The outlook for Bahraini banks remains strong while their profitability levels this year will be broadly in line with the previous year, thanks to a benign operating environment and higher petrodollar inflows, Fitch Ratings said in its latest report on the country's banking sector.
High oil prices have facilitated increased GCC government spending and rising levels of regional liquidity resulting in robust demand for credit, which Bahraini banks have benefited from.
The report forecast outlook for retail banks Ahli United Bank (AUB), National Bank of Bahrain (NBB) and Bank of Bahrain and Kuwait (BBK) will remain positive as their prospects are closely linked to the local and regional markets.
The rating agency said in its annual report the performance of the Bahraini banking sector in 2007 benefited from its buoyant operating environment, reflected in an estimated real GDP growth of seven per cent.
However, Fitch warned that threats to the economy could arise from rapid loan growth, a possible regional property market bubble, inflation, and pressure on regional currency pegs. It said the main risk to the Bahraini economy would be a sharp decline in oil prices, but the rating agency does not expect this to happen in the medium term. Sustained high oil prices are likely to result in further liquidity inflows into the banking system.
Fitch said growth of banks would be constrained due to the relatively small Bahraini market. Fitch warned that like other GCC states, Bahrain is over-banked and a number of new licences have been granted, increasing competition. "This is likely to put pressure on profitability and market share. While AUB's recent acquisitions in Egypt and Oman require further integration into the group, it has a good track record in this field."
The report said the operating environment for Arab Banking Corporation (ABC) and Gulf International Bank (GIB) remains positive, on the back of increasing government spending on infrastructure and rising capital markets activity.
However, ABC and GIB are likely to go through a period of retrenchment and strategic review.
GIB's performance has also been impacted by turmoil in the structured credit markets. In 2007, the bank incurred $966m (Dh3.5bn) impairment charges for structured investment vehicles (SIVs) and collateralised debt obligations (CDO) investments, as well as a $87m trading loss largely from its UK subsidiary, resulting in the bank reporting an operating loss of $758m.
ABC reported a 59 per cent decline in operating profits in 2007. Given adverse market conditions, further write-downs for structured credit investments are possible but are not expected to be as large as those already incurred, Fitch said.
The rating agency said ABC and GIB – as the largest GCC casualties of the global credit crisis – remain fragile, and their exceptionally large losses are likely to cause significant concern about their franchises, profitability, funding and prospects.
Fitch stated the level of operating profitability for Bahraini banks was volatile in the first quarter of 2008 and 2007. AUB reported healthy growth in operating profits of 37 per cent and impairment charges for investment securities. Investments in structured finance were $32m in 2007, or a low eight per cent of 2007 pre-impairment operating profit.
NBB reported 13 per cent growth in operating profits in 2007, underpinned by loan growth and consistently low impairment charges.
BBK incurred a 29 per cent drop in operating profits in 2007 as it needed $64m impairment charges for investment securities, largely SIVs. This was mitigated by $15m income from the sale of certain long-term equity investments, which had greatly appreciated in value, and $16m one-off non-operating income from the sale of a land investment.
The report said the asset quality ratios continue to improve and remain satisfactory at most banks, though these ratios are flattened by rapid loan growth.
Loan growth was particularly rapid at GIB (55 per cent), but the bank expects future loan growth to be slower in the medium term. ABC also reported rapid loan growth in 2007 of 43 per cent. Both NBB and BBK reported lower levels of loan growth (20 per cent), while AUB's higher (36 per cent) loan growth is somewhat distorted by the first-time consolidation of subsidiaries.
Growth in loans was primarily in the corporate book and was driven by increasing activity in project finance, trading, petrochemicals and energy sectors. Government and public sector credit demand also remained strong, but has been falling as a share of many banks' loan books in recent years.
However, compared internationally, due to the relatively undiversified nature of the regional economy and the relatively small size of Bahraini banks, substantial concentrations are typical in loan books.
NBB has strong asset quality, reflected in the bank not requiring a net loan impairment charge in 2005-2007, its long-standing relationships with large local corporates and public sector entities, and leading market share, allow it to maintain a conservative risk profile. Despite AUB's international activities, which expose it to some additional risks, the bank also appears to have good credit risk control.
BBK has a weaker impaired loans/gross loans ratio (5.7 per cent) but its impaired loans are overstated. This is because loans are typically only written-off as a last resort due to the perceived negative impact this might have on future court action, as well as onerous regulation. A large proportion of BBK's end-2007 impaired loans were fully reserved pre-1991 Iraqi invasion loans in Kuwait.
The wholesale banks held substantial investment portfolios primarily for liquidity purposes, given their restriction to wholesale funding and longer term project finance lending.
Fitch said Bahraini retail banks maintain fairly liquid balance sheets, with liquidity typically placed in GCC Government securities and interbank placements. Most of their funding comes from customer deposits, which have historically tended to be relatively stable, even during times of crisis such as the recent Iraqi war.
Nevertheless, liquidity weakened somewhat at AUB in 2007, as loan growth out-paced growth in deposits and some longer-term funding matured. Furthermore, turmoil in international credit markets has left ABC and GIB with substantial structured credit and debt securities rendered illiquid by adverse market conditions, though these banks are able to repo much of their investment portfolios if necessary.
Net interest margins of Bahraini banks were broadly stable in 2007 and were not significantly negatively affected by the global credit crisis through higher funding costs, though net interest margins declined slightly at some banks.
The CBB discount rate was reduced in 2007 in line with US Fed interest rate cuts and is expected to move in step with US dollar rates.
Banks with domestic retail franchises have benefited from increasing demand for consumer credit, which tends to be wider-margin than the more competitive wholesale sector, as with BBK and NBB.
Retail banks have gained from increasing demand for credit cards and mortgages. BBK and NBB also benefited from large local retail deposits market shares, giving access to relatively inexpensive and stable funding and thus supporting these banks' net interest margins.
AUB's net interest margin is lower than the other retail banks', partly due to higher costs from capital markets funding. AUB's margins were affected to a lesser extent by the first-time consolidation of its Kuwaiti brokerage subsidiary in 2007, following an increase in its overall stake to 63 per cent from 48 per cent during the year.
ABC's net interest margin declined in 2007, partly due to the cost of its $500m dated subordinated debt issuance in the second quarter of 2008, but ABC may also have been affected by somewhat higher funding costs due to the credit crisis.
Despite problems from its structured credit-related investments, GIB's net interest margin rose slightly in 2007. Nevertheless, both ABC and GIB earn relatively thin margins from the largest part of their loan books, GCC project finance deals, where competitive pressure is strong and likely to continue from foreign banks operating in the GCC and focusing on the top end of the market.