Jordan
Jordanian Banks: 2019 Peer Review Challenging Operating Environment Constrains Banks’ Ratings Special Report
Key Rating Drivers Rating Outlooks Stable Negative/RWN Positive/RWP Operating Environment Constrains Ratings: The Long-Term Issuer Default Ratings (IDRs)
(%) of Fitch-rated Jordanian banks are driven by their standalone credit profile, as defined by their 100 Viability Ratings (VR), which are correlated with and constrained by the Jordanian operating environment. 80
60 Arab Bank’s (AB) IDRs are constrained but not capped by Fitch’s view on Jordanian sovereign
40 risk. AB’s geographical diversification in the Gulf Cooperation Council (GCC) and outside the MENA region, as well as about half of its holdings of liquid assets in Europe and other highly 20 rated sovereigns could help to offset the impact of a sovereign crisis. Nevertheless, AB’s high 0 exposure to the Jordanian sovereign relative to its equity via holdings of government securities Current End-2018 offsets, to a degree, the benefits of its geographical diversification and weighs on its ratings. Source: Fitch Ratings Challenging Operating Environment: The operating environment suffers from below- potential GDP growth, elevated unemployment and a challenging regional environment. The Stable Outlook on the rated banks reflects our expectation that Jordan’s operating environment will be stable in the near term.
Resilient Asset-Quality Metrics: Jordanian banks’ asset-quality metrics have been well maintained through economic cycles, supported by the banks’ conservative risk appetites. The sector’s impaired loans ratio is declining (4.6% at end-1H18) as banks continue to clean up their balance sheets from legacy impaired loans. However, the ratio increased for some banks in 2018 as the implementation of IFRS 9 resulted in more conservative loan classification.
Healthy Profitability Despite Margin Pressure: Jordanian banks’ net interest margins (NIM) came under pressure in 2018 as a result of rising funding costs (due to tighter liquidity) and limited assets repricing ability (due to high competition). However, pre-impairment operating profitability remains healthy, providing banks with good buffers against deterioration in asset quality without hurting their capital base.
Adequate Capital Ratios: The sector average capital adequacy ratio was 17.2% at end-1H18, comfortably above the minimum regulatory requirement. We consider capitalisation to be only adequate given banks’ high loan book concentration and 0% risk weighting on local-currency sovereign debt and sovereign guaranteed exposures. IFRS 9 expected credit losses (ECL) charges had a manageable impact on most banks’ capital, ranging from 2%-5% of banks’ equity.
Funding and Liquidity Strength: Banks continue to demonstrate strong funding profiles Analysts underpinned by large and granular retail deposits. The sector’s loans/deposits ratio remains Zeinab Abdalla healthy at below 80%. Banks maintain a comfortable stock of liquid assets, including interbank +971 4 424 1210 [email protected] placements, cash balances and sovereign securities.
Gilbert Hobeika +971 4 424 1214 Limited Sovereign Support: Jordanian banks are mainly domestic (with the exception of AB), [email protected] and Fitch considers the sovereign’s propensity to support the banking system to be high.
Ramy Habibi Alaoui However, the sovereign’s ability to provide support is constrained by its weak financial flexibility +44 20 3530 1649 and high reliance on grants and IMF support. [email protected]
www.fitchratings.com 8 May 2019 Banks
Ratings Highly Correlated with the Operating Environment Jordanian banks have high exposure to domestic sovereign debt and/or sovereign credit exposures, which increases the correlation between banks and the operating environment. This effectively constrains the ratings and applies, for example, to Jordan Islamic Bank (JIB) and Bank of Jordan (BOJ).
AB is an exception in the Jordanian banking system. Its ratings reflect the bank’s geographical diversification, with notable operations (branches, subsidiaries and affiliates) in the GCC region, North Africa and Europe. Jordan represents less than a third of AB’s assets. The bank’s regional operations, and about half its holdings of liquid assets in Europe and other highly rated sovereigns (cash, placements and high-quality investment securities), could help to offset the impact of a sovereign crisis and enable it to be rated higher than its peers in Jordan. However, the bank’s high exposure to the Jordanian sovereign relative to its equity via holdings of government securities offsets, to a degree, the benefits of its geographical diversification and weighs on its ratings. Accordingly, AB’s ratings are constrained but not capped by the Jordanian sovereign.
