By Andy Sambidge
Rating agency says it expects challenging credit and business conditions to continue.
Moody's on Thursday assigned a negative outlook for Bahrain's banking system, reflecting expectations that challenging credit and business conditions will continue over the medium term.
Although the Gulf state's economy is set to see a modest rebound in 2010, the rating agency said weaknesses would remain in its real estate sector which would impact the rest of the economy.
The negative outlook was also driven by the more severe challenges at investment banks, which in many cases do not possess sufficient franchise depth to cope with the sharply lower private investment activity and depressed regional asset values, Moody's added.
The negative outlook also assumes further deterioration in at least some aspects of Bahraini banks' franchises and risk profiles, the agency added in a new report.
It said it sees possible further increases in non-performing loans, with banks' significant construction and real estate exposures being an area of particular concern.
George Chrysaphinis, Moody's analyst, said: "Our current assessment is that although real estate loan quality has generally remained robust so far, continued weakness in this sector will eventually feed through to banks' loan portfolios, both directly and indirectly through loan exposures to other sectors of the economy."
The report also noted that with the severity and timing of real estate-related losses still uncertain, Moody's did not currently believe it was necessary to adjust Bahraini bank ratings downwards.
"However, we will continue to monitor the condition of real estate borrowers in Bahrain and could revise our view if it appears that the size of likely losses could threaten banks' financial health," added Chrysaphinis.
Despite these negative factors, significant positive factors remain, Moody's report said, with the strong capitalisation of most retail and wholesale banks providing "significant loss-absorption capacity".