Ratings has placed Dukhan Bank Q.P.S.C.'s Long-Term Issuer Default Rating (IDR) of 'A' on Rating Watch Negative (RWN). The Short-Term IDR and Support Rating Floor (SRF) were also been placed on RWN. Dukhan Bank's Viability Rating (VR) has been affirmed at 'bb+'.

The RWN reflects the Qatari banking sector's increasing reliance on external funding and recent rapid asset growth, which may have moderately weakened the sovereign's ability to provide support to the system, in case of need.

A full list of rating actions is included below.

The ratings of debt related to Dukhan Bank's special purpose vehicle - IBQ Finance Limited - were withdrawn as there are no issuances outstanding and Dukhan Bank has wound down the entity.

KEY RATING DRIVERS

Non-resident funding reached USD193 billion or 48% of the Qatari banking sector's liabilities at end-August 2021 (up from USD121 billion or 38% at end-2018), while the banks' foreign assets remained broadly stable (USD60 billion at end-August). As a result, the banking sector's net external debt at end-August 2021 increased to a substantial USD133 billion or 82% of forecast 2021 GDP (USD57 billion or 31% at end-2018). This high level of external funding, coupled with the large size of the banking system (total assets increased to 302% of forecast 2021 GDP at end-August 2021 from 212% of GDP at end-2018), could have moderately weakened the authorities' ability to support the banking sector, if needed, notwithstanding the substantial resources at the sovereign's disposal.

The 'A' domestic systemically important bank (D-SIB) SRF for Qatari banks is at the higher end of the typical range for D-SIB SRFs in jurisdictions where the sovereign is rated 'AA-' and in Fitch's view, reflects a high propensity to support the banking system.

Fitch will resolve the RWN following further analysis of the current composition and stability of Qatari banks' non-resident funding, the evolution of this funding in volumes and sources, the banks' liquidity- management plans, and the sovereign's ability to provide liquidity support to banks if needed. In the event of a downgrade, Dukhan Bank's Long-Term IDR and SRF are expected to remain in the 'A' category.

IDRs, SR and SRF

Dukhan Bank's IDRs, Support Rating (SR) and Support Rating Floor (SRF) continue to reflect an extremely high probability of support from the Qatari authorities for domestic banks, if needed. This considers Qatar's still strong ability to support its banks, as reflected in its 'AA-/Stable' rating and substantial net foreign assets (end-2020: equivalent to 187% of GDP) and revenues. It also reflects Fitch's view of a strong propensity to support the banking sector, including Dukhan Bank, based on past episodes of support. Examples of support include the authorities placing significant deposits with the banks to support sector liquidity following the start of the blockade between Qatar and some of its neighbours in 2H17; and in 2009-2011 some banks received capital injections to enhance their capital buffers, and the government purchased problem assets from the banks. The government owns stakes in all Qatari banks.

Dukhan Bank's Short-Term IDR of 'F1' is the lower of two options mapping to an 'A' Long-Term IDR, reflecting that a significant proportion of the banking sector's funding is government-related and stress on Dukhan Bank is likely to arise at a time when the sovereign itself is experiencing some form of stress.

VR

Fitch has revised the outlook on Qatari banks' operating environment to stable as short-term downside risks from the pandemic fallout on banks' credit profiles have subsided. Fitch Forecasts Qatar's real GDP growth to rebound to 1.6% in 2021 (2022: 2.5%), following a 3.6% contraction in 2020, supported by higher hydrocarbon prices and the North Field LNG expansion. The sector's credit growth was 6.7% (annualised) in 1H21 (2020: 8.5%) despite cutbacks in capital expenditure by the government.

We believe the near-term risks on the sector's asset quality (end-1H21 average Stage 3 loans ratio was about 2%) are largely contained - even after the expiry of the QCB credit deferrals - and offset by the recovering operating environment and the banks' strong provisioning levels (end-1H21: 140% average total reserve coverage of impaired loans). Qatari banks have adequate capital buffers (end-1H21: average common equity Tier 1, CET1, ratio of 14% against the 8.5% minimum regulatory requirements) and healthy pre-impairment operating profitability offsetting a potential moderate increase in problem loans.

Dukhan Bank's 'bb+' VR reflects the bank's moderate - though growing - franchise in Qatar, high asset quality risks and above-average growth appetite, as well as its weak funding and liquidity profile. It also considers its reasonable operating profitability and core capitalisation.