Fitch Rated Jordanian Banks Long-term Short-term Viability Support Support Bank name IDR IDR Ratings Rating Rating floor Outlook Arab Bank Plc BB B bb 5 NF Stable Jordan Islamic Bank BB- B bb- 4 B+ Stable Bank of Jordan BB- B bb- 4 B+ Stable Source: Fitch Ratings
Ratings Navigator Summary Mid-point Operating Company Management & Earnings & Capitalisation Funding& score environment profile strategy Risk appetite Asset quality profitability & leverage liquidity bbb+ bbb bbb- AB bb+ AB AB AB bb JIB AB AB AB, BOJ and AB JIB bb- JIB, BOJ JIB, BOJ BOJ JIB BOJ JIB, BOJ b+ BOJ JIB, BOJ JIB b b- Red = Higher Influence on the banks’ VR Blue = Moderate influence on the banks’ VRs Light Blue = Lower influence on the banks’ VR Source: Fitch Ratings
Related Criteria Bank Rating Criteria (October 2018)
Jordanian Banks: 2019 Peer Review 2 May 2019 Banks
Operating Environment Improving but Still Challenging Operating Environment The operating environment in Jordan is stabilising but remains challenging due to below- potential GDP growth, high unemployment, a difficult, although slowly improving, regional environment and rising social tension resulting from fiscal consolidation measures. The Stable Outlooks on the rated banks reflect our expectation that Jordan’s operating environment will remain stable in the near term.
Fiscal Consolidation Underway Fiscal consolidation measures under Jordan’s three-year IMF Extend Fund Facility (EFF) signed in August 2016 are expected to lead to a gradual decline in general government debt. Fitch expects public debt to fall to 90.5% of GDP in 2020 from a peak of 95.6% in 2017. This reduction will be supported by a continued decline in Jordan’s fiscal deficit to an estimated 1.7% of GDP in 2020 (from 2.6% in 2017). The decline results from a drop in oil prices, fiscal consolidation measures, a new income tax law and reduction in subsidies. Jordan has been funding its fiscal deficit by a combination of mostly concessional foreign borrowing and domestic issuance. The banking sector has proved a stable investor in domestic government debt and domestic debt of sovereign-owned enterprises.
Resilient Growth Despite Unfavourable Regional Environment Real GDP growth was resilient in 2018 at 2% despite the challenging regional environment but remains well below the average GDP growth rate of 6.3% for the period 2004-2011. We expect growth to remain subdued in 2019-2020, averaging 2% on the back of fiscal consolidation measures, higher interest rates and a gradual improvement in regional trading conditions. The reopening of border crossings with Syria and Iraq and improving tourism activity should support export growth. However, the challenging regional environment constrains the growth outlook and trajectory. Accordingly, we believe trade with the country’s neighbours may be slow to recover and reach pre-conflicts levels.
Slight Pick Up in Growth and Reduction in Fiscal Deficit
General government balance (RHS) Real GDP growth (LHS) (%) (% GDP) 3.5 0 -1 3.0 -2 2.5 -3 2.0 -4 -5 1.5 -6 1.0 -7 -8 0.5 -9 0.0 -10 2014 2015 2016 2017 2018 2019 2020 Source: Fitch Ratings
Declining International Reserves but Peg Expected to Be Maintained Gross official reserves including gold (as published by the Central Bank of Jordan (CBJ)) declined by close to USD1 billion in 2018 but remained high at USD13.4 billion, which is about seven months of current external payments. The CBJ has increased its policy rate since January 2017 by a cumulative 200bp to prevent dollarisation. Fitch expects reserves to remain adequate and the peg to be maintained, supported by monetary policy. The country’s external position is also improving with the current account deficit narrowing to 8% of GDP in 2018 from 10.6% in 2017. This is helped by export growth, higher tourism revenue and constrained import demand.
