Fitch rates Iraq's Gulf Commercial Bank 'CCC+'

Fitch Ratings - Dubai : Fitch Ratings has assigned Gulf Commercial Bank (GCB) a Long-Term Issuer Default Rating (IDR) of 'CCC+'. A full list of rating actions is detailed below.

KEY RATING DRIVERS

IDRs AND VIABILITY RATING (VR)

The IDRs of GCB are driven by its standalone strength, as indicated by its VR. GCB's VR reflects a weak franchise and unstable business model, operations in the highly volatile operating environment of Iraq, a high impaired loans ratio, which is partially due to its related-party lending and its structurally weak profitability. The VR also reflects the bank's adequate capital and liquidity ratios.

Fitch expects Iraq's economic and political instability, high oil dependence and weak regulatory framework to continue to weigh on Iraqi banks' operating environment.

GCB is a privately-owned bank, headquartered in Baghdad and regulated by the Central Bank of Iraq (CBI). The bank has minimal market shares in Iraq and no competitive advantages with a small network of 18 branches. The Iraqi banking sector is dominated by three state-owned banks, while private banks have fragmented market shares.

The bank's business model and profitability are volatile and sensitive to the domestic operating environment. Given the limited lending opportunities, loans represented only 28% of the bank's total assets at end-2020, of which 42% of gross loans were related-party lending. Similar to peers, GCB parks its excess liquidity in placements with CBI, representing about a third of the bank's total assets.

GCB's reported impaired loans ratio increased to 42% at end-2020 (39% at end-2019), but we believe that the actual impaired loan ratio is close to 80% as some of the bank's legacy related-party non-performing exposures are not classified as impaired. Reserve coverage of reported impaired loans was 99% at end-2020 (90% at end-2019) but drops to around 50% when all non-performing loans are included. The bank holds real-estate collateral against some of its largest exposures, but its ability to foreclose this collateral is constrained by the regulatory framework in Iraq.

GCB has been incurring net losses for the last three years, due to large non-to-low-interest-earning liquid assets and its significantly high cost-to-income ratio (115% in 2020). Non-interest income is the main operating income source (73% of gross revenues in 2020), comprising mainly fees and commissions related to CBI's foreign-currency auctions and fluctuates with business volumes.

GCB's consolidated equity to asset ratio was 58% at end-2020 (48% at end-1H21 on a standalone basis). However, we view capitalisation as only adequate in light of the bank's negative internal capital generation, weak asset quality, equity investments in loss-making companies and fair-value losses on some of its equity portfolio. Net impaired loans (including nonperforming related-party lending), equity investments and outstanding IQD20 billion CBI fines for misconduct related to foreign-currency auctions together represent two-thirds of the bank's equity; if written off the tangible leverage ratio drops to 29% at end-2020.

GCB is mainly funded by equity (58% at end-2020) and customer deposits (42% at end-2020). The deposit base is concentrated with the 20 largest deposits representing 21% of the deposit base at end-2019. Its funding structure is weak and volatility in the funding base has affected its ability to grow its balance sheet.

GCB's gross loans-to-customer deposits ratio has been on an increasing trend, reaching 107% at end-2020 (93% at end-2019), following a drop in customer deposits. However, liquidity remains adequate with cash balances at CBI less mandatory reserves covering 70% of total deposits at end-2020.

GOVERNMENT SUPPORT RATING (GSR)

GCB's GSR reflects Fitch's view that government support cannot be relied upon given the bank's limited systemic importance.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A downgrade of the sovereign rating could result in a downgrade of the bank's Long-Term IDR and VR.

Deterioration in the bank's capitalisation from further accumulated net losses or rapid asset growth could lead to a downgrade of the VR. Deterioration in the bank's domestic operating environment could lead to a negative rating action.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

VR upside is currently limited. A record of profitability supported by improving asset quality and a marked reduction in legacy impaired exposures could lead to an upgrade. An upward revision of the operating environment, which is likely to come from a sovereign upgrade, could have positive implications on the bank's credit profile.

VR ADJUSTMENTS

The operating environment score of 'ccc+' has been assigned below the 'b' category implied score for Iraq, due to the following adjustment reasons: Size and structure of economy (negative), and Financial market development (negative).

The business profile score of 'ccc' has been assigned below the 'b' category implied score, due to the following adjustment reasons: Business model (negative), Market position (negative), and Management and governance (negative).

The capital and leverage score of 'b-' has been assigned below the 'bb' category implied score, due to the following adjustment reasons: Reserve coverage and asset valuation (negative), and Internal capital generation and growth (negative).

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

GCB has been assigned with ESG Relevance Score of '4' for Governance Structure as it has material related-party loans, largely non-performing, and equity investments in loss-making entities, which we believe are also related to the bank's shareholders. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

GCB has been assigned with ESG Relevance Score of '4' for Financial Transparency, due to sizeable non-performing loans, which are not properly captured in the bank's financial statements. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

Except for the matters discussed above, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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Link to Rating Actions: Rating Actions

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Email:louisa.williams@thefitchgroup.com 

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