x Abu Dhabi, UAESaturday 22 July 2017

Highly rated? No, but agencies are here to stay

Not too long ago, much of the blame for the financial market meltdown was placed squarely at the feet of lax rating agency evaluation.

Things have come around full circle. Not too long ago, much of the blame for the financial market meltdown was placed squarely at the feet of lax rating agency evaluation. Having learned their lessons, and to avoid future criticism and possible legal action by investors, today's rating agencies are leaning too much towards the cautious side. If in doubt, go for a lower rating seems to be their motto.

This is not to denigrate their work, for in the final analysis we need independent financial analysts to guide the layman through financial reports and doublespeak - to see the accounting wood from the trees. In the Gulf, we have had our fill of rating reports and most seem to err on the side of caution, given the lack of acceptable levels of transparency. Who would believe that it was only foreign banks that suffered from the recent defaults of the Saudi Saad and Al Gosaibi groups, and that only a few Gulf banks had exposure?

This uncertainty drags investor confidence. The governor of the Saudi Arabian Monetary Agency seemed to think so, and publicly stated that the potential impact of these two companies' bad loans on Saudi banks would not materially affect the Saudi banking sector. It was gratifying to note, however, that some Gulf banks shared their true Saudi loan positions with the rating agencies, no doubt fearful that if they did not co-operate, albeit on a confidential basis, they would be downgraded, adding to their market share price woes.

Why the obsession with a rating? This grades countries and their financial institutions in terms of credit worthiness and ability to repay loans. Standing at the high table are the so-called sovereign ratings, mostly carried out by Moody's and Standard & Poor. Having the coveted "AAA" sovereign rating denotes a long track record of political and economic stability, and no Gulf country has achieved this rating yet.

A lack of transparency and the need for more legal and administrative system upgrades are cited. Gulf sovereign ratings vary, with Qatar and Saudi Arabia leaping a massive four steps in two years to reach "Aa2" and "A1 plus" respectively, while Kuwait and UAE are at "Aa2", and Oman and Bahrain at "A2". Bahrain and Kuwait were downgraded to negative by Moody's this year. As a comparison, Egypt and Morocco are rated at "Ba1", just below the minimum investment grade of "Baa3".

Countries have to work hard to maintain their rating and even the richest countries can stumble, as illustrated by the announcement in May that Standard & Poor's had put the UK on a negative watch list, but has now said that the rating would remain unchanged. Losing an "AAA" rating involves more than simply a loss of face. The interest rate Britain has to pay to borrow in the global markets depends on how creditworthy the country is perceived to be: the higher the rating, the lower the borrowing cost.

Financial institutions are rated, too. Just as a potential negative downgrade might concentrate political minds, the thought of a rating downgrade is not such a bad idea. It might bring bankers to their senses and force them to reconsider their policies in light of changing economic circumstances. In the Gulf, Moody's Investors Service placed the ratings of four banks in the UAE on review for possible downgrade, reflecting the rising challenges facing the sector, chiefly triggered by the stressed domestic property market, especially in Dubai.

The four banks affected are Emirates Bank International and National Bank of Dubai (currently merging into Emirate NBD), Mashreqbank and Dubai Islamic Bank. In all cases, their bank financial strength ratings and long-term debt and deposit ratings were placed on review for possible downgrade. In Bahrain, even the mighty Investcorp has had its rating downgraded. Moody's anticipates that the pressures facing the UAE banking system will result in rising corporate defaults as well as an increase in delinquencies from retail lending, especially among unsecured credits.

Having a strong sovereign rating helps, however. The UAE banking system is largely government-owned or controlled and much of the capital improvement has been through the provision of external support aimed at ensuring the banks are better prepared for both expected and unexpected levels of loan losses. Moody's stress tests of the rated UAE banks' portfolios have indicated that the Abu Dhabi-based banks are more resilient. This primarily reflects two factors: first, their high Tier 1 capital ratios; and second, their lower concentrations of loans and deposits to the more volatile economic conditions prevailing in Dubai.

In Saudi Arabia, the government is a direct shareholder in the largest bank, the National Commercial Bank, and in Riyad Bank, and has indirect ownership in virtually all the other banks through the GOSI pension organisation. This has cushioned any potential rating downgrades and the recent Credit Suisse upgrade of six Saudi banks has helped boost confidence in this sector. Whether we love or hate them, rating agencies are here to stay until an internationally acceptable formula is found.

Dr Mohamed A Ramady is a former banker and visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia.