Fitch Ratings has affirmed UAE-based Abu Dhabi Islamic Bank’s (ADIB) Long-Term Issuer Default Rating (IDR) at ‘A+’ with a Stable Outlook and Viability Rating (VR) at ‘bb’.
A full list of rating actions is below.
Fitch has withdrawn ADIB’s Support Rating and Support Rating Floor as they are no longer relevant to the agency’s coverage following the publication of our updated Bank Rating Criteria on 12 November 2021. In line with the updated criteria, we have assigned ADIB a Government Support Rating (GSR) of ‘a+’.
KEY RATING DRIVERS
IDRS AND GSR
ADIB’s IDRs and GSR reflect an extremely high probability of support available to the bank from the UAE and Abu Dhabi 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, despite lower oil prices. Fitch also expects a high willingness from the UAE authorities to support the banking sector. This has been demonstrated by their long record of supporting domestic banks, and is also underlined by the state’s close ties with and partial ownership of a number of lenders.
ADIB’s GSR is at the Abu Dhabi domestic systemically important banks’ (D-SIB) GSR of ‘a+’, reflecting the bank’s high systemic importance. ADIB has a 4% market share of total system assets. Abu Dhabi banks’ D-SIB GSR is one notch higher than other UAE banks’, due to Abu Dhabi’s superior financial flexibility.
ADIB’s Short-Term IDR of ‘F1’ is the lower of two options corresponding to an ‘A+’ Long-Term IDR, reflecting that a significant proportion of the UAE banking sector funding is related to the government and stress on banks is likely to come at a time when the sovereign itself is experiencing some form of stress.
SPV AND SENIOR DEBT
The ratings of ADIB’s senior unsecured sukuk programme, housed under a special purpose vehicle (SPV), ADIB Sukuk Company, are in line with the bank’s Long- and Short-Term IDRs because Fitch views the likelihood of default on any senior unsecured obligation as the same as that of the bank.
VR
The ‘bb’ VR of ADIB reflects its weak asset quality, low coverage of impaired financing, sizeable balance-sheet concentrations, strengthened, but only adequate, core capitalisation, adequate profitability and high related-party lending. The VR also considers the bank’s strong and resilient UAE-wide franchise, especially in Islamic retail banking, sound liquidity and stable funding. ADIB’s VR is one notch below the ‘bb+’ implied VR, due to the weakest-link adjustment, reflecting the key rating driver of asset quality assessed by Fitch at ‘bb’.
Fitch has revised its outlook on the UAE operating-environment score to stable from negative. The outlook revision reflects our view that pressures on the operating environment from the pandemic and lower oil prices have eased sufficiently, and that banks’ financial metrics have been resilient in the past quarters, despite these pressures.
ADIB has a solid retail deposit franchise. It is the second-largest UAE Islamic bank and the fourth-largest Islamic bank globally by total assets.
ADIB’s strong UAE-wide franchise is a funding-and-liquidity strength. Customer deposits accounted for 84% of the bank’s total funding base at end-1H21, including 76% of low-cost deposits, which have proven stable. Liquid assets account for 19% of total assets and cover 23% of total deposits. The 20- largest deposits represented 17% of the total at end-1H21, which is significant, but below concentration levels seen at other UAE banks.
The quality of ADIB’s financing book remains weak. It deteriorated in 2020, due to one-off large impairments and a difficult operating environment. Total problem financing, which includes Stage 2 and Stage 3 financing, remains high, at 19% of gross financing at end-1H21 (end-2020: 17%; end-2019: 13.6%). Coverage of impaired financing (56% at end-1H21) is well below large UAE peers’, and unreserved impaired financing represented a high 25% of common equity Tier 1 (CET1). The top 20 exposures represented a high 24% of total gross financing at end-1H21, although this is still lower than at most UAE banks.
Capitalisation is adequate with a CET1 ratio of 13.3% at end-1H21, up slightly from 12.9% at end-2020, due to moderate financing growth and healthy internal capital generation. The bank is compliant with the fully loaded (from 1 January 2019) CET1 minimum in the UAE of 9.5% (excluding the Targeted Support Scheme relaxation). The bank’s low financing growth plan should help preserve capital ratios.
Performance metrics remain acceptable and are starting to recover following the pandemic, supported by declining financing impairment charges (FICs). Return on average equity increased to 15.2% in 1H21 from 11.4% in 2020 as a result, and compares adequately with direct peers’. Profit margins are still compressed by low interest rates, intense competition on yield between banks and limited financing opportunities outside lower-yielding government financing. However, ADIB was able to release some high-cost time deposits to preserve margins. Financing loss allowances remain below that of peers and would hit profitability if they increase to similar levels.
In assessing ADIB’s ratings, we considered important differences between Islamic and conventional banks. These factors include closer analysis of 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.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
ADIB’s IDRs and GSR are sensitive to a negative change in Fitch’s view of the creditworthiness of the UAE and Abu Dhabi authorities and on their propensity to support the banking system or the bank. Negative rating action on the sovereign would trigger negative rating action on the bank’s IDRs.
Pressure on ADIB’s VR could result from deterioration in asset quality, particularly in the event of a sharp increase in total potential problem financing (Stage 2 and Stage 3 financing). Negative rating action on the VR could also come from a large increase in uncovered impaired assets eroding the bank’s capital buffers. A downgrade could also be triggered by sharp and sustained reduction in core capital ratios, as well as significant deterioration in profitability.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Given our existing view of the high creditworthiness of the UAE and high propensity to support the banking system and the bank, positive rating action on the bank’s Long-Term IDR is unlikely.
A sustained improvement in asset quality, concentration and capital ratios could lead to an upgrade of the VR but this is unlikely in the short term. Positive rating action could also result from a material decrease in problem financing and an improvement in the bank’s risk profile.
VR ADJUSTMENTS
The operating-environment score of ‘bbb’ has been assigned below the ‘aa’ category implied score for the UAE due the following adjustment reasons: size and structure of economy (negative), financial market development (negative), regulatory and legal framework (negative).
The earnings & profitability score of ‘bb+’ has been assigned below the ‘bbb’ category implied score, due to the following adjustment reason: earnings stability (negative).
The capitalisation & leverage score of ‘bb’ has been assigned below the ‘bbb’ category implied score, due to the following adjustment reason: reserve coverage and asset valuation (negative).
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
ADIB’s IDRs and GSR reflect an extremely high probability of support available to the bank from the UAE and Abu Dhabi authorities, if needed.
ESG CONSIDERATIONS
All 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 relevance influence score of ‘3’ for comparable conventional banks). This has a negative impact on the banks’ credit profiles and is relevant to the ratings in combination with other factors.
In addition, Islamic banks have an Exposure to Social Impacts ESG Relevance 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 embedded in their operations and obligations, although this only has a minimal credit impact on the entities.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores