AL RAJHI BANKING AND INVESTMENT CORPORATION
Fitch Ratings has affirmed
Fitch has also downgraded ARB's Short-Term IDR to 'F2' from 'F1' and affirmed the bank's Viability Rating (VR) at 'a-'.
The downgrade of ARB's Short-Term IDR to 'F2', which is the lower of two options mapping to a Long-Term IDR of 'A-' as per our bank rating criteria, reflects a weakening of the bank's funding and liquidity profile in line with the sector, as reflected by an increased cost of funding, a decreasing share of non-profit-bearing deposits and a higher financing/deposits ratio. This also incorporates our expectations that Saudi banks will continue to face tight liquidity conditions in the near term due to changes in how authorities redeploy liquidity in the economy and banks' strong growth plans over the near term, which should underpin demand for liquidity.
Key Rating Drivers
ARB's 'A-' Long-Term IDR is driven by its standalone credit profile, as captured in its 'a-' VR. Its 'F2' Short-Term IDR is the lower of two options mapping to a Long-Term IDR of 'A-' as per our bank rating criteria because the bank's funding and liquidity do not support an 'F1' Short-Term IDR.
ARB's VR is underpinned by a strong business profile, strong funding profile, healthy profitability and strong asset quality. It also reflects comfortable capitalisation and a favourable operating environment supported by high hydrocarbon prices.
ARB's National Rating is the highest in the sector, reflecting the bank's strongest retail franchise in the country and some of the sector's best financial metrics.
Favourable Operating Environment: High oil prices, reduced risks from the pandemic, the authorities' strategy to diversify the economy as part of Vision 2030, and solid GDP growth provide Saudi banks with solid business growth opportunities.
Strong Franchise and Business Model: ARB is the second-largest bank in
Fast Financing Growth to Moderate: ARB's risk profile benefits from its focus on low-risk mortgage financing, which the bank has been rapidly increasing in recent years, resulting in pressure on capital ratios. We expect financing growth to moderate to about 15% in 2023 (23% in 9M22, non-annualised).
Strong Asset Quality: ARB's Stage 3 financing ratio (end-3Q22: 0.8%) and total potential problem (Stage 2+3) financing ratio (end-3Q22: 2.5%) are consistently the best in the sector. Reserve coverage of stage 3 financing by total provisions was 189% at end-3Q22. We expect ARB's Stage 3 financing ratio to remain below 1% in 2023, flattered by fast growth.
Narrowed Margin, but Healthy Profitability: ARB's net financing margin decreased to 3.6% in 9M22 from 4.2% in 2021 due to a higher cost of funding. The financing book is mostly under fixed rates and long term (due to the focus on mortgages). At the same time, ARB's performance metrics are supported by good asset quality and strong cost efficiency. The annualised operating profit to risk-weighted asset ratio of 4% in 9M22 was the strongest among Fitch-rated Saudi banks and we forecast it will remain around the same level in 2023.
Comfortable Capitalisation: ARB's strong capital ratios are at the top end of the sector. The bank's common equity Tier 1 ratio increased to 17.1% at end-3Q22 from 16.5% at end-2021 as the bank did not pay dividends after 1H21, to support business growth. The bank's capitalisation is also supported by strong pre-impairment operating profitability (4.1% of average gross financing in 9M22, annualised). We expect the bank will grow in line with internal capital generation in 2023, so its capital ratios will be stable.
Strong Funding Profile; Liquidity Tightening: The share of non-profit-bearing deposits decreased to 68% at end-3Q22 from 91% at end-2019 on the back of liquidity tightening in the sector. However, it remains stronger than the sector average of 61%. The Fitch-calculated financing-to-deposit ratio increased to 102% at end-3Q22 from 82% over the same period as financing growth outpaced deposit growth. The regulatory loan to deposit ratio was lower at 88.4% at end-3Q22, compared with a 90% regulatory maximum.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A downgrade of ARB's Long-Term IDRs would be driven by a downgrade of the bank's VR. The VR could be downgraded if Fitch believes the operating environment has weakened significantly or if the bank's financial profile deteriorates.
ARB's National Rating is sensitive to a negative change in its Long-Term Local-Currency IDR and the bank's creditworthiness relative to other Saudi Arabian issuers'.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade of the bank's Long-Term IDRs would come from an upgrade of the VR, which is unlikely without a material improvement in the Saudi Arabian operating environment.
ARB's National Rating is sensitive to a positive change in its Long-Term Local-Currency IDR and the bank's creditworthiness relative to other Saudi Arabian issuers'.
OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS
The ratings of senior debt (sukuk) issued by ARB through
ARB's Government Support Rating (GSR) of 'bbb+' reflects potential support from the Saudi authorities and is in line with all other rated Saudi banks. The Saudi authorities have strong ability and willingness to provide support to domestic banks irrespective of size, franchise, funding structure and level of government ownership. High contagion risk among domestic banks is an added incentive for the state to provide support to any Saudi bank, if needed, to maintain market confidence and stability.
OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES
Sukuk ratings are sensitive to changes in ARB's Long-Term and Short-Term IDRs, to which these are aligned. The ratings may also be sensitive to adverse changes to the roles and obligations of ARB under the sukuk's structure and documents.
ARB's GSR is sensitive to changes in
VR ADJUSTMENTS
The business profile score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reasons: market position (positive) and business model (positive).
The asset quality score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: underwriting standards and growth (positive).
The earnings and profitability score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: earnings stability (positive).
The capitalisation and leverage score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: risk profile and business model (positive).
The funding and liquidity score of 'a-' has been assigned above the 'bbb' category implied score due to the following adjustment reason: deposit structure (positive).
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
ARB has an ESG Relevance Score of '4' for Governance. Islamic banks need to ensure compliance of their entire operations and activities with sharia principles and rules. This entails additional costs, processes, disclosures, regulations, reporting and sharia audit. This results in a Governance Structure relevance score of '4' (in contrast to a typical ESG relevance score of '3' for comparable conventional banks), which has a negative impact on the banks' credit profiles in combination with other factors.
ARB has an ESG Relevance Score of '3' for Exposure to Social Impact, in contrast to a typical ESG relevance score of '2' for comparable conventional banks. This reflects that Islamic banks have certain sharia limitations imbedded in their operations and obligations, although this only has a minimal credit impact on the entities.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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