Moody's upgrades DIB's long-term issuer ratings to A3 from Baa1; outlook stable
Moody's Investors Service has upgraded Dubai Islamic Bank’s (DIB) local and foreign currency long-term issuer ratings to A3 from Baa1 and also upgraded its baseline credit assessment (BCA) and adjusted BCA to ba2 from ba3. At the same time, the long and short-term Counterparty Risk Assessment has been upgraded to A2 (cr) from A3 (cr) and P-1(cr) from P-2(cr) respectively.
The outlook on the bank's long-term issuer ratings has been changed to stable from positive.
The upgrade of DIB's BCA reflects: 1) significantly improved asset quality and provisioning coverage; 2) solid and improving profitability, driven by the bank's strong Islamic franchise and lower impairments and; 3) sound capitalisation and liquidity.
The upgrade of DIB's issuer rating takes into account the higher BCA and rating agency's continued expectation of a very high level of support from the United Arab Emirates (UAE) government (Aa2, stable outlook).
Improved asset quality and provision coverage levels
The primary driver for the BCA upgrade is the bank's significant improvement in its asset quality and provisioning coverage, despite challenges in the operating environment owing to low oil prices. The bank's non-performing financing (NPF) ratio (incorporating Moody's adjustments) of 3.7 per cent as of June 2017 has improved significantly in recent years, down from 14.7 per cent as of December 2012. This compares favorably to the five per cent UAE average and is broadly in line with the 3.6 per cent median of Moody's rated banks with ba2 BCAs.
The peak in the NPF ratio was driven by the bank's exposure to the real estate and contracting sectors. This has been significantly reduced, from around 37 per cent of its overall financing book as of December 2008 to 16 per cent as of December 2016 and the rating agency expects this trend to continue.
As with other UAE banks, the improvements in the NPF ratio reflect settlements, recoveries and re-classifications of legacy restructured exposures, following a sustainable period of repayment performance. This is combined with solid financing growth that has given rise to a significant denominator effect.
Although Moody's expects asset quality pressures in the small and medium-sized (SME) companies and retail (loans to individuals) sectors for UAE banks, the rating agency nevertheless expects DIB's asset quality to remain solid owing to a diversified financing book (including a higher proportion of financing to individuals at 32 per cent of the total financing book vs 13 per cent UAE average), combined with ongoing improvements in risk management and controls.
The upgrade also captures DIB's improving profitability in recent years, with return on assets (ROA) improving to two per cent for 2016 (stable during the first six months of 2017), up from 1.4 per cent for 2013. Such profitability metrics compare favorably to the 1.5 per cent UAE average and 0.9 per cent global median of ba2 peers. The bank's relatively high profitability is driven by its strong Islamic franchise, yielding higher net profit margins (analogous to net interest margin) at 2.6 per cent. The improvement is driven by a substantial reduction in the bank's provisioning charges, which absorbed 17 per cent of pre-provision income in the first half of 2017, down from 36 per cent in 2013. Going forward, the rating agency expects that the bank's net profitability may face modest pressure, due to increased funding costs, but that it will remain above the domestic average and global median.
Sound capital and liquidity
The bank has also maintained solid capitalisation, as exhibited by tangible common equity to risk weighted assets at 11.5 per cent as of June 2017. Additionally, the bank has built capital buffers through Additional Tier1 Sukuk issuances which represent around 3.8 per cent of total assets. Financing growth has been exerting pressure on the bank's capitalisation, driving the need to raise funding through a rights issue and senior Sukuk issuance during 2016 and 2017. Going forward Moody's expects pressure on capital to continue, albeit more slowly, as credit growth is expected to slow down for DIB in the current low oil price environment, while remaining higher than the UAE average.
The bank's BCA is also supported by its liquidity and funding profile, which despite high financing growth remains solid. The bank's liquid assets to total assets ratio is 21.7 per cent lower than the UAE average, however, the net financing to deposit ratio at 88.8 per cent is relatively low. Such solid metrics are driven by the bank's strong retail Islamic franchise, supporting a strong deposit growth of an average around 16 per cent for last three years.
Continuous strong government support
The upgrade of DIB's long-term issuer ratings to A3 from Baa1 also takes into account Moody's continued view of a very high likelihood of support from the UAE Government (Aa2, stable outlook), translating into five notches of uplift from the ba2 BCA. Moody's bases this view on: 1) the bank's systemic importance within the UAE banking system as the fourth largest bank in the country as well as its dominant flagship Islamic franchise (oldest Islamic bank in the UAE); 2) DIB's 30 per cent Dubai government and related entities ownership and; 3) a strong track record of the UAE authorities supporting all banks in the past.
The senior unsecured ratings assigned to DIB Sukuk have also been upgraded to A3 from Baa1 as these ratings are aligned with the DIB's long term issuer rating.
The stable outlook reflects Moody's view that DIB's financial fundamentals, in particular asset quality and profitability, are expected to remain at their current levels.
Upward pressure on DIB's ratings could develop from a combination of: 1) further improvements in asset quality; 2) improving capitalisation and profitability and; 3) a significant reduction in borrower and sector concentration, particularly with regards to real estate.
Downward pressure on DIB's ratings could develop from; 1) a weakening of asset quality; 2) a reduction in size and profitability of the retail franchise and; 3) weaker liquidity and capital.