Jordanian Banks: 2019 Peer Review 3 May 2019 Banks
Tight Monetary Policy to Preserve the Peg Regime
CBJ foreign exchange reserves (RHS) CBJ policy rate (LHS) (%) (USDbn) 5.0 13.0 4.5 12.5 4.0 12.0 3.5 11.5 3.0 11.0 2.5 2.0 10.5 1.5 10.0
1.0 9.5
Jul17 Jul18
Apr17 Oct17 Apr18 Oct18
Jan 17Jan Jun17 Jan18 Jun18
Feb17 Mar 17 Feb18 Mar 18
Nov17 Dec17 Nov18 Dec18
Aug17 Sep17 Aug18 Sep18
May17 May18
Source: Fitch Ratings, Central Bank of Jordan
Market Share Concentration
Domestic Market Shares End-2017 (%) Assets (LHS) Loans (RHS) Deposits (RHS) (%) 20 25 Abbreviations Used 15 20 15 10 Arab Bank AB 10 The Housing Bank for Trade HBTF 5 5 and Finance 0 0 Jordan Islamic Bank JIB Bank of Jordan BOJ Jordan Kuwait Bank JKB
Jordan Ahli Bank JAB InvestBank
(HBTF)
ArabBank Plc
ArabJordan Jordanie
Capital Bank of Jordan CB BankAl Etihad
Bankof Jordan
Investment Bank Jordan AhliBank
Source: Fitch Ratings HousingBank for
Trade andFinance
Cairo AmmanBank
SafwaIslamic Bank
Jordan KuwaitBank
Jordan IslamicBank SocieteGenerale de
Source: Fitch Ratings, CBJ, Bloomberg CapitalBank of Jordan
The banking system in Jordan is formed of 25 banks, including four Islamic banks. AB and Housing Bank for Trade and Finance (HBTF) together account for about a third of banking- sector assets, and the next five or six banks account for an additional third. JIB is the largest Islamic bank and third-largest bank in Jordan, representing around 55% of total Islamic banking sector financing. Jordan does not attract many regional or international banks despite low barriers to entry. HSBC withdrew from Jordan in 2013 by selling its operations to Arab Jordan Investment Bank. Dubai Islamic Bank’s Jordanian Islamic banking unit was sold to Jordan’s Bank Al Etihad. Banks are mainly privately owned, with the Jordan Social Security Corporation maintaining small stakes in most banks.
Undiversified but Stable Business Models Jordanian banks’ business models are undiversified, in line with the nature of the Jordanian economy, but have proved to be stable through economic cycles. Corporate and government loans represent the majority of bank lending but retail and SME financing are areas of growth. Single-name borrower concentration is high given the limited number of strong domestic corporates in the country. AB has a more diversified business model and significantly lower loan book concentration than domestic peers given its geographical diversification.
Profitability is highly dependent on interest income, which represents around 75% of the banks’ operating income. Banks are trying to grow their fee income through increased trade finance but we do not expect this to increase materially given the stagnant economic environment.
Jordanian Banks: 2019 Peer Review 4 May 2019 Banks
Expected Subdued Credit Growth In 9M18, total banking sector credit growth was 6% (8% in 2017) and was mainly driven by the private sector in general industries, trade and construction. We expect low single-digit loan growth in 2019 as a result of a high interest-rate environment and a still-weak operating environment weighing on credit demand. Growth is expected to be in SME and retail financing due to the limited number of large corporates and the initiative by the CBJ to encourage SME financing. This may increase the banks’ credit risk but the banks’ cautious risk appetite provides some comfort.
Growth of Gross Loans
2015 2016 2017 9M18 (%) 30 25 20 15 10 5 0 -5 -10 AB HBTF BOJ JIB JAB JKB CB Sector Average Source: Fitch Ratings, Banks, Central Bank of Jordan
Resilient Asset-Quality Metrics Jordanian banks tend to display high single-obligor credit concentration given the narrow structure of the economy and limited lending opportunities, exposing them to event risk. Banks have high exposure to sovereign risk through the holding of sovereign debt securities and credit facilities extended to government-related entities (against 100% government guarantee) such as the National Electric Power Company and the Water Authority of Jordan. The banks’ total exposure to sovereign risk is estimated at around 25% of their total assets.
Jordanian banks’ asset-quality metrics have been well-maintained through the economic cycles, supported by the banks’ conservative risk appetite. The sector’s impaired loans ratio is on a declining trend (4.6% at end-1H18 from 4.9% at end-2015 excluding interest in suspense) as banks continue to clean up their balance sheets from legacy impaired loans. However, the ratio increased for some banks in 2018 as the implementation of IFRS 9 resulted in more conservative loan classification. Stage 2 and Stage 3 loans collectively represent an average of around 20% of the banks’ loan books.
