Fitch Affirms Dubai Islamic Bank

Fitch Ratings - Moscow: Fitch Ratings has affirmed UAE-based Dubai Islamic Bank's (DIB) Long-Term Issuer Default Rating (IDR) at 'A' with a Stable Outlook. At the same time Fitch has upgraded Noor Bank's Long-Term IDR to 'A' from 'A-' and Short-Term IDR to 'F1' from 'F2'. The agency has also affirmed and withdrawn Noor's VR. The list of rating actions is at the end of this commentary.

Link to Rating Actions: Rating Actions

Noor's VR and SRF withdrawn for the following reason: Reorganisation of rated entity (for reasons other than financial distress).

KEY RATING DRIVERS

IDRs, SUPPORT RATINGS (SR), SRFs

DIB's acquisition of Noor was executed on 22 January 2020 in the form of a share swap, with Noor becoming a fully-owned subsidiary of DIB. As part of the transaction, DIB issued 651 million shares to Noor's shareholders in exchange for all of Noor's shares, and both banks retained their equity bases. The government of Dubai (through Investment Corporation of Dubai) directly owns about 26% of DIB's shares following the Noor acquisition.

The upgrade of Noor's IDRs to the level of DIB's reflects completion of the acquisition, as a result of which Noor became an integral and fully-owned subsidiary of DIB. Fitch has also revised Noor's support assessment to institutional support from DIB, as the agency believes this would now be the primary form of support for Noor, in case of need. DIB's IDRs are based on potential support from the UAE authorities, as a domestic systemically important bank. In Fitch's view, this support would flow through to Noor if needed. The withdrawal of Noor's SRF reflects the completion of the acquisition and the change of support assessment to institutional from sovereign.

The affirmation of DIB's IDRs, SR and SRF reflects Fitch's view of an extremely high probability of support available to the bank from the UAE authorities if needed. Fitch's view of support factors in the sovereign's strong capacity to support the banking system, sustained by sovereign wealth funds and recurring revenue mostly from hydrocarbon production. Fitch also expects high willingness from the authorities to support the banking sector. This has been demonstrated by the UAE authorities' long track record of supporting domestic banks, as well as by the authorities' close ties with and part-government ownership links to a number of banks.

DIB's 'A' SRF is at the level of the UAE domestic systemically important banks' (D-SIB) SRF, reflecting the bank's systemic importance and D-SIB status in the UAE and in particular Dubai, where DIB is based. DIB's consolidated market share of total system assets increased to approximately 9% after the acquisition.

We assign Short-Term IDRs according to the mapping correspondence described in our rating criteria. A 'A' Long-Term IDR can correspond to a Short-Term IDR of either 'F1' or 'F1+'. In the case of DIB, we assign 'F1', the lower of the two Short-Term IDR options. This is because a significant proportion of the UAE banking sector's funding is related to the government and a stress scenario for banks is likely to come at a time when the sovereign itself is experiencing some form of stress. Fitch judges this "wrong-way" risk to be high in the UAE.

SPV AND SENIOR DEBT

The rating of the senior unsecured debt (Sukuk) issued by DIB Sukuk Limited (100% owned subsidiary of DIB) and by Noor Sukuk Company Limited (100% owned subsidiary of Noor) are in line with the banks' Long-Term IDRs because Fitch views the likelihood of default on any senior unsecured obligation issued by the SPV the same as the likelihood of default of the bank.

VRs

The affirmation of DIB's VR reflects Fitch's view that DIB's business model, risk appetite and asset quality are only moderately influenced by the acquisition of the weaker (as reflected by its VR of 'bb-') Noor. This view is based on the following: (i) Noor makes up only a moderate 20% of DIB's consolidated assets post-acquisition; (ii) Noor will be gradually integrated in terms of risk appetite and systems, and the banks' underwriting standards and risk controls will be aligned; and (iii) most new business of the group will be booked at DIB, while Noor's business will gradually run-off.

The affirmation of Noor's VR reflects limited changes in its standalone profile since the full review in June 2019 (see Fitch Affirms Noor at 'A-'; Outlook Stable dated 10 June 2019). The withdrawal of Noor's VR reflects (i) the expected gradual reduction of Noor's balance sheet as all new business is planned to be booked at DIB; (ii) expected integration with DIB in terms of risk appetite, underwriting and risk controls; and (iii) limited management independence as Noor's board of directors has been reconstituted with some of DIB's board members and DIB's group chief executive.

