(2018-10-08) Fitch Affirms National Bank of Egypt at 'B'; Outlook positive
Fitch Ratings-Paris/London-01 October 2018: Fitch Ratings has affirmed National Bank of Egypt's (NBE) Long-Term Issuer Default Rating (IDR) at 'B' with a Positive Outlook. Fitch has also affirmed National Bank of Egypt (UK) Ltd's (NBEUK) Long-Term IDR at 'B' with Positive Outlook and its Support Rating at '4'. NBEUK is a wholly owned subsidiary of NBE. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS IDRS, VR, NATIONAL RATINGS NBE's IDRs are driven by its 'b' Viability Rating (VR) and are underpinned by the potential support from the Egyptian authorities, in case of need. The Positive Outlook on NBE mirrors that on the Egyptian sovereign (see 'Fitch Affirms Egypt at 'B'; Outlook Positive dated 6 August 2018 at www.fitchratings.com). NBE's VR reflects the strong correlation between the bank's credit profile and that of the sovereign given the bank's sizeable holdings of Egyptian government debt (39% of total assets at end-2017) and significant lending to public sector companies (around 16% of total assets). The ratings also factor in the large loan concentrations and weak capitalisation. The ratings are supported by NBE's dominant market position (31% of sector assets) and solid funding franchise as well as improved asset quality metrics. The economic environment in Egypt has largely stabilised, supported by stronger GDP growth (Fitch forecasts real GDP to expand by 5.2% in 2018 and 5.5% in 2019), smaller current account deficit and a rebound in foreign currency (FC) reserves (to USD44 billion in July 2018 from USD19 billion in October 2016). Access to FC liquidity has improved in the market following the floatation of the Egyptian pound in November 2016. The Central Bank of Egypt (CBE) cut interest rates by 200bp in 2018 (following a cumulative 700bp increase from November 2016). However, economic activity is not expected to be strong enough to absorb the banks' excess liquidity. Accordingly, we expect government debt holdings to continue to represent 30-50% of banks' balance sheets. The banking sector average impaired loans ratio was a moderate 4.9 % at end-2017 with solid coverage of 99% by loan loss allowances. FC loans accounted for 37% of the total and were issued mainly to borrowers with FC proceeds. Asset concentration is the main risk for Egyptian banks, particularly given their sovereign debt investments. Solvency ratios came under pressure in 2016 following the Egyptian pound devaluation but improved by end-2017, supported by healthy internal capital generation and moderate increases in risk-weighted assets (RWAs). Capital ratios benefit from 0%-risk weights for local currency sovereign securities. The sector average leverage ratio improved to 6% at end-2017 from 4.8% at end-2016. NBE's asset quality metrics have been improving since 2012 as the bank has been cleaning its balance sheet from legacy impaired loans. The impaired loans ratio was 2% at end-2017, also helped by the loan book expansion, and reserve coverage strengthened to 259%, comparing well with peers. Capitalisation remains a rating weakness, in particular in light of large balance-sheet concentrations. The devaluation-driven rise in RWAs (by 128% between June 2016 and June 2017) caused the bank's Fitch Core Capital (FCC) ratio to fall to 6.7% at end-June 2017 from 11.3% at end-June 2016. In 2017 the CBE provided NBE with a EGP43 billion 10-year term loan qualifying as Tier 1 capital to boost its capital ratios. In return the bank bought 10-year Treasury bonds for an equivalent amount. We view the term loan as a liability for NBE that will need to be repaid and accordingly we do not consider this loan as equity or FCC. NBE's FCC ratio stood at 8.3% at end-2017 and its equity to assets ratio was only 4.1%, below rated peers. NBE's profitability in 2016-2017 was supported by high loan growth and relatively low loan impairment charges, while the bank increased its loan loss allowances in 2017 (to 5.2% of loans at end-2017 from 3.9% at end-June 2016) in preparation to IFRS 9. However, profitability remains highly dependent on the interest income generated by the sizeable government debt portfolio (on average, over 