Sunday 30, April 2017 by Nabilah Annuar

Moody's affirms United Arab Bank's long-term deposit rating and revises outlook to negative

Moody's Investors Service has affirmed United Arab Bank PJSC (UAB)'s Baa2 long-term deposit ratings, its Prime-2 short-term deposit ratings, ba1 adjusted baseline credit assessment (BCA), ba1 BCA and Baa1(cr)/Prime-2(cr) Counterparty Risk Assessment. At the same time, Moody's has changed the outlook on the bank's long-term deposit ratings to negative from stable.

Moody's affirmation of UAB's Baa2 long-term deposit ratings, despite the bank incurring a loss and high provisioning charges during 2016, reflects the bank's still sound capitalisation, funding and liquidity, moderated by weak asset quality and profitability. The affirmation also reflects

Moody's continued assessment of a 'high' likelihood of government support in case of need.


The bank's sound funding and liquidity profile is supported by its deposit-funded balance sheet. The bank's market funds to tangible banking assets ratio decreased to 15.6 per cent at end-2016 (14.9 per cent in March 2017) from 17.2 per cent in 2015 (17.8 per cent UAE average) and its liquid banking assets to tangible banking assets ratio improved to 30.3 per cent at end-2016 (29.5 per cent in March 2017) from 27.5 per cent in 2015 (28 per cent UAE system average).


The affirmation also takes into account the 'high' likelihood of public support from UAE authorities in case of need, based on UAE's strong record of supporting banks in time of stress. This continues to provide two notches of uplift for the bank's Baa2 long-term deposit rating, from the ba1 BCA.


While UAB has over the last eighteen months made progress in winding down its high risk assets, Moody's in a statement has explained that the change in outlook to negative, from stable reflects: the downside risk of further asset quality deterioration, stemming from both its high-risk exposure to non-core small businesses and its concentrated exposure to core mid corporates; the potential for pressure on profitability resulting from high provisioning requirements and; potential pressure on capitalisation.


The primary driver of the negative outlook is the downside risk to UAB's already weakened asset quality, owing to its high-risk exposure to small businesses and its concentrated exposure to mid corporates, in a soft local operating environment. While we expect the bank to reduce further its stock of non-core legacy assets, there remains a risk, given the soft economy and the bank's concentrated core loan book, of core exposures currently classified as performing migrating to non-performing loans. UAB's problem loans to gross loans ratio stood at 5.6 per cent at end-March 2017 up from 4.6 per cent at 2015 year-end, and comparing unfavourably with the 5.1 per cent local average and the 3.2 per cent ba1 global median.


The second driver underpinning the negative outlook is the potential for further pressure on UAB's profitability, which could arise from further high levels of provisioning and a decline in operating income. While the bank has returned to profit during the first quarter of 2017, we expect its profitability to remain weak over the next eighteen months, stemming from continued restructuring and provisioning charges from the non-core unit, combined with a moderate growth in the new target core business. Provisioning charges consumed 207 per cent of pre-provision income in 2016 (67 per cent during Q1 2017), compared to 126 per cent in 2015. The speed and cost of running off high-risk assets while originating lower risk new business will be an important driver of the firm wide profitability.


The third driver of the negative outlook is the downside risk on UAB's capitalisation metrics that could materialise due to continued weak profitability. The bank's tangible common equity to RWAs ratio declined to 12.0 per cent in March 2017 (12.2 per cent as of end-2016) from 13.9 per cent as of end-2015, and is now lower than the 13.8 per cent local average and the 12.8 per cent ba1 global median. However, the bank's capital adequacy ratio of 13.2 per cent at end March 2017 remains above the local minimum regulatory threshold.


Upwards pressure on the ratings of UAB is limited the negative outlook on its rating. A significant reduction in the risk profile, combined with an increase in capital buffers and a substantial and sustainable improvement in the core profitability could lead to a stabilisation of the ratings.


Downwards pressure on the bank's ratings could materialise from a further deterioration of asset quality metrics and/or a further weakening of the capitalisation buffers and/or a material weakening in the bank's funding and liquidity profile.


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