The post-acquisition DIB's VR reflects only acceptable asset quality metrics given the bank's credit risk profile and high concentrations, still high exposure to the real estate sector, notably in Dubai, only adequate capital in light of asset quality risks. It also considers the bank's solid domestic franchise and healthy profitability, as well as sound liquidity and funding backed by a large and stable customer deposit base.

Fitch estimates the pro-forma consolidated Stage 3 ratio at 3.7% at end-3Q19 (DIB standalone: 3.6%), and reserve coverage at a comfortable 116%. Stage 2 financing represented 6.2% of the total pro-forma consolidated loan book at the same date, resulting in a total Stage 2+3 financing ratio of about 10%. Financing of construction and real estate companies (viewed by Fitch as of potentially higher risk due to the softening real estate sector in the UAE and in particularly in Dubai) made up 23% of the consolidated financing book at the same date.

Pro-forma profitability metrics are largely in line with DIB's metrics prior to the acquisition, with an annualised operating income/risk weighted assets ratio of around 2.7% in 9M19 (DIB standalone: 2.9%) and a net financing margin of about 3.1% in 9M19, both of which compare well with peers.

Both banks retained their equity bases as the acquisition was in the form of a share swap. However, DIB's consolidated capital ratios slightly decreased post-acquisition as Noor is more weakly capitalised. We estimate DIB's consolidated pro-forma Fitch Core Capital (FCC) ratio at 14.1% (compared with its standalone ratio of 14.6% at end-3Q19), which we still view as reasonable.

Fitch views funding and liquidity as a rating strength for both banks, with each funded mainly by customer accounts (84% of DIB's funding and 83% of Noor's at end-9M19) and keeping a comfortable liquidity cushion. We estimate the pro-forma financing-to-deposit ratio at 97%, a reasonable level compared with large UAE peers.

As Islamic banks, we consider important differences when assessing DIB's and Noor's ratings compared with conventional banks. These factors include closer analysis of regulatory oversight, disclosure, accounting standards and corporate governance. Fitch's Islamic bank ratings do not express an opinion on the rated banks' compliance with sharia. Fitch will assess non-compliance with sharia if it has credit implications.

RATING SENSITIVITIES

IDRs, SR and SRF

The ratings are sensitive to a change in Fitch's view of the creditworthiness of the UAE authorities or on their propensity to support the banking system as a whole or the bank.

Noor's IDRs and SR are likely to move in line with DIB's IDRs and SR.

SPV AND SENIOR DEBT

The rating of the sukuk issued under DIB Sukuk Limited is subject to the same sensitivities as the bank's IDR.

The sukuks issued via Noor Sukuk Company Limited are rated in line with Noor's IDR and their rating is therefore subject to the same sensitivities as Noor's IDR.

VR

DIB's VR remains sensitive to marked deterioration in asset quality affecting the bank's capital or profitability, and to high financing growth that puts pressure on the bank's capital ratios. A track record of sound asset-quality performance and a further reduction in single-name and sector concentration could lead to an upgrade.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

DIB's IDRs, SR and SRF reflect an extremely high probability of support available to the bank from the UAE authorities if needed.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entities, either due to their nature or to the way in which they are being managed by the entities. For more information on our ESG Relevance Scores, visit www.fitchratings.com/esg.

Islamic banks need to ensure compliance of their entire operations and activities with sharia principles and rules. This entails additional costs, processes, disclosures, regulations, reporting and sharia audit. This results in a Governance Structure relevance score of '4' (in contrast to a typical ESG relevance score of '3' for comparable conventional banks), which has a negative impact on the banks' credit profiles in combination with other factors.

In addition Islamic banks have an Exposure to Social Impacts score of '3' (in contrast to a typical ESG relevance score of '2' for comparable conventional banks), which reflects that Islamic banks have certain sharia limitations imbedded in their operations and obligations, although this only has a minimal credit impact on the entities.

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

Additional information is available on www.fitchratings.com

© Press Release 2020