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Fitch Downgrades Arab Bank; Affirms 2 Jordanian Banks; Outlook Negative
March 9, 2017 / 3:02 PM / 6 months ago

Fitch Downgrades Arab Bank; Affirms 2 Jordanian Banks; Outlook Negative

(The following statement was released by the rating agency) DUBAI, March 09 (Fitch) Fitch Ratings has downgraded Arab Bank Plc's (Arab Bank) Long-term Issuer Default Ratings (IDRs) to 'BB+' from 'BBB-' and affirmed Jordan Islamic Bank's (JIB) and Bank of Jordan's (BOJ) Long-Term IDRs at 'BB-'. The Rating Outlook is Negative for all three banks. The downgrade of Arab Bank reflects the increased indebtedness of the Jordanian Sovereign, where it is domiciled and where a substantial portion of its local currency liquidity is placed. The downgrade also reflects increased risks in MENA markets where Arab Bank holds large assets; specifically Saudi Arabia, Tunisia, Bahrain and Lebanon have seen a downgrade from Fitch in the last 12 months. A full list of rating actions is available at the end of this commentary. KEY RATING DRIVERS IDRS AND VRS The operating environment in Jordan remains difficult due to sluggish growth, the significant influx of Syrian refugees, which is putting pressure on the country's resources, and disrupted trade routes with Iraq, one of Jordan's main export markets. Tourism has also been affected by the regional turmoil. We do not expect the operating environment to deteriorate, but it is likely to remain challenging given regional instability and the sovereign's weak financial flexibility. Our view on the operating environment also considers the rising government debt trajectory, external financing vulnerabilities and vulnerabilities to shocks. Both JIB's and BOJ's IDRs are driven by the respective banks' intrinsic strength, as indicated by the Viability Ratings (VRs). As both BOJ and JIB are essentially domestic banks, their ratings and Outlook are constrained by the difficult operating environment in Jordan and increasing indebtedness of the sovereign. The ratings of JIB and BOJ reflect asset quality risks, which are mainly driven by the banks' concentrated exposure to the Jordanian operating environment - where lending/financing and funding is mainly domestic and banks have large lending concentrations to the government or government-guaranteed entities. The ratings also take into account both banks' well-established domestic franchises, solid funding bases, adequate capitalisation and sound liquidity. The ratings further reflect the banks' healthy profitability. Both banks have a long track record of solid profit generation. Both banks have a solid and diversified deposit base. Accordingly, deposit concentration is low. Highly liquid assets, consisting of cash and interbank placements and sovereign securities, covered 25% of JIB's customer deposits and 51% of BOJ's at end-3Q16. JIB has a small short term investment portfolio due to limited sharia-compliant investment opportunities. However, in 2016, the sovereign issued JOD75 million for financing the National Electric Power Company (NEPCO), which paves the way for the emergence of a local sukuk market. Asset quality indicators remain adequate, due to both banks maintaining conservative risk appetites and longstanding relationships with customers. JIB's impaired financing represented an acceptable 4.5% of gross financing at end-3Q16. Reserve coverage remained at an adequate 78%, which excludes investment risk fund reserves (as per Central Bank of Jordan (CBJ) regulations, Islamic banks deduct at least10% of their total jointly income to build their investment risk funds to cover losses related to each bank's financing and investment books). When adding the investment risk fund to JIB's specific reserves, coverage was 95% at end-3Q16. We believe both banks have adequate capitalisation in light of their risk profiles and simple business models. The Fitch Core Capital (FCC) ratio for JIB stood at 22% at end-3Q16 and BOJ's was 23% at end-2016. However, we believe JIB's risk-weighted assets (RWAs) and capital ratios benefit from the application of the alpha factor as per CBJ regulations for Islamic banks. JIB applies an alpha factor of 30% when calculating credit RWAs that are funded by unrestricted investment accounts (URIA deposits). This means only 70% of the bank's credit RWAs that are financed by URIA deposits feed into the bank's regulatory RWAs calculation. As such, while JIB's regulatory capital ratios are strong, its equity to assets ratio is significantly lower than peers, at only 8% at end-3Q16 (against 17.6% for BOJ at end-2016). Arab Bank's IDRs are also driven by the bank's standalone strength, as indicated by its VR. The ratings reflect the bank's geographic diversification, with notable operations (branches, subsidiaries and affiliates) in the Gulf Cooperation Council (GCC), North Africa and Europe. The bank's operations in the GCC countries and outside the MENA region, and its holdings of liquid assets mainly in Europe (cash and bank deposits along with some high-quality investment securities), enable the bank to be rated higher than its peers in Jordan. The bank's geographic diversification, solid capital ratios, conservative overall risk appetite, stable funding profile, the structure of its network and affiliates, and large stock of liquid assets that could be used to repay the bank's creditors help mitigate risks to its credit profile associated with its domicile. Arab Bank's IDRs are