Bank Rating Framework Presentation & A Brief Look Into GCC Banks - 2018

Timucin Engin

Senior Director, S&P Global

Ratings

Copyright © 2018 by S&P Global.

All rights reserved.

A very general overview of our analytical approach for bank credit ratings.

Given our time-constraints today. We will not:

- Discuss the detailed scoring of our sub-factors

- Discuss in depth our the financial ratios we look at

- Discuss all-applicable criteria used in bank ratings

At the end of our session, we will set aside 15mins to discuss the current

credit trends, strengths and challenges for the GCC banks.

If there is interest we can always organize a detailed seminar such as a half

a day or a full day seminar.

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What to expect in today’s session?

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S&P Global Ratings - Bank Ratings Framework

ALAC Support

introduced in 2015

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Banking Industry Country Risk Assessment (BICRA) – What is it and what it is not?

Designed to evaluate and compare global banking systems

Scored on a scale from 1 (lowest-risk) to 10 (highest-risk)

Covers rated & unrated financial institutions and incorporates influence

of government supervision & regulation

Based on a time horizon of 3 to 5 years

Divided into two components: "economic risk" and "industry risk“

BICRA IS NOT A RATING!

Main Factors in our BICRA Analysis

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Economic Risk Industry Risk

A. Economic resilience

• Economic Structure and stability

• Macroeconomic policy flexibility

• Political Risk

A. Institutional framework

• Banking regulation and supervision

• Regulatory track record

• Governance and transparency

B. Economic imbalances

• Private-sector credit growth

• Residential real estate prices

• Equity prices

• Current-account balance / external debt position

B. Competitive dynamics

• Risk appetite

• Industry stability

• Market distortions

C. Credit risk in the economy

• Private-sector debt capacity and leverage

• Lending and underwriting standards

• Payment culture and rule of law

• Sovereign government credit stress

C. System-wide funding

• Core customer deposits

• External funding

• Domestic debt capital markets

• Government role

Government Tendency To Support Banking System

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Governments support to financial institutions varies among countries and can

change over time.

The criteria assess the capacity and willingness of sovereigns to support failing

banks during a crisis and classify sovereigns into three groups:

o Highly supportive

o Supportive

o Uncertain

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Bank Ratings - Where does it fit in the methodology?

ALAC Support

introduced in 2015

Determining The Anchor From Economic Risk And Industry Risk

Industry

Risk

Economic Risk

1 2 3 4 5 6 7 8 9 10

1 a a a- bbb+ bbb+ bbb — — — —

2 a a- a- bbb+ bbb bbb bbb- —

3 a- a- bbb+ bbb+ bbb bbb- bbb- bb+ — —

4 bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb —

5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+

6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+

7 — bbb- bbb- bb+ bb+ bb bb bb- b+ b+

8 — — bb+ bb bb bb bb- bb- b+ b

9 — bb bb- bb- b+ b+ b+ b

10 — — b+ b+ b+ b b b-

Anchor for a domestic bank in ER 5/IR 5

The Anchor Matrix

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A bank is generally compared

with banks in its home country

Banks with similar industry risk

All banks globally

Banks with similar economic risk and product mix

Funding: banks in the country / Liquidity: All banks globally

From Anchor to SACP – stand-alone drivers

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Business Position Assessment

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Subfactor Scope Indicators

Business stability Stability or fragility of a

bank’s franchise

Revenue stability, market

shares, and customer base

Concentration and

diversity

Concentration and

diversification of business

activities

Contribution of different

business lines and

geographies to overall

revenues

Management and

corporate strategy

The quality of management,

strategy and corporate

governance

Strategic positioning,

operational effectiveness,

financial management,

governance & financial

policies.

Capital & Earnings Assessment

Regulatory Capital 1St step - How does the bank’s regulatory ratios

compare with the requirements? What are the trends?

Quality of capital &

earnings

3rd step - Analysis of other factors that determine the

overall quality of capital and earnings that were not

captured in the first two steps.

Earnings Capacity

Final Step – Does the bank’s earnings demonstrate the

capacity to absorb normalized losses through the credit

cycle?

Risk-Adjusted

Capital Ratio

2nd step – Assessing the capital using our strength

using our risk-adjusted capital framework methodology.

Calculation of the Risk-Adjusted Capital

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How does it impact the SACP?

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Borderline RAC (+/- 25 bps): the assessment can

be pushed up if the quality of capital is high; the

assessment could be puled down if the quality of

capital or earnings are low.

Risk Position Assessment

Growth & Changes

in Exposure

For ex: is the bank growing into higher risk asset

classes or new lending sectors / geographies where

they have limited experience?

Risk concentration

& risk

diversification

A look at the impact of risk concentrations or

diversifications; For ex: single-name, geography, asset

class concentrations

Complexity A look at additional risks associated with complexity. For

example excess use of derivatives, securitizations etc.

Risks not covered

by RACF

A comparison of past & expected losses with those of

peers

Loss Experience &

Expectations

For ex: legal risks, foreign exchange risk, interest rate

risk, maturity risk etc.

