Moody's maintains negative outlook on Bahrain's banking system amid weakening operating conditions

Moody's Investors Service has maintained its negative outlook on Bahrain's banking system, reflecting the rating agency's expectation that operating conditions for the country's banks will continue to deteriorate over the next 12-18 months.

Moody's report, entitled "Banking System Outlook -- Bahrain: Modest Pressure on Loan Quality and Profits Drives Our Negative Outlook" is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release. Please note that this report does not constitute a rating action.

"We expect low oil prices and reduced government spending to weigh on Bahraini banks," says Christos Theofilou, an Assistant Vice President -- Analyst at Moody's. "However, this will likely be partly mitigated by the non-oil economy's diversity and a Gulf Cooperation Council (GCC)-funded economic support package."

Moody's expects economic growth to slow to 2.2% in 2016 from 2.9% in 2015 as the sharp drop in oil prices since 2014 continues to take its toll. Lower oil prices will also likely constrain government spending and weaken consumer and investor confidence.

As a result, asset quality will likely suffer as more challenging operating conditions lead to rising problem loans. "We expect problem loans for the system to rise to around 6.0%-6.5% of total loans by mid-2017, compared to an estimated 5.8% at year-end 2015," explains Mr. Theofilou. Bahraini banks' heavy exposure to government and other public-sector debt will likely rise further, strengthening the linkage between the banks' credit profiles and the weakening fiscal position of the Government of Bahrain (rated Ba2, negative).

However, deteriorating asset quality is likely to be partly mitigated by Bahraini banks' ongoing initiatives to recover and write-off legacy problem loans, while earnings will be ample to absorb expected losses. The recent rebound in tourism and construction will also help to offset pressure on loan quality. Capital buffers will likely remain stable at around 10.5% of adjusted risk-weighted assets, according to the rating agency.

Funding conditions will be more challenging as deposit inflows slow amid a combination of lower government and public-sector oil revenue, lower corporate profits and falling household savings. That said, Moody's expects banks' funding and liquidity positions to remain resilient overall supported by high liquidity buffers and loan growth of around 4% in 2016 that will require only modest levels of new funding.

Banks' profitability is also likely to suffer, in Moody's view. Asset quality pressure will translate into higher loan-loss provision requirements, which will weigh on bottom-line profitability. The rating agency expects net income to decline slightly to about 1.2% of tangible assets in 2016 (2015: 1.3%). However, pre-provision income will likely remain broadly stable at around 1.7% of tangible assets, supported by modest credit growth and banks' costcutting initiatives.

Finally, Moody's considers that fiscal pressure will reduce the government's capacity to provide support to banks in the event of need. Nevertheless, the rating agency considers that willingness to provide support to failing banks remains high; creditors of retail banks have never suffered losses given authorities track record of support for troubled retail banks.