1 FITCH AFFIRMS 5 UAE BANKS Fitch Ratings-Moscow/London-12 February 2018: Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of five UAE banks with Stable Outlooks. The agency also affirmed their Viability Ratings (VRs). A full list of rating actions is at the end of this commentary. KEY RATING DRIVERS IDRS, SUPPORT RATINGS AND SUPPORT RATING FLOORS The affirmation of First Abu Dhabi Bank's (FAB), Emirates NBD's (ENBD), Union National Bank's (UNB) and Abu Dhabi Commercial Bank's (ADCB) Long-Term IDRs, Support Ratings and Support Rating Floors (SRF) reflects the extremely high probability of support from the UAE authorities. Fitch's view of support reflects the sovereign's strong capacity to support the banking system, sustained by sovereign wealth funds and recurring revenue mostly from hydrocarbon production despite lower oil prices, and the moderate size of the UAE banking sector in relation to the country's GDP. Fitch also expects high willingness from the authorities to support the banking sector, which has been demonstrated by the UAE authorities' long track record of supporting domestic banks, as well as close ties with and part government ownership links to a number of banks. FAB, ADCB, UNB and ENBD all have Support Ratings of '1', reflecting the extremely high probability of state support. FAB's 'AA-' Support Rating Floor reflects the bank's flagship status in the UAE and Abu Dhabi in particular, at one notch above Abu Dhabi domestic systemically important banks' (D-SIB) Support Rating Floor of 'A+'. The other two Abu Dhabi banks - UNB and ADCB - are at the Abu Dhabi D-SIB Support Rating Floor of 'A+', reflecting their high systemic importance. Abu Dhabi banks' D-SIB Support Rating Floor is one notch higher than other UAE banks due to Abu Dhabi's superior financial flexibility. ENBD's Support Rating Floor of 'A+' is one notch above the UAE D-SIB Support Rating Floor of 'A', reflecting the bank's flagship status in the UAE, and Dubai in particular. The affirmation of HSBC Bank Middle East's (HBME) Long-Term IDR at 'AA-' and Support Rating at '1' reflects very strong potential institutional support from the parent, HSBC Holdings plc (HSBC, AA-/Stable). Fitch's view is based on HBME being a key and integral subsidiary of HSBC, where HBME is HSBC's wholly owned bank and important for its Middle East and North African operations. A high level of integration and common branding also provide strong motivation to support in case of need, in Fitch's view. DEBT RATINGS The existing senior unsecured programmes, the trust certificate issuance programme of FAB Sukuk Company Ltd and notes issued under these programmes are rated in line with the Long-or Short- Term IDRs of the banks. ENBD's and ADCB's (issued through ADCB Finance (Cayman) Limited spv) subordinated debt is notched off the respective banks' IDRs, as is common in the GCC, reflecting Fitch's view that the probability of sovereign support remains sufficiently strong to extend to the banks' subordinated notes. The one-notch difference reflects relative loss severity. VRs
2 All five banks' VRs reflect strong and resilient franchises, adequate capital positions and sound balance sheet liquidity. All banks report stable asset quality metrics, while asset quality issues (to differing extents) are viewed by Fitch as rating constraining factors for ENBD and ADCB's VR. FAB FAB's VR is underpinned by its leading domestic franchise (it accounted for 28% of banking assets at end-2017 and is the largest UAE bank), its flagship status in Abu Dhabi and its close links to the Abu Dhabi government. FAB was formed from the merger between National Bank of Abu Dhabi and First Gulf Bank on 2 April Fitch understands the integration of these two banks is ongoing and is expected to be fully completed by FAB's funding and liquidity profile is a rating strength. Customer deposits represented 70% of the bank's funding at end Given FAB's flagship status, state and public-sector companies maintain large accounts with it (at end-2017 these accounted for 39% of total deposits). Liquid assets (cash and equivalents, net short-term interbank and repo-able bonds) made up 21% of total assets, comfortably covering customer accounts by 36%. Impaired loans accounted for 3.6% of gross loans at end-2017 and were fully covered by loanloss reserves. Loans that were 90 days past due but not impaired (PDNI) and restructured loans made up a further 1.5%, giving a total problem loans ratio of 5.1% and total problem loans reserve coverage of 82%. Fitch views this coverage as reasonable as some problem loans are well covered by collateral with reasonable loan/values ratios. The Fitch Core Capital (FCC) ratio was a reasonable 14.7% at end The Tier 1 capital ratio was higher at 16.6% due to AED10.8 billion of hybrid capital that is not included in FCC. The Central Bank of UAE (CBUAE) considers FAB to be a D-SIB, applying an additional D-SIB capital requirement. The Tier 1 capital ratio should be a minimum of 10.5% and the total capital adequacy ratio (CAR) 12.5% at end-2017, over which FAB currently has comfortable cushions. FAB reported AED10.9 billion of net income