S&P: Salama/Islamic Arab Insurance Co. Downgraded To 'BBB-' On Weaker Financial Risk Profile And Liquidity; Outlook Negative
The downgrade reflects our opinion that Salama's financial risk profile, asset quality, and liquidity have materially deteriorated as a result of multiple factors including severe losses seen in 2015 and forecast for 2016, the deconsolidation of the Best Re subsidiary (now in run-off), and a high proportion of investments in unrated and speculative-grade bonds and deposits.
Salama's capital adequacy weakened in 2015 to very strong from extremely strong due to accumulated losses of United Arab Emirates (UAE) dirham (AED) 163 million and forecast losses for 2016. In addition to the losses, Salama decided to deconsolidate one of its subsidiaries (Best Re), which is currently in run-off with net assets of AED117 million, which are fully written off from our capital adequacy calculations as there is very little chance of any recovery. We consequently revised our capital and earnings assessment to moderately strong from very strong. We do not see material improvements in the capital adequacy in 2016 due to the aforementioned factors and volatile operating performance in Salama's UAE motor portfolio. Our forecast does take into account some recovery in 2017-2018 but this is not sufficient to restore the extremely strong capital adequacy. While there are signs that management is taking necessary steps to ensure these losses do not reoccur, the amount of losses already accounted for in the financial statements have materially deteriorated the capital adequacy.
We reassessed Salama's risk position to high risk from moderate risk predominantly due to its increased proportion of investment in high risk assets (equities, real estate, and unrated and speculative-grade bonds and deposits), relative to a weakened capital position.
Apart from the fall in factors that determine the financial risk profile (capital and earnings and risk position), the financial risk profile score is also capped at less than adequate--from previously strong--as a result of average asset quality in the 'BB' range. Of AED611 million in total investments in bonds and deposits, AED540 million (88%) is held in unrated or speculative-grade instruments.
We take the view that Salama's liquidity is also under stress. As per our liquidity model, we believe that total stressed assets only cover 113% of the total stressed liabilities. The primary factors behind this deteriorated ratio are Salama's investments in illiquid instruments such as private equity and unrated and speculative-grade bonds and deposits.
The negative outlook reflects our expectation that Salama's financial risk profile and liquidity might further deteriorate over the outlook period.
We would consider further downgrades in the next 12 months if:Salama's average asset quality further deteriorated to the 'B' range. Salama's liquidity further weakened to less than adequate or we observed a severe risk to Salama's liquidity. We assessed material weakness in risk controls implemented by Salama and therefore changed our enterprise risk management assessment to weak. As a result of severe losses and negative market indicators, we assessed Salama's competitive position as less than adequate. We would consider revising the outlook to stable if Salama improved the credit quality of its investment portfolio by moving away from unrated and speculative-grade bonds and deposits, which might also improve its liquidity ratio.
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