70% of interest income in 2016-2017). The weaker net interest margin of 2% in the six months ending December 2017 was attributable to higher funding costs due to issuance of the high-yielding (priced at 20% a year) 18 month certificate of deposits (CDs) in local currency. The cost to income ratio was 29% in December 2017, generally in line with the peer average. Operating return on average assets was moderate at around 1.8% in December 2017. NBE has a strong funding profile supported by its dominant domestic franchise and deposit market share (29%), in particular in the retail segment. The deposit base is well diversified, with the largest 20 deposits representing 10% of the total. The overall balance sheet is liquid with a loans- to-deposits ratio of 42% at end-2017. FC liquidity is relatively weaker with a FC loans-to- deposits ratio at a high 98% at end-2017 (sector average of 68%), although FC liquid assets (including FC T-bills and interbank placements) were sufficient to cover over 80% of the bank's FC deposits and interbank funding. NBE's 'AA(egy)' National Rating is also based on the bank's standalone financial strength and reflects its relative creditworthiness in Egypt. SUPPORT RATING AND SUPPORT RATING FLOOR In our view, the authorities would likely have a high propensity to support the bank in light of its high systemic importance. However, the ability to provide support is constrained by the state's still weak credit profile, as reflected in the 'B' sovereign rating. NBE is fully owned by the Egyptian government. NBE's Support Rating Floor is equalised with the Egyptian sovereign rating. SUBSIDIARY AND AFFILIATED COMPANY NBEUK's IDRs are equalised with those of its parent, NBE. We consider NBE would have a strong willingness to support NBEUK in case of need given the reputational damage that a NBEUK default would have on NBE, the role that NBEUK plays in the group, NBEUK's full ownership by NBE, as well as the common branding between the two banks. Nevertheless, NBE's ability to provide support is weak, as indicated by its 'B' IDR. NBEUK's businesses, including trade finance activities with Egyptian counterparties and servicing the UK's Egyptian community, are inherently dependent on NBE's franchise. In addition, most of NBEUK's funding is provided either by NBE or by Egyptian state entities. Hence, we have not assigned a VR to NBEUK. RATING SENSITIVITIES IDRS, VR AND NATIONAL RATINGS Given the high correlation between bank and sovereign risk, an upgrade of NBE's VR and IDRs is unlikely without a corresponding upgrade of Egypt's sovereign rating. Reduced lending concentration risks and better revenue diversification would be credit positive but on their own are unlikely to lead to an upgrade. Negative sovereign rating action would likely be mirrored by the bank's ratings, in particular if the rationale for the negative sovereign rating action was related to a deteriorating operating environment. Worsening asset quality, for instance from a large corporate default, ultimately affecting capitalisation could lead to a downgrade of the bank's VR. NBE's National Ratings are sensitive to any change in Fitch's view of the relative creditworthiness of the bank in Egypt. SUPPORT RATING AND SUPPORT RATING NBE's Support Rating and Support Rating Floor are primarily sensitive to a change in Egypt's ability to provide support as reflected in the sovereign rating, as we consider the sovereign's willingness to support domestic banks is, and will remain, strong. SUBSIDIARY AND AFFILIATED COMPANIES NBEUK's ratings are primarily sensitive to any change to NBE's ratings. NBEUK's ratings are also sensitive to our assessment of NBEUK being a core subsidiary of NBE. The rating actions are as follows: National Bank of Egypt Long-Term IDR: affirmed at 'B'; Outlook Positive Short-Term IDR: affirmed at 'B' National Long-Term Rating: affirmed at 'AA(egy)'; Outlook Stable National Short-Term Rating: affirmed at 'F1+(egy)' Viability Rating: affirmed at 'b' Support Rating: affirmed at '4' Support Rating Floor: affirmed at 'B' National Bank of Egypt (UK) Limited Long-Term IDR: affirmed at 'B'; Outlook Positive Short-Term IDR: affirmed at 'B' Support Rating: affirmed at '4'