in If this is adjusted for integration costs and amortisation of intangible assets (total balance was AED20 billion at end-2017) net income was higher at AED11.5 billion, which translated into a reasonable return on average equity (ROAE) of 11.5%. FAB's pre-impairment operating profit accounted for 4.1% of average loans, providing reasonable safety buffers over potential impairment losses. ENBD ENBD's VR is constrained by the bank's high but improving impaired loans ratio, moderate share of restructured loans and high loan concentration. The VR also reflects the bank's leading UAE franchise, improved profitability, strong customer base and healthy capital ratios. The impaired loans (including interest in suspense) ratio fell to 8.2% of gross loans at end-2017 from 18.6% at end-2013, partially due to recoveries, but also due to loan restructuring and reclassification back to performing. The total problem loans ratio (impaired (including interest in suspense), restructured and more than 90 days PDNI) accounted for about 13% of gross loans at end Impaired loans were fully covered by reserves. The total problem loans coverage ratio was weaker at 75%, but is still viewed by Fitch as reasonable. ENBD has substantial exposure to the Dubai government and related entities. At end-2017 the Dubai sovereign exposure represented 42% of gross loans, equal to 3.2x FCC. The FCC ratio was high at 16.7% at end The Tier 1 ratio was higher at 19.7% due to additional Tier 1 capital of AED9.5 billion. The total CAR was also healthy at 22%. ENBD is treated by the CBUAE as a D-SIB under its Basel III equivalent framework, therefore ENBD should comply with capital ratios increased by a D-SIB buffer (0.75% for 2017 and rising to 1.5% by 2019). Fitch believes ENBD has a comfortable capital cushion over CBUAE capital
3 requirements. However, this needs to be viewed in light of ENBD's capital ratios benefiting from the zero risk-weight applied to the loans to the Dubai government. ENBD is mainly funded by customer deposits, which represented about 80% of total funding at end The bank has a strong retail deposit franchise in the UAE, therefore its deposit base is more diversified than other local banks. The 20 largest deposits represented 19% of total customer deposits, lower than peers. ENBD's liquidity is adequate, with liquid assets accounting for 24% of total assets and covering deposits by a reasonable 34%. Net profitability is robust as assessed by ROAE of 18% in ADCB ADCB's VR is driven by the bank's solid franchise, experienced management, low level of impaired loans, stable capital ratios, good liquidity and performance metrics. However, the rating is constrained by significant name and sector concentration, high related-party lending (to the Abu Dhabi government) and undisclosed levels of restructured exposures. ADCB is the UAE's third-largest bank by loans and advances (11% market share) and has a wellestablished retail and corporate franchise. Impaired loans accounted for 2.1% of gross loans at end-2017, one of the lowest ratios among UAE banks. However, the bank does not disclose the exact amount of restructured loans and Fitch understands that these could be significant. The FCC ratio was a reasonable 14.1% at end The Basel III Tier 1 ratio was higher at 15.9% due to additional Tier 1 capital of AED4 billion, which Fitch does not include in FCC. The total CAR was a high 19.1% providing a reasonable buffer over the 11.75% regulatory minimum (being phased up to 13% by end-2019). This does not include any D-SIB buffers. Performance is robust, with ROAE of 16% in 2017 and annual pre-impairment operating profit equal to 3.6% of average gross loans. Revenue is reasonably diversified with non-interest income accounting for 25% of operating income. The bank was 76% funded by customer deposits at end These are highly concentrated by name but have historically been very sticky. The bank's wholesale funding repayment schedule is comfortable. ADCB keeps a sound cushion of liquid assets (Fitch estimates a total volume of AED61 billion at end-9m17), which represented 23% of total assets and covered customer deposits by 37%. UNB UNB's VR reflects strong capitalisation, stable profitability, adequate liquidity and a wellestablished franchise. The rating also considers moderate deterioration in asset quality and loan concentration. The impaired loans ratio increased to 4.2% at end-9m17 from 3.4% at end Restructured and more than 90 days PDNI loans made up a further 6%, resulting in a total problem loans ratio of 10.2%. Impaired loans were almost fully reserved, while coverage of total problem loans was weaker at 40%. The loan book is moderately concentrated, with the 20 largest loans accounting for 28% of total gross loans (1.2x of FCC) at end-9m17. Capitalisation remains very strong and adequate for UNB's risk profile. The FCC ratio was sound at 16.8% at end-9m17, the Tier 1 ratio was higher at 18.5% due to AED2 billion of additional Tier 1 securities held by the Abu Dhabi government, which Fitch does not include in FCC. The total CAR was 19.7%, providing a robust buffer over the regulatory minimum.