Impaired Loans/Gross Loans
End-2015 End-2016 End-2017 End-3Q18 (%) 16 14 12 10 8 6 4 2 0 AB HBTF BOJ JIB JAB JKB CB
Source: Fitch Ratings, Banks
Jordanian Banks: 2019 Peer Review 5 May 2019 Banks
IFRS 9 Gross Loans Breakdown By Stages (% of Gross Loans) End-2018 (%) Stage 1 Stage 2 Stage 3
100
80
60
40
20
0 AB HBTF BOJ JAB JKB CB Source: Fitch Ratings, Banks
JKB and CB are among the banks that reported the highest impaired loans ratios at end-3Q18. This could indicate relatively weaker underwriting standards. JAB’s impaired loans ratio has been reducing from above 10% at end-2016 to 7.6% at end-3Q18 (mainly through write offs and recoveries of legacy exposures) but remains higher than the sector average. We expect the banks’ impaired loans ratios to be maintained or increase slightly in 2019 as a result of subdued loan growth and higher interest rates weighing on borrowers’ debt-servicing ability.
Reserve for Impaired Loans/Impaired Loans End-2015 End-2016 End-2017 End-3Q18 (%)
140 120 100 80 60 40 20 0 AB HBTF BOJ JIB JIB Including JAB JKB CB investment risk fund Source: Fitch Ratings
The sector average reserve coverage of impaired loans was 74% at end-1H18, which we view as adequate given the banks’ risk profiles and collateral in place. Reserve coverage for JKB and CB dropped in 2018 due to the sharp increase in their impaired loans and is below sector average.
Pre-Impairment Operating Profit/Average Loans
2015 2016 2017 9M18ª (%) 7 6 5 4 3 2 1 0 AB HBTF BOJ JIB JAB JKB CB
a Source: Fitch Ratings, Annualised figures
Jordanian banks also have healthy pre-impairment operating profitability, which provides them with an extra cushion against an increase in impaired loans without affecting their capital. BOJ’s pre-impairment operating profit/average loans ratio (6.2% in 2017) is above that of peers, supported by healthy margins and revenue generation. Absent significant credit events, we expect the banks’ reserve coverage to be maintained and loan impairment charges to be kept at levels that are supportive of the banks’ capital ratios.
Jordanian Banks: 2019 Peer Review 6 May 2019 Banks
Healthy Profitability Despite Margin Pressures Interest Rates on Loans and Deposits Net Interest Income/Average Earnings Assets Difference between (1) and (2) 2015 2016 2017 9M18 Weighted average interest rates on (%) loans (2)Weighted average interest rate on 6 (%) time deposit 5 10 8 4 6 4 3 2 0 2
1
Jul18
Oct14 Apr17
Jan16 Jun16
Mar 15 Feb18
Sep17 Aug15 Nov16 Dec18 Source: Fitch Ratings, Central Bank of 0 Jordan AB HBTF BOJ JIB JAB JKB CB Source: Fitch Ratings, Banks
Jordanian banks’ profitability has proved resilient through the different economic cycles. Domestic banks have undiversified business models, with interest income being the largest revenue driver at about 75% of operating income. We do not expect NIMs to improve despite rising interest rates. This is because banks have limited loan repricing ability due to high competition, while cost of funding is rising as a result of slightly tightening liquidity. Time deposits represented 56% of total banking sector deposits at end-2018 and are interest-rate sensitive.
AB’s NIM is lower than that of domestic peers given its operations in lower interest-rate environments including Europe and the GCC, as well as the bank’s focus on liquidity rather than yield. Islamic banks also have lower profit margins than conventional banks due to limited sharia-compliant investment opportunities into which to deploy their excess liquidity. The recent Ministry of Finance sukuk issuances could strengthen Islamic banks’ margins as a viable high- quality replacement for the current placements with the CBJ, which are non-profit-bearing. BOJ has one of the strongest NIMs due to its large share of CASA deposits (about two-thirds of its deposit base).
