Fitch Ratings has affirmed Arab Tunisian Bank's (ATB) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B-' with a Stable Outlook.

At the same time, Fitch has downgraded the bank's Viability Rating (VR) to 'ccc-' from 'ccc+'. The rating action follows the downgrade of Tunisia's sovereign IDR to 'CCC-' on 9 June 2023 (see Fitch Downgrades Tunisia to 'CCC-' on www.fitchratings.com). ATB's National Ratings are unaffected by the event.

ATB's 'B-' IDRs are above the sovereign's 'CCC-' IDRs but its Long-Term Foreign-Currency IDR is capped by Tunisia's 'B-' Country Ceiling. This reflects transfer and convertibility risks, which would constrain ATB's ability to use external support to service its foreign-currency debt.

The VR downgrade follows the downgrade of Tunisia's Long-Term Foreign- and Local-Currency IDRs and reflects the close links between ATB's standalone credit profile and the sovereign's. ATB is exposed to sovereign risk through holdings of government debt and loans to public sector entities, which was significant relative to the bank's equity. High exposure to a 'CCC-'-rated sovereign poses a threat to ATB's already weak core capitalisation.

Key Rating Drivers

ATB's IDRs and National Ratings are driven by potential support from the bank's 64.2% shareholder, Jordan-based Arab Bank Plc (AB; BB/Stable). ATB's National Ratings are the highest ratings among Fitch-rated Tunisian issuers. The VR is heavily influenced by the bank's capitalisation and constrained by the sovereign rating.

ATB's 'ccc-' VR is one notch below the 'ccc' implied VR due to the following adjustment reason: capitalisation and leverage.

Shareholder Support: Our view of shareholder support is based on ATB's majority ownership by AB and its role in the group, as the subsidiary operates in a strategic market for AB. Despite being a large overseas subsidiary, ATB contributes only 4% to the group's assets, making any required support manageable for the parent. Integration links are strong, with AB defining ATB's strategy and overseeing its credit, market and liquidity risks. ATB's IDRs are constrained by Tunisia's Country Ceiling of 'B-', reflecting transfer and convertibility risks.

Very Challenging Operating Environment: Real GDP growth was a moderate 2.4% in 2022 and we expect it will slow significantly to 1.6% in 2023. The banks' operating environment is undermined by high inflation (9.6% in May 2023), an unfavourable policy mix, political uncertainties, and a weak business climate due to uncertainties around the IMF disbursement of a USD1.9 billion fund facility to Tunisia.

Established Franchise: ATB is Tunisia's eighth-largest bank with 6.6% of sector loans at end-2022. It operates a traditional business model with loans accounting for 69% of total assets.

Heightened Risk Profile: ATB's risk profile is inevitably high, given its focus on the vulnerable Tunisian economy. The bank's credit profile is highly linked to the sovereign risk via holdings of government bonds and direct loans to the state and to public companies, although this has declined since 2022. Investments in unquoted illiquid securities (4% of assets, or 0.4x Fitch Core Capital (FCC)) also suggest a high risk appetite, although these have been declining as well.

Weak Asset Quality: ATB's impaired exposures (including off balance sheet) were 13.6% of total exposures at end-2022, which is broadly in line with the market average of 13.2%. Coverage of impaired assets by provisions was only moderate at 80%, which translates into high FCC encumbrance by unreserved impaired exposures. Substantial restructured and watchlist loans add to asset-quality vulnerabilities. Tunisian government bonds were 1.6x equity at end-2022, which is negative for ATB's credit profile.

Modest Profitability: ATB's operating performance has been modest in recent years. Steep rises in overheads, affected by high inflation, and rising provisioning requirements have combined to depress operating profitability. ATB's high exposure to low-yielding corporates and its limited pricing power in a highly competitive market put pressure on performance.

Small Capital Buffers, Support Available: We view ATB's capital buffers as weak relative to the bank's risk profile. Its end-2022 Tier 1 ratio provided a limited buffer over the regulatory minimum of 7%. However, AB provides regular ordinary capital support to ATB, and we expect it will subscribe to any rights issues initiated by ATB.

Adequate Funding and Liquidity: ATB is mainly deposit-funded (85% of total liabilities at end-2022), and a large proportion (57%) is in the form of current accounts and savings accounts. ATB's liquid assets, net of wholesale funding maturing within the next 12 months, covered a moderate 19% of total deposits at end-2022. The bank may benefit from liquidity support from AB in case of need.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

ATB's Shareholder Support Rating (SSR) and Long-Term IDRs are sensitive to a downgrade of Tunisia's Country Ceiling, which is primarily sensitive to a downgrade of Tunisia's Long-Term Foreign-Currency IDR. They are also sensitive to regulatory or potential operational restrictions constraining AB's ability to provide support, particularly in foreign currency, or to adverse changes in Fitch's assumptions regarding AB's capacity and willingness to support the bank. They would also be downgraded if AB's strategic interest in the bank weakens.

ATB's VR is sensitive to further deterioration in asset quality and a sustained weakening of profitability leading to a breach its minimum Tier 1 ratio regulatory requirement for a few consecutive quarters with no clear path to restore it.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade of ATB's SSR and IDRs would require an upgrade of Tunisia's Country Ceiling. This is highly unlikely in the near term.

An upgrade of the VR would require sustained improvement in the bank's asset quality, earnings and capitalisation, which is unlikely at present.

VR ADJUSTMENTS

The operating environment score of 'ccc' is below the 'b' category implied score, due to the following adjustment reason: sovereign rating (negative).

The business profile score of 'ccc' is below the 'b' category implied score, due to the following adjustment reason: business model (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.

Public Ratings with Credit Linkage to other ratings

ATB's ratings are driven by AB's IDRs.

ESG Considerations

ATB's ESG Relevance Score of '3' for social impacts reflects ATB's exposure to social disapproval of interest rate practices in the banking sector compared with the '2' typically assigned to banks. Nevertheless, environmental, social or governance assessments are not rating drivers for ATB.

Unless otherwise disclosed in this section, 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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