Amid Egypt’s ongoing foreign currency shortage, commercial banks are borrowing more dollars from abroad to finance local businesses that depend on imports. According to the Central Bank of Egypt (CBE), commercial banks’ net foreign asset deficit jumped from the equivalent of EGP 219 billion in June 2022 using the official exchange rate to EGP 529 billion a year later.
Within three months of the news, credit rating agencies Fitch Ratings, Moody’s Investor Services, and Standard & Poor’s Global Ratings downgraded some of Egypt’s most prominent banks. Those downgrades were expected, as all three agencies had a “negative” outlook for the sector since 2022.
Downgraded banks “face higher borrowing costs … because investors consider them riskier bets,” Jay Menozzi, chief investment officer and portfolio manager at Orange Investment Advisors, told Investopedia. “The banks’ cost of capital will go up [meaning] consumers would face higher borrowing costs.” That could ultimately lead to economic stagnation or even recession.
Fitch: Risks, upside, forecast
In November, Fitch Ratings downgraded the “operating environment” score of the three biggest state-owned banks by deposits: National Bank of Egypt (NBE), Banque Misr (BM) and Banque Du Caire. They also downgraded Commercial International Bank (CIB), Egypt’s biggest listed private-sector bank, whose shares comprise 40% of the EGX30’s tradable stocks.
All four dropped from “B” with a “negative” outlook to “B-” with a “stable” outlook, keeping them in the “high credit risk” category. They are now just one rank above the “very high credit risk” classification.
Fitch explained, “The operating environment score is in line with [Egypt’s] sovereign rating as operating conditions for banks are highly correlated with sovereign profits.” The rating agency “estimates [exposure] to be almost 50% of the banking sector’s total assets, and around 8x banks’ capital at the end [of] July 2023.”
Fitch also noted the risks associated with “persisting foreign currency shortages weighing on credit demand” and “high core inflation.”
That combination means “rising input costs for corporates underpinning weak business conditions.” Fitch cited the Purchasing Managers Index score, which shows new purchasing orders by the Egyptian private sector have been shrinking since November 2020.
Despite the elevated financial risks corporate borrowers face, those banks’ “nonperforming loans ratio was stable at 3.3%” in the first half of 2023. Fitch said CBE regulations to give SMEs more time to pay overdue obligations “helped contain the loan quality deterioration.”
The other upside is that “yields on sovereign securities have increased sharply since March 2022 — by more than 1,300 basis points … as the CBE has increased its policy rates by 1,100 basis points.”
In 2024, Fitch said, increasing income from treasuries should offset losses from the inevitable pound devaluation. It is “the main risk to banks’ capital ratios, … as around 45% of banks’ [risk-weighted assets] are denominated in foreign currency.”
Another factor those local banks must contend with is too much SME funding. Fitch says it is “the sector most affected by current liquidity issues, and we expect it to [weaken] credit performance in 2024.”
Overall, “foreign currency liquidity conditions [will] remain tight [in 2024], widening the banking sector’s net foreign liability.” The biggest threat will be the portfolio size of nonresidents investing in the government’s local currency securities (hot money).
Moody’s: Risks, upside, forecast
In October, Moody’s Investor Services “downgraded the long-term bank deposit ratings of NBE, BM, Banque Du Caire, CIB and Italy’s Intesa Sanpaolo’s Bank of Alexandria (AlexBank).
The first four entered the “very high credit risk” (Caa1) from “high credit risk” (B3). AlexBank remained in the latter category, dropping from B2 to B3. Moody’s said its higher grade is “driven by affiliate support … from Intesa Sanpaolo.” All five have a “stable” outlook, an improvement from their previous “negative” outlooks.
Meanwhile, all five’s “standalone strength, without external support” (baseline credit assessment) dropped from “high risk” (B3) to “very high risk” (Caa1). Their profiles, which “capture systemic risks that can influence a bank’s creditworthiness,” went from “very weak+” to “very weak.”
That downgrade came from “elevated foreign currency funding and liquidity pressures, renewed credit challenges [due to] high interest rates and inflation and weakened fiscal conditions.”
Moody’s said those factors hurt the quality of bank assets, earnings, capital buffers, and their ability to meet foreign-currency-denominated obligations.
Like Fitch, Moody’s cited “significant holdings of sovereign debt securities” as another reason for the downgrade. Their exposure ranges from eight to 2.4 times their reserves and equity (Tier-1) capital. “These banks’ standalone credit profiles and ratings are effectively constrained by the rating of the government,” which is currently “very high credit risk” (Caa1).
The upside is those banks “demonstrated defensive characteristics,” said Moody’s analysis. “[They] enjoy a growing deposit-based funding profile, reporting resilient profitability metrics, [with] nonperforming loans … contained at 3.5% of gross loans as of March 2023.”
Looking to 2024, Moody’s said it would downgrade those banks’ ratings if Egypt’s sovereign credit rating declines. Additionally, Moody’s would downgrade those banks’ baseline credit assessments if there are “more acute foreign currency liquidity pressures or a rise in problem loans [or] rising funding costs that materially reduce their profitability and capital metrics.”
S&P: Risks, upsides, forecast
In October, S&P downgraded three local banks: NBE, BM, and CIB. Their “long-term” rating dropped from B to B-, similar to Fitch. Their “short-term” rating remains at B, in the middle of the “high credit risk” classification. All those ratings come with a “stable” outlook.
The main reason S&P cited for the downgrade was the “lack of progress on key monetary and structural reforms [which] exacerbated imbalances in the [currency] market, deteriorated the net foreign asset position of systemic banks and delayed disbursement of IMF and other multilateral and bilateral financing.”
The rating agency also attributed the downgrade to the government’s ongoing import restrictions and shipping delays, which hinder local businesses. S&P also noted the proliferation of the dollar black market, which creates multiple exchange rates, confusing businesses and investors.
S&P said local banks will be noticeably affected if the government devalues the pound, as international markets expect. A “weaker pound and toughening operating conditions will hit banks’ creditworthiness,” S&P said. “The largest effect from this scenario will be on banks’ capitalization by inflating foreign currency risk for weighted assets.”
The rating agency said the upside is “limited direct effects on private borrowers’ creditworthiness because foreign currency is granted to companies that generate revenue in the same currency, and households do not borrow in foreign currency.”
S&P expects local commercial banks to be flush with local currency deposits in 2024, allowing them to buy government treasuries. However, they will likely “liquidate foreign assets and increase borrowing from abroad at increasing costs, to face high demand for foreign currency via official channels from households and companies … weighing on their funding portfolios.”
In 2024, S&P forecasts that credit losses will be higher by 33.3% in 2024 and 41.6% in 2025 than during the past four years. However, those losses may prove temporary, as S&P believes “the Egyptian banking sector is in a correction phase.”
