Fitch Ratings has placed HSBC Bank Oman SAOG's (HBON) Long-Term Issuer Default Rating (IDR) of 'BB+' and 'bb-' Viability Rating (VR) on Rating Watch Negative (RWN).

The 'bb+' Shareholder Support Rating (SSR) has also been placed on RWN.

The rating action follows the Central Bank of Oman's approval of the merger between HBON and Sohar International Bank SAOG (SIB) on 5 February 2023.The closing of the transaction is subject to approval by other regulatory bodies as well as the shareholders of both banks and is expected to take place in 2H23.

The RWN on the SSR and IDR reflects that upon completion of the merger, Fitch will cease to factor potential support from HSBC Holdings plc (HSBC; A+/Stable) into HBON's ratings, which is likely to result in a downgrade and withdrawal of HBON's SSR and Long-Term IDR as HBON will be liquidated as a legal entity after the merger completion. Without the benefits from HSBC and as part of the merger with SIB, Fitch expects HBON's standalone credit profile to converge towards SIB's, as reflected in the RWN on HBON's VR.

Key Rating Drivers

HBON's IDRs are driven by potential support from the bank's ultimate parent, HSBC, as reflected in the bank's SSR of 'bb+'.

HBON's VR reflects its adequate franchise and business model, benefiting from its links with HSBC, as well as its conservative risk profile, sound asset quality in the local context, sound capitalisation, stable funding and strong liquidity. The RWN on HBON's VR reflects Fitch's view that HBON's intrinsic credit profile will likely converge towards SIB's, which is lower.

Shareholder Support Rating of 'bb+': HSBC has a strong ability and propensity to support HBON, if needed. This mostly considers the reputational risk to HSBC of an HBON default. Nevertheless, HBON's SSR is capped by Oman's Country Ceiling of 'BB+'. Fitch believes that HSBC's propensity to support HBON will remain strong until the merger is completed.

Improved Operating Conditions: Fitch revised its assessment of the Omani banks' operating environment score to 'bb' from 'bb-' following the Omani sovereign upgrade in August 2022. This signals improvements in operating conditions in the context of higher oil prices, which will drive credit demand and ease pressures on banks' financial profiles.

Adequate Business Profile: HBON's business profile incorporates benefits from being part of the HSBC group, which provides the bank with competitive advantages, including a well-known brand, access to large and international corporates, and the ability to participate in larger government-related projects supported by the parent through the provision of guarantees to manage single name concentration limits.

Conservative Risk Profile: Fitch's overall assessment of the bank's risk profile considers cautious loan growth, good reporting and appropriate risk control tools, which mitigate risks associated with high levels of concentration.

Sound Asset Quality: HBON's Stage 3 loans ratio of 3.4% at end-2022 (end-2021: 3.2%) was one of the lowest in the sector, while reserve coverage is consistently maintained above 100% (end-2022: 115%). Non-loan assets, which were about 44% of HBON's end-2022 total assets, are of good quality in the local context, comprising Omani government securities, cash and placements with highly-rated banks.

Sound Profitability but Below Peers': HBON's profitability rebounded strongly in 2022 with net income up 46% vs. 2021 owing to 10% growth in operating income, lower operating expenses, and releases of expected credit loss provisions. However, through the cycle profitability (the operating profit to risk-weighted assets ratio has averaged 1.3% in the last four years) remains lower than larger peers due to a higher proportion of lower-yielding non-loan assets and a higher cost structure, although it has improved over the past three years.

Sound Capitalisation: The bank's common equity Tier 1 (CET1) ratio (24.1% at end-2022) is the highest in the sector, benefiting from a larger share of total assets in the form of securities with low risk weighting and sound internal capital generation. HBON's CET1 minimum requirement of 8.25% provides a sizeable buffer to absorb asset quality shocks or declining collateral values.

Stable Funding; Strong Liquidity: Stable customer deposits account for a high proportion of total funding (end-2022: 97%), with 67% low cost current accounts and savings accounts. Liquidity is strong with a liquidity coverage ratio and a net stable funding ratio of 442% and 167%, respectively, at end-2022.

Rating Sensitivities

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

HBON's Long-Term IDR, SSR and VR could be downgraded and withdrawn upon the completion of the merger with SIB as the bank will cease to exist as a legal entity.

A downgrade of Oman's Country Ceiling would likely lead to a downgrade of HBON's IDRs and GSR.

HBON's VR is 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%). A funding stress, in the form of large government deposits exiting the banking system and materially affecting HBON's liquidity profile, could also be negative for the VR.

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

An upgrade of Oman's sovereign rating and an upward revision of Oman's Country Ceiling could result in an upgrade of HBON's IDR.

Positive rating action on HBON's VR is unlikely given the RWN.

HBON's IDRs, SSR and VR could be affirmed if the merger does not go ahead.

VR ADJUSTMENTS

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

The business profile score of 'bb-' has been assigned above the 'b' category implied score due to the following reason: group benefits and risks (positive).

The earnings and profitability score of 'b+' has been assigned below the 'bb' category implied score due to the following reason: earnings stability (negative).

The capitalisation and leverage score of 'bb' has been assigned below the 'bbb' category implied score due to the following reason: risk profile and 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

HBON's IDRs are linked to HSBCs and indirectly to the sovereign rating.

ESG Considerations

The highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on HBON, either due to their nature or to the way in which they are being managed by HBON. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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