4 UNB's liquidity has slightly tightened since 2015 as assessed by its loans-to-deposits ratio, which increased to 96% at end-9m17 and UNB's ratio is currently above the peer average. Customer deposits constitute most of UNB's non-equity funding (87% at end-9m17). Concentration is high - the 20 largest deposits represent 52% of total customer deposits, but Fitch views most of these as sticky. The bank's cushion of liquid assets is comfortable at 23% of total assets. Due to tighter liquidity, UNB's cost of funding has increased by 70bp since 2015, but thanks to timely renegotiation of interest rates with borrowers, the net interest margin fell by only 40bp in 2017 and was reasonable at 2.8%. Pre-impairment operating profit was also reasonable at 3.3% of average loans (annualised) in 9M17; this comfortably covered loan impairment charges equal to 0.9% of average loans, resulting in a reasonable annualised ROAE of 11%. HBME HBME's VR benefits from a high level of integration of the bank with the HSBC group, such as management, staff, systems, branding and products. HBME shares the group risk-management culture and follows the same risk policies. The rating also reflects adequate capitalisation, lower than local banks related party lending, but high borrower concentration and a significant volume of restructured loans. The loan book is highly concentrated, with the 20 largest exposures accounting for 42% of gross loans at end-9m17 (2.3x FCC). The impaired loans ratio remained stable at 7.4% at end-9m17 despite a 9% decrease in the stock of impaired exposures as the gross loans balance decreased by 12% in the same period. Restructured exposures and more than 90 days PDNI exposures made up an additional 2.3% of gross loans at end-9m17, resulting in a total problem loans ratio of 9.7%. Reserve coverage is viewed by Fitch as reasonable - impaired loans were 82% covered, although coverage of total problem loans was weaker at 63%, but is still viewed by the agency as reasonable as most restructured exposures are currently performing under their renegotiated terms. HBME's FCC ratio improved to 13.6% at end-9m17 from 12.5% at end-2015 largely due to contraction of the loan book. The Tier 1 capital ratio was 14.1% and the total CAR was 17.8%. HBME has a reasonable capital buffer over its regulatory 12.5% CAR minimum for banks registered in the Dubai International Financial Centre (DIFC). Customer accounts made up 72% of HBME's liabilities at end-1h17. Thanks to HBME's strong retail and private banking franchise, current and saving accounts represent 76% of customer accounts and benefit the bank with a 0.5% cost of funding, which is the lowest among UAE banks. Deposit concentration is also low - the largest 20 deposits account for only 11% of total deposits. Despite low deposit concentration, the bank is conservative in liquidity management, keeping a comfortable cushion of liquid assets (37% of total assets, covering customer deposits by 58% at end-1h17). As a result of the bank's low and stable cost of funding and higher loan yields in the UAE, HBME's net interest margin improved to 3.1% in 1H17 from 2.7% in Annualised pre-impairment operating profit was good at 4.3% of average gross loans and ROAE was healthy at 14%. RATING SENSITIVITIES IDRS, SUPPORT RATINGS AND SUPPORT RATING FLOORS The banks' Support Ratings and Support Rating Floors are sensitive to a change in Fitch's view of the ability or willingness of the authorities to provide support, or a change in Fitch's view of support in the UAE. Given the still robust fiscal position of Abu Dhabi, and by extension the UAE, the authorities' strong track record of support for local banks and no plans for resolution legislation at this stage, downward pressure is currently low.