Loan Impairment Charges/Pre-Impairment Operating Profit 2015 2016 2017 9M18
80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% AB HBTF BOJ JIB JAB JKB CB
Source: Fitch Ratings
The banks’ conservative underwriting standards have kept their loan impairment charges at contained levels. With the implementation of IFRS 9, banks have strengthened their loan loss allowances and, in the absence of significant credit events, we do not expect a rise in loan impairment charges. Banks with legacy impaired exposures (JAB) display higher and more volatile loan impairment charges and profitability metrics.
Jordanian Banks: 2019 Peer Review 7 May 2019 Banks
Non-Interest Expense/Gross Revenues
2015 2016 2017 9M18 (%) 80 70 60 50 40 30 20 10 0 AB HBTF BOJ JIB JAB JKB CB
Source: Fitch Ratings
The banks’ cost bases have been well-maintained except for JAB and JKB. JKB’s cost/income ratio is inflated by provisions on its foreclosed assets, as per CBJ regulations. AB’s cost/income ratio has been on a downward trend as the bank no longer needs to book legal expenses (accounted for as other operating expenses) to build provisions against its legal case (in 2004 AB was accused of providing financial services to entities affiliated with terrorist organisation. The bank decided to settle with the plaintiffs to put the legal case behind it and in 2008 it won the appeal). As the legal case is now settled, we expect the ratio to stabilise; it should nevertheless remain above domestic peers’ as the bank’s geographical diversification entails a higher cost base.
Operating Profit/Risk-Weighted Assets
(%) 2015 2016 2017 9M18ª
6
5
4
3
2
1
0 AB HBTF BOJ JIB JAB JKB CB a JAB, JKB and CB figures are at end-1H18 Source: Fitch Ratings
JIB’s operating profit to RWAs ratios stand strongly above peers’ as they are inflated by lower RWAs. As per CBJ instruction based on IFSB standards, Islamic banks apply an alpha factor of 30% when calculating credit RWAs that are funded by unrestricted investment accounts (URIA deposits). This means that only 30% of the bank’s credit RWAs that are financed by URIA deposits feed into its regulatory RWAs calculations.
Jordanian Banks: 2019 Peer Review 8 May 2019 Banks
Adequate Capital Ratios FCC Ratio
End-2015 End-2016 End-2017 End-3Q18ª (%) 30 25 20 15 10 5 0 AB HBTF BOJ JIB JAB JKB CB a JAB, JKB and CB figures are at end-1H18 Source: Fitch Ratings
Jordanian banks are adequately capitalised. Banks calculate their capital ratios in line with CBJ and Basel III requirements. Capital is mostly made up of Tier 1 capital. However, we consider capitalisation to be only adequate given the banks’ high loan book concentration and 0% risk weighting on local-currency sovereign debt and sovereign guaranteed exposures. We expect capital ratios to be maintained as lending growth is expected to be moderate and we do not anticipate significant pressure on asset quality. JAB’s core capital ratios are lower than peers’ given its weak internal capital generation, which is constrained by high loan impairment charges and low cost efficiency.
Total Capital Ratio Under Basel III End-2015 End-2016 End-2017 End-3Q18ª (%) 25
20
15
10
5
0 AB HBTF BOJ JIB JAB JKB CB a JAB, JKB and CB figures are at end-1H18 Source: Fitch Ratings
The average sector total capital ratio was 17.2% at end-1H18. This is above the 12% minimum ECL Provisions Under IFRS 9 % of equity regulatory requirement excluding domestic systemically important banks’ (D-SIB) buffers (14% (%) for banks with international operations or offshore branches - excluding D-SIB buffers). JAB 0 and CB’s total capital ratios, which benefit from Tier 2 subordinated debt, were 14% and 15% -2 respectively at end-1H18 and provided minimal buffers against the minimum regulatory -4 requirement of 14%. -6 -8 IFRS 9 implementation had a manageable impact on the banks’ capital ratios, with ECL -10 provisions accounting for 2%-5% of most banks’ equity. JKB had the largest impact on capital -12 due to the sharp increase in its impaired loans with IFRS 9 implementation. This is also due to
its relatively weak reserve coverage leading to a high share of unreserved impaired loans
AB
CB
JIB
JKB JAB BOJ HBTF relative to the bank’s Fitch Core Capital (FCC). JAB’s unreserved impaired loans relative to Source: Fitch Ratings, Banks FCC are improving owing to an increasing reserve coverage and lower impaired loans generation. CB’s capital ratios should also be viewed in the context of its unreserved loans, which represented 18% of FCC at end-3Q18, and its exposure to Iraq, which accounts for about 40% of its equity.
