Fitch: Egyptian banks’ capital ratios can withstand a further pound depreciation

Egyptian banks’ regulatory capital ratios can withstand further Egyptian pound depreciation as they are supported by healthy internal capital generation, Fitch Ratings said on Tuesday.

“Large private-sector banks are better-placed to withstand currency depreciation than the two largest public-sector banks, National Bank of Egypt (NBE) and Banque Misr (BM), due to their higher regulatory capital buffers.” Fitch report read.

The Egyptian pound has weakened 16 percent against the U.S. dollar so far this year, and by about 40 percent since the end of June 2022.

“The pound currency may remain under pressure in 2023 given Egypt’s import backlog, estimated at $5.4 billion (16 percent of FX reserves), and large gross external funding needs, estimated at over $19 billion for 2023 (about 60 percent of FX reserves). It remains to be seen whether the Central Bank of Egypt will let the exchange rate and interest rates adjust sufficiently to attract new portfolio flows.”

Some Egyptian banks keep moderate long open-currency positions, which can lead to pressure on capital ratios due to inflation of foreign-currency (FC) denominated risk-weighted assets (RWA), Fitch added.

FC assets accounted for 37 percent of RWA on average at the five largest banks at end of the first half of 2022. Assuming a 100 percent risk-weight for most FC assets, Fitch estimates that a 10 percent currency depreciation would erode banks’ common equity Tier 1 (CET1) ratios by 30bp, on average.

“We estimate that FC RWA have inflated by about 60% since end-1H22.”

However, Fitch said the Commercial International Bank’s (CIB Egypt) (‘B+’/Negative) and QNB Al Ahli’s (QNB AA; not rated) CET1 ratios are the most sensitive to currency depreciation.

“We estimate that the 60% depreciation will have reduced their CET1 ratios by about 500bp and 300bp, respectively. However, despite this, both banks still have strong regulatory capital buffers.”

The National Bank of Egypt (NBE) and Banque Misr had the weakest CET1 ratios at end of the first half of 2022, the rating agency added.

“Both banks are rated ‘B+’/Negative and have a ‘b-’ capitalisation and leverage score. However, we estimate the ratios will remain above the 4.5% minimum requirement, even without factoring in subsequent profits. We estimate annualised 1H22 net income, if fully retained, would add 220bp and 190bp to NBE’s and BM’s ratios, respectively.”

Capital is also vulnerable to mark-to-market losses on investment portfolios due to the sharp rise in interest rates and yields on sovereign securities since the first quarter of 2022.

“We expect fair-value losses to continue to affect banks’ capital in 2023, but less so than in 2022 when average yields on treasury bills increased by about 540bp. Other comprehensive income (OCI) losses eroded regulatory capital ratios by 90bp on average in 1H22 (after a cumulative 300bp of policy rate rises), but the losses could be reversed if banks hold the securities until maturity.

“However, further policy rate increases in 2023 could drive additional OCI losses, and some banks may reduce dividends to support internal capital generation in the face of OCI losses and currency depreciation.”

Fitch noted that Egyptian banks have so far maintained healthy profitability despite the macroeconomic challenges, supported by higher interest rates and FC revaluation gains. As shown below, annualised net income averaged 2.6 percent of RWA in the first half of 2022, fully offsetting the RWA inflation from currency depreciation, as well as the OCI losses.

The introduction of certificates of deposit (CDs) this month paying 25 percent interest will squeeze NBE’s and Banque Misr’s net interest margins, while private-sector banks are likely to see further deposit outflows.

“However, yields on sovereign securities, which increased by more than 500bp in 2022, should underpin private sector banks’ net interest margins and overall profitability metrics.”

“Asset quality risks are increasing as business activity slows due to macroeconomic pressures and FC shortages, but banks’ strong provisioning buffers of large holdings of sovereign securities should mitigate the impact.”

Even further sharp currency falls should not directly trigger rating downgrades, Fitch highlighted.

“Egyptian banks’ main ratings sensitivity is to a change in Egypt’s ‘B+’/Negative sovereign rating.” Fitch concluded.