linked to but not capped by Fitch's view of Jordanian sovereign risk. Fitch believes that the risk associated with parts of the bank's operations across the MENA region have increased, particularly in Saudi Arabia, Tunisia, Bahrain and Lebanon. Risk remains in operating in Jordan, especially with the sovereign becoming increasingly indebted, and in other weaker MENA markets (Egypt and Algeria) as the operating environment in these countries remains challenging. Asset quality is sound, with an impaired loans ratio of 6.7%, and reserve coverage of 112% at end-2016, and has been stable despite turbulence in the region. Impaired loans are largely formed of two large legacy exposures that are fully provided for. Profitability is strengthening mainly because of lower legal charges as the bank has already built adequate provisions against its legal case. In August 2015, Arab Bank decided to settle a long-standing US litigation case. The terms of the agreement remain confidential; however, the settlement agrees to cap the bank's liability to a specified amount and also prevents any future litigation for the same charge. Arab Bank has been building provisions against the legal case since 2011; these stood at USD1bn at end-2016. We expect the provisions to be sufficient and if the settlement amount ends up being slightly higher than the current provisions, it is not expected to materially impact the bank's credit profile. The Negative Outlook continues to reflect some residual risks to Arab Bank's credit profile arising from its domicile, operations in other MENA markets, and some remaining uncertainty about the final outcome of the litigation. SUPPORT RATING AND SUPPORT RATING FLOOR Arab Bank's Support Rating of '5' and Support Rating Floor of 'No Floor' reflect Fitch's opinion that support from the Kingdom of Jordan, if required, is possible but cannot be relied upon given Arab Bank's size. The bank has several core shareholders, but it is difficult to assess their willingness and ability to provide support at all times. JIB's and BOJ's Support Ratings of '4' and Support rating Floor of 'B+' reflect the limited probability of support from the Jordanian sovereign due to constraints on its ability to provide it, although we believe willingness to provide support would be high as both banks are systemically important. In JIB's case, support from the bank's main shareholder, Al Baraka Banking Group, is possible, but is not factored into the ratings. RATING SENSITIVITIES IDRS AND VRS An adverse change in Fitch's assessment of Arab Bank's ability to offset sovereign-related risks (eg banking sector intervention risk or transfer and convertibility risk), an increase in economic and political risks in Jordan or the broader MENA region, or a material increase in indebtedness of the Jordanian sovereign could result in downward pressure on the bank's VR and IDRs. In addition, a change in the bank's allocation of assets leading to an increase in the exposure to weaker, lower-rated, sovereigns relative to equity would also be negative for the ratings. Should the final outcome of the settlement have a material negative impact on the bank's capital ratios or should the litigation negatively affect the franchise and reputation of the bank, the ratings could be downgraded. However, Fitch believes this is unlikely. JIB's and BOJ's VRs and IDRs are mainly sensitive to operating environment risks. Changes in Fitch's perception of risks relating to Jordan, in either direction, could affect the banks' ratings. Material deterioration in asset quality could have a negative impact on the banks' ratings. Upside depends mainly on material positive developments in the local economy, and an expansion of growth opportunities. SUPPORT RATING AND SUPPORT RATING FLOOR As Fitch does not factor in any support from the Jordanian sovereign to Arab Bank, the Support Rating and Support Rating Floor are at their lowest levels. Fitch does not expect these factors to change. JIB's and BOJ's Support Ratings and Support Rating Floors are sensitive to changes in Fitch's perception of the Jordanian sovereign's ability or willingness to support the banks. Fitch acknowledges that important differences between Islamic and conventional banks were considered in JIB's ratings. These factors include closer analysis of risk management, funding and liquidity, 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. The rating actions are as follows: Arab Bank Plc Long-Term IDR downgraded to 'BB+' from 'BBB-'; Outlook Negative Short-Term IDR downgraded to 'B' from 'F3' Viability Rating downgraded to 'bb+' from 'bbb-' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Jordan Islamic Bank Long-Term IDR affirmed at 'BB-'; Outlook Negative Short-Term IDR affirmed at 'B' Viability Rating affirmed at 'bb-' Support Rating affirmed at '4' Support Rating Floor affirmed at 'B+' Bank of Jordan Long-Term IDR affirmed at 'BB-'; Outlook Negative Short-Term IDR affirmed at 'B' Viability Rating affirmed at 'bb-' Support Rating affirmed at '4' Support Rating Floor affirmed at 'B+' Contact: Primary Analyst Redmond Ramsdale Senior Director +971 4 424 1202 Fitch Ratings Limited Al Thuraya Tower 1, Office 1805 and 1806 Media City, PO Box 502030, Dubai Secondary Analyst Zeinab Abdalla Associate Director +971 4 424 1210 Committee Chairperson Eric Dupont Senior Director +33 1 44 29 91 31 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. 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