Fitch Ratings says it is seeing a sharp increase in banks in the Gulf Cooperation Council (GCC) region looking to issue subordinated debt in the international markets. In this context, it is worth highlighting that Fitch’s ratings for GCC banks’ subordinated debt often factor in a high probability that sovereign support will be available for this debt class if and when required.
Fitch’s approach to rating banks’ regulatory Tier 2 capital qualifying securities in the six GCC countries (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) contrasts with the approach more commonly used in EMEA, where potential extraordinary sovereign support is excluded from the ratings.
In accordance with Fitch’s criteria ‘Assessing and Rating Bank Subordinated and Hybrid Securities’ dated 5 December 2012 at www.fitchratings.com, in most countries it is Fitch’s view that sovereign support, while possible, cannot be sufficiently relied upon to flow through to bank hybrids and subordinated securities. In most countries, Fitch believes the threat of resolution regimes (whether or not they are yet on the statute book), combined with the established concept of burden sharing in respect of regulatory capital securities, means that the likelihood of either full blown resolution or some form of distressed debt exchange has increased to such an extent that the non-performance risk of any subordinated debt should be linked to the issuer’s viability and hence be notched down from its Viability Rating (VR) as the starting assumption / anchor rating.
However, Fitch’s criteria recognise that in certain jurisdictions (such as the GCC) the likelihood of sovereign support remains sufficiently strong, at least for some issuers, for Fitch to continue to factor sovereign support into ratings of securities with gone-concern loss absorption features. In these cases the issuer’s Long-term Issuer Default Rating (IDR), which can be based on potential sovereign support, is used as the anchor rating.
Fitch does not assign generic subordinated debt ratings under programmes due to the variety and complexity of loss absorption features that may apply to specific issues, and subordinated debt issues are therefore rated on a case-by-case basis.
Typically Fitch rates GCC bank subordinated debt one notch below the Long-term IDR to reflect above average loss severity relative to senior debt. No additional notches for incremental non-performance risk are applied. The rating on the subordinated debt is therefore sensitive to any change in the issuer’s Long-term IDR and any change in Fitch’s assumption that extraordinary sovereign support will extend to subordinated debt. In the latter case, the anchor rating for notching purposes would become the bank’s VR, rather than it’s Long-term IDR, which could trigger a multiple notch downgrade of the subordinated debt.
At the present time, in Fitch’s opinion, GCC sovereigns are exceptional in terms of being highly supportive of their banking systems. This is reflected in the authorities’ strong track record of support, the high degree of state (or ruling family) ownership and influence in the banks, the strong hands-on control exercised by regulators, the absence in most countries of deposit insurance schemes, and the lack of reliance on tax-payer funds to support banks. It is likely that the degree of state ownership in each bank will influence the extent to which Fitch expects sovereign support to flow through subordinated debt.
The Tier 2 subordinated debt issued by GCC banks to date and rated by Fitch does not have any contractual loss absorption features at the point of non-viability and is not Basel III compliant. Furthermore, none of the GCC regulators have in place bail-in laws affecting subordinated debt. However, Fitch expects Basel III to be fully implemented in the GCC during the life of recent issuance. In such an event, Fitch’s base case is that the subordinated debt would probably be called (such as under a regulatory redemption clause in the documentation). If, however, the securities are subsequently subject to some form of retrospective statutory loss absorption e.g. ‘bail-in’ in a resolution regime, and the issuer does not/cannot redeem the securities, Fitch would consider this to be event risk and the issues would be likely to suffer a multiple notch downgrade.
Fitch is in discussion with central banks and rated banks in the GCC as to when Basel III guidelines will be fully implemented and how considerations around resolution and potential ‘bail-in’ (loss imposition on creditors) are developing in the region. Central banks have yet to issue specific guidelines on the treatment of hybrid issuance under Basel III and therefore it is difficult to predict how the central banks will treat subordinated debt already issued. Fitch will review its ratings approach to subordinated debt in the GCC region if and when any developments in the regulatory approach emerge that prompt it to do so.