5 Any changes in HBME's IDR would be linked to that of HSBC or to a change in Fitch's expectation of HSBC's propensity to support its subsidiary. DEBT RATINGS A change in the banks' IDRs would ultimately lead to a change in the ratings of the unsecured bond and sukuk issuance programmes, the senior and subordinated notes rated under these programmes, as well as other senior or subordinated debt. VRs The banks' VRs could be downgraded if asset quality, profitability or capital metrics weaken significantly. FAB's VR could be downgraded if its risk appetite, strategy or business model place greater emphasis on high-risk customer segments, resulting in asset quality weakening. An upgrade of ENBD's VR could be possible if the bank works out the remaining impaired and restructured loans, and reduces its high concentration. ADCB's VR could be upgraded if its largest exposures balances reduce and lending concentrations decrease, or Fitch gets more colour on the level and quality of restructured exposures. Upside potential for UNB's VR is currently limited but could arise in the longer term from a reduction in concentration levels on both sides of the balance sheet and the repayment of restructured exposures. An upgrade of HBME's VR would require a consistent improvement in asset quality metrics. CRITERIA VARIATION (FAB, UNB, ADCB): Under Fitch's Global Bank Rating Criteria, Fitch's SRFs are based on the ability and propensity of the government to provide support. Within the UAE, Fitch assesses the potential for support at a federal level as Fitch believes that support would be forthcoming from the UAE authorities acting together. However, in respect of Abu Dhabi, Fitch has varied the criteria to reflect the superior financial flexibility of the Abu Dhabi authorities. As such, the SRFs for banks in Abu Dhabi are based on Fitch's assessment of the ability and propensity of the Abu Dhabi authorities to provide support in its own right. This results in a one-notch higher SRF for Abu Dhabi banks (compared with other UAE banks), and results in a one-notch higher rating for Abu Dhabi banks. First Abu Dhabi Bank: Long-Term IDR: affirmed at 'AA-'; Stable Outlook Short-Term IDR: affirmed at 'F1+' Viability Rating: affirmed at 'a-' Support Rating Floor: affirmed at 'AA-' EMTN programme: affirmed at 'AA-'/'F1+' ECP programme: affirmed at 'F1+' Senior unsecured debt: affirmed at 'AA-'/'F1+' FAB Sukuk Company Limited: Trust certificate issuance programme: affirmed at 'AA-'/'F1+' Emirates NBD: Long-Term IDR: affirmed at 'A+'; Stable Outlook Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'bb+'
6 Support Rating Floor: affirmed at 'A+' ECP programme: affirmed at 'F1' Senior unsecured notes: affirmed at 'A+'/'F1' Subordinated notes: affirmed at 'A' Senior unsecured programme: affirmed at 'A+'/'F1' Abu Dhabi Commercial Bank: Long-Term IDR: affirmed at 'A+', Stable Outlook Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'bb+' Support Rating Floor: affirmed at 'A+' ECP programme: affirmed at 'F1' ADCB Finance (Cayman) Limited: GMTN programme: affirmed at 'A+' Senior unsecured notes: affirmed at 'A+' Subordinated notes: affirmed at 'A' Union National Bank: Long-Term IDR: affirmed at 'A+'; Stable Outlook Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'bbb-' Support Rating Floor: affirmed at 'A+' EMTN programme: affirmed at 'A+'/'F1' Senior unsecured debt: affirmed at 'A+' HSBC Bank Middle East Long-Term IDR: affirmed at 'AA-', Stable Outlook Short-Term IDR: affirmed at 'F1+' Viability Rating: affirmed at 'bbb' EMTN programme and senior unsecured notes: affirmed at 'AA-'/'F1+' Contacts: Primary Analyst Anton Lopatin Director Fitch Ratings CIS Limited 26 Valovaya Street Moscow Secondary Analyst Nicolas Charreyron Analyst Committee Chairperson Eric Dupont Senior Director