Fitch Ratings has affirmed UAE-based Commercial Bank of Dubai’s (CBD) long-term issuer default rating (IDR) at A- with a stable outlook, and viability rating (VR) at bb+.
CBD’s IDRs, Support Rating and Support Rating Floor reflect the extremely high probability of support available to the bank from the UAE authorities if needed. Fitch’s opinion of support is based on the ability and willingness of the UAE Federal Authorities to support CBD given the bank’s systemic importance.
Fitch has also considered the authorities’ strong track record of support for the domestic banking system particularly since the global financial crisis, including the provision of significant liquidity support.
CBD’s IDRs, Support Rating and Support Rating Floor are sensitive to a change in Fitch’s view of the propensity or ability of the UAE authorities to provide timely support.
The VR reflects CBD’s strong capitalisation and consistent performance through the crisis. The key constraints on the rating are the bank’s high NPL ratio and only adequate reserve coverage, as well as its high exposure to past due and restructured loans. CBD remains sensitive to event risk through sizeable loan concentrations. Balance sheet liquidity is also a rating constraint, given the bank’s elevated Fitch calculated loans/deposit ratio.
Downside pressure on the VR could result from persistent weaker asset quality trends, including a rising problem loan balance (a combination of NPLs, restructured loans and past due loans) and lower reserve coverage. Further tightening in balance sheet liquidity indicators could also trigger a downgrade, particularly as its Fitch calculated loans/deposits ratio is high (end-9M12: 111%). The lack of progress in CBD’s diversification strategies and its continuing reliance on a niche segment, leading to modest performance ratios over time, could also be rating negative.
CBD reported a small decline in 9M12 net income, down 5% yoy, reflecting fewer lending and business opportunities in the private sector. However, margins remain strong due to its niche focus on family-owned business groups in the UAE, preference towards short-term lending and good access to low cost funding. Furthermore, CBD continues to derive strong non-interest earnings from mainly trade finance and transaction banking, which to some degree offsets pressure on lower interest income generation.
Rising loan impairment charges continue to constrain the bottom line, although the bank has demonstrated good loss absorption capacity through healthy pre-impairment operating earnings. Fitch expects modest revenue and profit growth given the still challenging operating environment in Dubai, despite current signs of modest real GDP growth.
Fitch remains cautious about CBD’s future asset quality and believes that problem loans are unlikely to peak in 2012. Its high NPL ratio (end-9M12: 9.6%) and only adequate, albeit improving, reserve coverage (end-9M12: 76.8%) are negative rating factors. Borrower and sector concentrations in lending also pose a moderate risk at present, but one that in Fitch’s view has to be monitored closely.
Mitigating credit risk is CBD’s strong capitalisation, a key factor underpinning its VR. CBD’s Fitch core capital ratio of 19.3% at end-9M12, is high compared with peers and provides a good buffer against concentration risk and any potential sharp rise in NPLs.