Dukhan Bank's franchise (end-1H21: 6% of sector assets; end-2018: 3.1%) and competitive advantages have moderately improved following the merger with International Bank of Qatar in 2Q19. The government ultimately owns a 44% stake in the bank, supporting both its financing (end-1H21: sovereign-related financing/total financing ratio of 33%) and funding flows.

Financing growth was a very rapid 34% in 1H21 (sector average of 7%), although it largely reflected the origination of a lumpy long-term sovereign-related financing. The bank's above-average financing growth strategy could put pressure on its risk framework and result in some moderate capital erosion.

Despite higher real estate impairments in 2020, the bank's non-performing financing (NPF) ratio decreased to a reasonable 2.8% at end-1H21 (end-2019: 3.6%), flattered by large NPF write-offs (2020: about 190bp of financing) and the base effect from high growth. The NPF generation rate decreased to 0.3% in 1H21 (annualised basis) from a higher 2.6% in 2020. At end-1H21, the deferred financing/total financing ratio was a limited 2.5%. However, risks are heightened by exposures to high-risk real estate and contracting (end-1H21: a combined 27% of financing), Stage 2 financing (20%), and high borrower concentration risk (top 20 credit exposures/equity ratio of 4.5x).

The total reserves fully covered NPFs at end-1H21 (end-2020: 84%), although specific coverage of 59% was below-average. This largely reflects the presence of collateral held against lumpy real estate exposures.

Dukhan Bank's operating profitability is reasonable (1H21: 1.7% of risk-weighted assets), underpinned by its rapid growth and an adequate net financing margin (1H21: 2.6%). Its cost efficiency has improved (1H21: cost/income ratio of 26%) reflecting synergies from the merger. A large goodwill impairment (equivalent to 43% of operating profit in 2020) related to the bank's subsidiaries dented performance in 2020 (5% return on average equity). Financing impairments consumed a still significant 42% of pre-impairment operating profit in 1H21 (down from 47% in 2020), although these impairments should gradually tail off considering the stabilisation in the operating environment and easing of asset quality risks.

Dukhan Bank's CET1 ratio (end-1H21: 14.7%) compares well with most peers and is comfortably above the minimum requirement (620bp buffer). However, core capitalisation is at risk from above-average financing growth and unreserved Stage 2 and Stage 3 financing (end-1H21: 1.6x CET1), as pre-impairment operating profit (1H21: an annualised 2.8% of average financing) provides only a moderate buffer to absorb losses through the income statement.

The bank's total capital adequacy ratio (CAR) was 15.9% at end-1H21, indicative of a limited cushion above its 15% minimum regulatory requirement (including a 2% ICAAP Pillar II charge and a 0.5% D-SIB buffer). The bank issued USD500 million of perpetual Additional Tier 1 Sukuk in 3Q21, which provided about a 260bp uplift to the total CAR.

Dukhan Bank's funding profile is constrained by concentration risk and a lack of long-term funding. Customer deposits (end-1H21: 81% of total funding) are highly concentrated (top 20 deposits/total deposits ratio of 58%), although this is partly inflated by the presence of sovereign-related tickets (over half of top 20 deposits). The share of non-resident deposits (end-1H21: 21% of total deposits) increased in 2020, in line with the sector.

The bank aims to reduce its gross financing/deposits ratio (end-1H21: 114%), lengthen the maturity of its funding, and gradually bring its Net Stable Funding Ratio (end-1H21: 90%) in line with the 100% minimum requirement.

Liquid assets (cash, unrestricted central bank balances, unpledged government securities and short-term interbank placements) decreased to a low 9% of total assets at end-1H21 (end-2020: 15%), covering only 13% of deposits, as liquidity was largely deployed to support rapid financing growth. The regulatory liquidity coverage ratio was 147% at end-1H21.

In assessing Dukhan Bank's ratings, we consider the important differences between Islamic and conventional banks. These differences include regulatory oversight, disclosure, accounting standards and corporate governance. Islamic banks' ratings do not express an opinion on the bank's compliance with sharia. Fitch will assess non-compliance with sharia if it has credit implications.

SPVs and Senior Debt

The ratings of senior debt issued by Dukhan Bank's special purpose vehicle (SPV) are in line with the bank's Long or Short-Term IDRs because Fitch views the likelihood of default on any senior unsecured obligation issued by the SPV as the same as the likelihood of a default by the bank.

-Ends-

Link to Rating Actions: Rating Actions

Media Relations: Louisa Williams, London, Tel: +44 20 3530 2452, Email: louisa.williams@thefitchgroup.com 

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© Press Release 2021