Most banks within a system will have an average funding assessment unless

they demonstrate features of below or above average assessment.

If a bank does not have access to a central bank's funding mechanism, the

funding assessment is limited to below average at best.

Funding and Liquidity Assessment (1)

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Funding - Quantitative

assessment

Funding - Qualitative

assessment

We use ratios such as loan-to-deposit ratio, long-

term funding ratio, stable funding ratio, reliance on

short-term wholesale funding, and overall funding

mix.

We assess funding concentrations, other factors

that provide funding advantage / disadvantage etc.

We score funding & liquidity assessments separately, then combine them to

reach a final assessment for this section.

We will cap a bank’s SACP at certain levels if a bank demonstrates weakness in

its liquidity.

Funding and Liquidity Assessment (2)

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Liquidity - assessment

We try to understand the bank’s ability to manage

its liquidity in different scenarios and tenors, we

also look at standard ratios such as the liquid

assets to wholesale funding, liquid assets to core

deposits etc.

Support can take the form of:

Government support to

systemically important banks

(SIBs)

Government support for banks

that are considered as

Government Related Entities

Parent support for banks that are

part of private sector groups

Additional Loss Absorbing Capital

(subject to thresholds).

Factoring support in the ICR

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ALAC Support

introduced in 2015

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# Expect GCC banks' financial profiles to stabilize from the second half of 2018.

# Key challenges: muted loan growth, higher cost of risk, and lower profitability.

# Average credit quality stabilized at BBB+, 2/3 of the outlooks are stable.

Source: S&P Global Ratings

GCC Banks – A Brief Look Into 2018 & 2019

Source: S&P Global Ratings

The story is not the same for all GCC countries

UAE Weak lending opportunities due to fiscal consolidation; asset quality weakness in

real estate, SME & retail; liquidity improved.

KSA Very limited loan growth; asset quality metrics holding up better than expected;

deployment of excess liquidity is the key challenge.

Qatar Significant outflows of foreign funds compensated by public deposit inflows; asset

quality under increasing pressure from real estate, hospitality and expat retail,.

Kuwait Better loan growth prospects backed by large infrastructure spending pipeline;

banks face generally limited pressure on credit losses locally.

Oman Large twin deficits eroding the government’s net asset position and hindering

macro prospects; relatively high debt burden of the households.

Bahrain Fiscal and external positions are key vulnerabilities; stagnation in loan growth;

high NPL & restructured loans in cyclical construction and commercial real estate.

Key challenges – (1) Muted loan growth

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# Lower economic growth means lower growth opportunities for GCC banks.

# Funding profiles improved, deployment of liquidity is the key challenge.

# We expect low-single digit loan growth in 2018.

Source: S&P Global Ratings, GCC central banks, average loan growth is for all GCC banks at the system level

0%

2%

4%

6%

8%

10%

12%

2011 2012 2013 2014 2015 2016 2017* 2018f 2019f

Average Loan Growth Average GDP GrowthC

Key challenges – (2) Higher cost of risk

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# NPL ratios will deteriorate in the next 6 months and then progressively stabilize.

# General provisions that GCC banks accumulated will help a smoothen IFRS 9 impact.

# Capitalization is strong and banks have capacity to absorb mild increase in losses.

Source: S&P Global Ratings, data is aggregate of rated GCC banks’, * September 2017

0%

20%

40%

60%

80%

100%

120%

140%

160%

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

5%

2011 2012 2013 2014 2015 2016 2017*

NPLs / Total Loans Cost of Risk Loan Loss Reserves / Total LoansC

Key challenges – (3) Lower profitability

# Weaker top line growth as banks are prioritizing quality over quantity.

# Operating costs are likely to increase because of the introduction of VAT.

# Cost of risk will continue to increase and stabilize at a higher level.

# Profitability will plateau but at a lower level than historically.

Source: S&P Global Ratings, data is aggregate of rated GCC banks’

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2011 2012 2013 2014 2015 2016 2017*

Return on Assets Net Interest MarginC

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Our underlying assumptions for 2018

GDP Growth We forecast a gradual rebound in economic activity starting in 2018.

Average GDP growth of around 2-3% for the GCC.

Oil Price We assume a degree of normalization in oil with an average of $60

per barrel (Brent) in 2018 and $55 in 2019.

Geopolitical Risk

A surge in geopolitical risk could severely affect our base-case

scenario with implications on growth prospects and asset quality.

• We believe that GCC banks' financial profiles will start stabilizing

from the second half of 2018, absent any materialization of

geopolitical risk.

Key takeaways

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• The three key risks that we foresee for GCC banks, in addition to

geopolitical risks, are muted loan growth, a higher cost of risk, and

lower profitability.

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• Most of our ratings on GCC banks carry a stable outlook. The

negative outlooks are on the Qatari banks--where the evolution of the

boycott will determine their future creditworthiness--as well as on a

few banks in other GCC countries due to idiosyncratic factors.

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