Jordanian Banks: 2019 Peer Review 9 May 2019 Banks
Unreserved Impaired Loans/Fitch Core Capital
End-2015 End-2016 End-2017 End-3Q18 (%) 25 20 15 10 5 0 -5 -10 AB HBTF BOJ JIB JAB JKB CB Source: Fitch Ratings
Tangible Common Equity/Tangible Assets
End-2015 End-2016 End-2017 End-3Q18 (%) 20 18 16 14 12 10 8 6 4 2 0 AB HBTF BOJ JIB JAB JKB CB
Source: Fitch Ratings
JIB’s regulatory capital ratios benefit from the application of the alpha factor based on IFSB standards for Islamic banks, resulting in lower RWAs than conventional banks. As such, JIB’s tangible leverage ratios are significantly lower than peers’, highlighting weaker loss absorption buffers.
Funding and Liquidity Remains a Strength
Jordanian banks’ funding and liquidity profiles have been resilient amid weak operating conditions. The sector has not experienced deposit outflows and has maintained healthy liquidity, with an average loans/deposits ratio of 75%-80%. Liquidity came under pressure in 2017 due to the withdrawal of some of the public-sector deposits, which resulted in deposits increasing by less than 1% compared with 8% banking sector credit growth. Consequently, the loans/deposits ratio increased to 75% from 70% at end-2016. The ratio increased further to 77% at end-2018 but we expect the ratio to be maintained in 2019 owing to subdued credit demand.
Loans/Customer Deposits End-2015 End-2016 End-2017 End-3Q18 (%) 100 90 80 70 60 50 40 30 20 10 0 AB HBTF BOJ JIB JAB JKB CB Source: Fitch Ratings, Banks
Jordanian Banks: 2019 Peer Review 10 May 2019 Banks
Declining Excess Reserves Banks are mainly funded by customer deposits, with very little reliance on wholesale funding. In JDBbn (LHS) Deposits are granular with a higher proportion of retail funding and lower reliance on % of reserve money 3M average (RHS) government deposits (public-sector deposits formed only 7% of total deposits at end-2018). (JDbn) (%) There is a deposit insurance scheme in place that excludes deposits in Islamic banks. 1.8 25 1.5 20 However, discussions are under way in parliament to implement a deposit insurance scheme 1.2 15 for Islamic banks. 0.9 10 0.6 0.3 5 Banks hold healthy stocks of liquid assets, including interbank placements, cash balances and 0 0 sovereign securities. Islamic banks have lower holdings of investment securities due to limited
sharia-compliant investment opportunities. The several sukuk issuances by the Ministry of
Jul17
Jan14
Mar 15 Sep18 May 16May Finance in 2016, 2017 and 2018 (on behalf of the National Electric Power Company) have Source: Fitch Ratings, Central Bank of Jordan helped to improve Islamic banks’ liquidity management. We expect banks to maintain their stocks of liquid assets as credit growth is expected to remain subdued in 2019.
Sovereign’s Ability to Support Is Limited Fitch considers the sovereign’s propensity to provide support to banks to be high. Aside from AB, all banks are mainly domestic, which increases the likelihood of support. However, Fitch believes that the sovereign’s ability to support the banking system is constrained by its modest financial flexibility and high dependence on grants and IMF support. General government debt rose to 94% of GDP in 2018 from 89% of GDP in 2014, constraining the sovereign’s ability to support banks.
The D-SIB Support Rating Floor (SRF) of ‘B+’ reflects the constrained ability of the Jordanian sovereign to provide support, although the willingness to provide support would be high.
Fitch does not factor in any support from the Jordanian sovereign to AB as support, if required, is possible but cannot be relied on given AB’s large size relative to Jordan’s GDP. Accordingly, AB is assigned a SRF of ‘No Floor’.
Resolution legislation is being implemented and Fitch will review the SRFs once the legislation has been fully enacted.
Jordanian Banks: 2019 Peer Review 11 May 2019 Banks
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Jordanian Banks: 2019 Peer Review 12 May 2019