Fitch Ratings has affirmed Bank Muscat SAOG's (BM) Long-Term Issuer Default Rating (IDR) at 'BB' with a Stable Outlook.

Fitch has affirmed the bank's Viability Rating (VR) at 'bb' and upgraded its Government Support Rating (GSR) to 'bb' from 'bb-'.

The upgrade of BM's GSR reflects the Omani authorities' improved ability to provide support to the banking sector.

Oman's external balance sheet position has significantly improved and we expect this will be sustained over the rating horizon. In particular, Fitch forecasts the government debt/GDP ratio will fall to 46.7% in 2022 and 44.9% in 2023, from around 70% in 2020, on better budget performance and oil fuelled nominal GDP growth in 2022(forecast at 24%). Additionally, sovereign net foreign assets are forecast to turn positive by end-2022 at 1% of GDP (2021: -6.3%) before increasing to 4.6% of GDP in 2023. The Central Bank of Oman's gross foreign reserves will strengthen in 2022-2023 due to current account surpluses and average more than 4.5 months of current external payments.

Key Rating Drivers

BM's IDRs are driven by its VR and underpinned by potential support from the Omani authorities. BM's VR is capped by the Omani sovereign rating, given the bank's large exposure to the sovereign through holdings of sovereign and central bank assets, large exposure to the government and public-sector on both sides of the balance sheet, and domestically-focused business model.

The bank's VR reflects its flagship status in Oman, giving it access to high-quality borrowers and significant funding from the government and its related entities. It also considers BM's good asset quality, sound profitability and capitalisation, solid funding and good liquidity.

Oil Prices Support Growth: We expect economic growth momentum will continue to be supported by oil prices in 2023, which are expected to average USD85/bbl. This will underpin the government budget surplus and contribute to a further reduction in its debt/GDP. Fitch expects moderate loan growth of about 4% in 2023 as these positive developments will be tempered by continued government fiscal consolidation.

Flagship Bank in Oman: BM is the leading bank in Oman with significant market shares across most products supported by its large branch network, long-standing client relationships and strong links with the government. Its dominant market position gives it some pricing power and a low-cost funding base that supports its net interest margin.

Sound Risk Profile: BM's strong market position provides it with access to lower-risk borrowers and the bank has been growing cautiously in recent years. Fitch expects the bank will continue growing below its internal capital generation.

Good and Stable Asset Quality: Asset quality compares well with peers and has been stable with a Stage 3 loans ratio of 3.7% at end-3Q22 (unchanged from end-2021), below the peer average of 4.4%. Reserve coverage was healthy at 147% (peer average: 116%). BM's Stage 2 loans ratio of 20% at end-3Q22 is in line with the sector average. Its high level is partly due to the Central Bank of Oman's (CBO) conservative guidelines governing loan classification.

Good Profitability: BM's profitability remains superior to peers, underpinned by higher revenue diversification, stronger pricing power and controlled operating costs. The operating profit/risk-weighted assets ratio was 2.3% in 9M22 (sector average: 1.8%, annualised). The bank's operating profitability is supported by impairment charges that are lower than peers, averaging 22% of pre-impairment operating profit over 2019-9M22 (peer average: 31%).

Sound Capital Buffers: BM's common equity Tier 1 (CET1) ratio of 18.1% at end-3Q22 provides a significant cushion to absorb additional losses before breaching regulatory minimum requirements. We expect it to reduce to 15%-16% at end-2022 as the bank issued OMR375 million AT1 securities by way of dividend in 4Q22. Fitch expects the CET1 ratio will be maintained above 15% in the medium term, supported by earnings retention.

Solid Funding; Good Liquidity: BM is mainly funded by customer deposits, which accounted for 85% of total non-equity funding at end-3Q22. BM's deposit base is more granular than peers, underpinned by its strong retail franchise. Liquidity is adequate with a liquidity coverage ratio and a net stable funding ratio of 174% and 114%, respectively, at end-3Q22.

Sovereign Support: The Omani authorities have a high propensity to support the banking system given the high contagion risk in the sector and the importance of the banking system in building the local economy. However, their financial flexibility and ability to provide support remains limited. BM's GSR is one notch above other domestic systemically important banks' GSRs (bb-), given its flagship status.

Rating Sensitivities

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

A downgrade of BM's IDRs would require a downgrade of the VR and GSR. A downgrade of the GSR would be triggered by a sovereign downgrade.

BM's VR is mostly exposed to a sovereign downgrade. It is also sensitive to a combination of material weakening of its asset quality metrics (with the Stage 3 ratio increasing above 5%) together with weaker capital ratios (with the CET1 ratio falling below 12%). Given BM's flagship status and strong business profile, Fitch has more tolerance in terms of weakening of its financial profile before downgrading the VR.

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

An upgrade of the Long-Term IDR could come from an upgrade of the bank's VR or an upgrade of the GSR. An upgrade of the GSR would be triggered by a sovereign upgrade. An upgrade of the sovereign rating combined with further improvement in the business environment could lead to an upgrade of the VR.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

The senior unsecured EMTN programme and debt ratings are rated in line with the bank's IDRs.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

BM's senior unsecured euro medium-term note programme and debt ratings are subject to same sensitivities as BM's IDRs.

VR ADJUSTMENTS

The operating environment score of 'bb' has been assigned below the 'bbb' category implied score for Oman due the following adjustment reasons: size and structure of economy (negative) and sovereign rating (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

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, visitwww.fitchratings.com/esg.

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