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Moody's assigns A3/P-2 issuer rating to Sharjah Islamic Bank PJSC

June 30, 2014

Moody's Investors Service has today assigned to Sharjah Islamic Bank PJSC (SIB) issuer ratings of A3/Prime-2 and a standalone bank financial strength rating (BFSR) of D+, which is equivalent to a baseline credit assessment (BCA) of baa3. The long-term ratings and BFSR assigned to SIB carry a stable outlook.

Moody's rating assignment reflects SIB's (1) very strong capital buffers, (2) relatively low borrower and sector concentrations, which reduce vulnerability to event risk and (3) satisfactory profitability and liquidity metrics. These strengths are moderated by SIB's (1) relatively weak, although improving, asset quality and coverage metrics.

"Moody's assessment of Sharjah Islamic Bank's franchise takes into account the growing importance of Islamic finance and associated franchise opportunities in the United Arab Emirates (UAE)", commented Khalid Ferdous Howladar, Global Head of Islamic Finance at Moody's Investors Service.

"Sharjah Islamic Bank's baa3 standalone credit profile is driven by its sound financial fundamentals particularly very strong capital buffers" notes Nitish Bhojnagarwala, Local Market Analyst for Sharjah Islamic Bank. "The final A3 issuer rating benefits from a three-notch uplift from the standalone profile due to our assumptions regarding the high level of systemic support from UAE authorities in case of need."

SIB is a small (around one per cent market share in terms of total assets) but growing Islamic franchise particularly in the emirate of Sharjah. Although the bank grew in line with the market (CAGR of around eight per cent) until 2012, the bank has grown faster than the market in 2013 (19 per cent total assets growth vs. UAE average of around 13 per cent) albeit from a small base. The bank's franchise growth is supported by its strong presence in the emirate of Sharjah where it has the largest branch network with 21 branches (of the total 28 branches). Moody's expect the bank to continue to grow its balance sheet in its home market in addition to increasing focus in the other emirates (Dubai & Abu Dhabi).

A key driver of Moody's assessment is SIB's extremely strong capital position. Despite low profit retention (around 78 per cent dividend payout rate in 2013) combined with high asset growth, the bank's Tier 1 ratio (under Basel II standards) stood at around 31 per cent as of December 2013 (down from 34 per cent as of December 2012). Although the bank's capital levels are declining, the Tier 1 ratio remains amongst the highest in the GCC and 2.5 times the 12 per cent median of global banks with baa3 BCAs. Even under our 'adverse' scenario analysis (a low probability event) which assumes a protracted global recession leading to weak global demand and trade flows coupled with a sustained drop in oil prices, the bank's capital levels remain among the highest in the GCC and significantly higher than the global median.

Such strong capital levels are driven by a capital increase exercise concluded by the bank in April 2008 in anticipation of growth, which doubled their share capital to AED2 .2 billion from AED 1.1 billion. Going forward, Moody's expect the capital levels to incrementally decline as the bank continues to grow and pay high dividends, yet still remain more than 20 per cent (Tier 1 capital) for the next 12-18 months and compare favourably to global and local averages.

SIB's borrower and sector concentration levels are relatively low when compared to many of the banks in the region and the concentration levels reduce further when excluding the highly rated exposures. Such relatively low levels reduce the bank's vulnerability to event risk. In addition, like other GCC banks, SIB exhibits real estate sector concentrations – however the level is well below 100 per cent of Tier 1 capital (under Moody's sector classification) which compares favourably to most of its peers.  However, although SIB's real estate concentration levels are relatively low, they still contribute significantly (directly or indirectly) towards the bank's high levels of non-performing exposures.

SIB exhibits satisfactory profitability metrics with a net profit margin (analogous to net interest margin) of around 2.5 per cent (down from 2.9 per cent for 2012) which is lower than the UAE average of 2.8 per cent as of December 2013.

The declining trend in the bank's profitability is driven by margin compression due to increased competition in a low interest rate environment. As a result, the bank's pre-provision income and net income to risk weighted assets (RWAs) at 2.7 per cent and 2.2 per cent compares unfavourably to the 3.3 per cent and 2.3 per cent UAE average respectively. However such profitability metrics compare favourably to the global 2.6 per cent and 1.3 per cent medians of banks with baa3 BCAs respectively. Going forward, Moody's expect profitability metrics to broadly remain stable at these levels.

SIB's liquidity position is comfortable with liquid assets to total assets at around 25 per cent. However such levels compare unfavourably to 30 per cent UAE average and 32 per cent median of global banks with baa3 BCAs. Similarly, the bank's net financing-to-deposit ratio (analogous to loans-to-deposits) at 105 per cent compares unfavourably to the local averages and global medians. The bank also has a relatively higher proportion of capital market funding around 15 per cent of total assets compared to UAE average of less than five per cent. While such relatively high proportion of capital market funding improves the asset liability maturity mismatch prevalent at most GCC banks, it increases the net financing-to-deposit ratio and - as the bank continues to grow – Moody's expect these liquidity metrics to decline further.

Moody's assessment also recognises SIB's weak asset quality metrics as exhibited by the bank's non-performing financing (NPF: analogous to NPL ratio) ratio at nine per cent as of December 2013 down from the peak of 10.7 per cent as of December 2010. Such asset quality metrics - although in line with UAE averages - compare unfavourably to the 2.8 per cent median of global banks with baa3 BCAs. This elevated NPF ratio is largely driven by the bank's real estate related financings and the strategy of not writing-off impaired exposures due to the presence of collateral (generally real estate) which they tend to hold through the cycle with the expectation of eventual recoveries. Going forward, Moody's expect NPF levels to decline owing to (1) improvements in operating environment which will support settlements, write-offs and commercial restructurings and (2) asset growth (denominator effect).

The bank's loss coverage ratio at 29 per cent is also relatively weak compared to both local and global peers. However, SIB's solid buffers can absorb the uncovered amounts and still retain capital levels that are strong with respect to both global and local peers. Please note that Moody's considers all financing exposures which are overdue by more than 90 days as impaired for the calculation of NPF and coverage ratios. In addition, Moody's do not consider collateral in loss coverage calculations.

SIB's A3 issuer rating incorporates a high three notch uplift from its baa3 BCA. This reflects Moody's assessment of a high likelihood of systemic (government) support in case of need. Moody's base this view on (1) SIB's 31 per cent ownership by the Sharjah government (A3 rated by Moody's) and (2) the UAE's (Aa2 rated by Moody's) strong track record of supporting banks in times of stress.

Upward pressure on SIB's ratings could develop from a combination of the following: (1) a strengthening and diversification of its franchise and (2) a significant improvement in financial fundamentals, i.e. liquidity, capitalisation and asset quality.

Downwards pressure on SIB's ratings could develop from (i) an unexpected decline in capital levels or (ii) a further weakening of asset quality metrics or (iii) a significant increase in concentration levels increasing event risk.

As of March 2104, SIB reported total assets of around AED 22 billion (approximately $6 billion).

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Source: CPI Financial

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