OREANDA-NEWS. Fitch Ratings has affirmed AK BARS Bank's (ABB) Long-Term Foreign Currency IDR at 'BB-' with a Negative Outlook. At the same time, the agency has downgraded ABB's Viability Rating (VR) to 'ccc' from 'b-'. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS, SENIOR DEBT, NATIONAL AND SUPPORT RATINGS

The affirmation of ABB's IDRs, Support, National and senior debt ratings reflect Fitch's view of the moderate probability of support the bank may receive, in case of need, from the Republic of Tatarstan (RT, BBB-/Negative). This assessment takes into account (i) RT's majority ownership; (ii) the close association between the bank and the regional administration (RT's representatives sit on ABB's board); (iii) ABB's agent function for the RT budget and systemic importance in the region (market share of around 40%); and (iv) the recent track record of support.

The three-notch difference between RT's and the bank's ratings reflects the limited flexibility of the RT budget, which may impede its ability to provide support in a necessary amount and in a timely manner at all times given the bank's relatively large size. This risk is offset somewhat by the ability to provide support through RT-affiliated entities, as has been recently demonstrated. The notching also reflects significant corporate governance weaknesses at ABB, given its large and weakly-reserved related party and relationship-based lending exposure, which together with other risky and non-core assets amounted to a sizable 4.9x Fitch Core Capital (FCC) at end-1Q16. Coupled with weak core profitability, this could make support costly and less politically acceptable.

At end-1Q16, a 63% stake in ABB (up from 51% at end-1H15) was controlled by RT through its Ministry of Property, the RT-controlled Svyazinvestneftekhim (SINEK; BB+/Negative) and the State Housing Fund under the President of Tatarstan (HFPT).

In 2H15, ABB received an RUB9.8bn equity injection from HFPT and also recognised a RUB16.2 gain from the sale of RUB29bn of risky assets to RT-affiliated entities at above their net value, albeit the majority of sale proceeds were in non-cash form (listed shares of Russian companies rated in 'BBB'/'B' categories by Fitch and receivables of more such shares) , which undermines the quality of this support. The capital support was largely consumed by losses the bank incurred in 2015, and the bank's weak core capitalisation, as reflected in the FCC ratio, has therefore not improved.

VR

The downgrade of the bank's VR reflects the limited progress in derisking the balance sheet. Asset quality and capitalisation remain under pressure in light of sizable weakly-secured exposures to high-risk assets and only marginal capacity to absorb potential credit losses through capital and pre-impairment profits. On the positive side, the VR factors in large and stable funding from the budget and RT affiliated entities, and moderate refinancing risks in the medium term.

Reported NPLs (loans overdue by 90 days or more) were a moderate 5% of loans at end-2015 (mostly in the retail book) and were adequately reserved. However, certain weakly reserved corporate exposures of a relationship/related-party nature (which although not NPLs are considered very risky by Fitch) and investment property together amounted to a sizable RUB141bn net of reserves or 4.9x of FCC. These increased from RUB116bn, or 4.2x of FCC, at end-2014 despite the sale of certain high-risk loans to RT-related entities in 2015.

Fitch believes the origination of these exposures raises significant corporate governance risks, while their recoverability may be lengthy and most likely would require additional capital support and/or problem loan buy-outs from the authorities or related entities.

The high risk exposures net of reserves include:

- RUB25bn (0.9x FCC) of receivables from RT-related companies in the form of listed shares of a Russian company. According to management, RUB7bn of this was repaid in April 2016, with the bank receiving more of these shares;

- RUB15bn (0.5x FCC) loans to a shell company ultimately used, according to management, to refinance SINEK's Eurobond in 2015;

- RUB40bn (1.4x FCC) of long-term construction/real estate loans (with considerable non-completion risks), mainly related to RT-administration;

- RUB10bn (0.3x FCC) blank loan to HFPT, the bank's new shareholder, used to purchase risky real estate from the bank;

- RUB18bn (0.6x FCC) of unsecured or weakly-secured loans to investment companies. Management reported that RUB10bn of this were repaid in June 2016;

- RUB19bn (0.7x FCC) of other related-party/relationship loans and/or high risk exposures;

- RUB14bn (0.5x of FCC) of investment property/non-core assets, mostly comprising land and commercial real estate in RT.

According to management, one of ABB's shareholders provided RUB22bn of sureties at end-1Q16 against some of these exposures, but Fitch considers these to be a weak mitigant. Some additional risks may also be identified as a result of the ongoing review of the bank by the Central Bank of Russia.

ABB's core capital ratios have not improved since end-2014, as capital support has been largely consumed by losses, and therefore remain very weak (FCC ratio of 7% at end-2015), especially relative to the significant unreserved high-risk exposures. The regulatory capital cushion at end-1Q16 was sufficient to increase reserves by only 2% of loans, while core pre-impairment profitability (net of one-offs, securities revaluation gains and accrued but not received interest income) was slightly above break-even in 1Q16 after being deeply negative in 2015. Net income in 1Q16 was supported by significant revaluation gains, as equity and debt markets rebounded.

Fitch believes there are also risks with regards to the quality of RUB14bn of Tier 2 capital, which in the agency's view could have been financed from the bank's balance sheet through the posting of excess collateral in a direct repo transaction.

The liquidity buffer (of cash, net short-term interbank placements and unpledged liquid securities) net of near-term wholesale repayments was sufficient to withstand around 20% deposit outflow at end-1Q16. Liquidity mangement is supported by limited near-term refinancing risks (no bulky wholesale repayments after ABB refinanced its USD500m eurobond in 2015) and fairly sticky corporate customer funding from budget/RT-related entities.

SUBORDINATED DEBT

ABB's 'old-style' (without mandatory conversion triggers) subordinated debt is rated two notches below its Long-Term IDR. The rating differential reflects one notch for incremental non-performance risk (in Fitch's view, the risk of default on subordinated debt could be moderately higher than on senior obligations in a stress scenario) and one notch for potential loss severity (lower recoveries in case of default).

RATING SENSITIVITIES

IDRS, DEBT RATINGS, SUPPORT AND NATIONAL RATINGS

The Negative Outlook on ABB reflects that on RT's ratings. ABB's IDRs could be downgraded if either (i) the RT is downgraded (e. g. as a result of a sovereign downgrade); or (ii) the scale of ABB's support requirement increases, potentially reducing the RT's ability or propensity to provide assistance to the extent needed.

The Outlook could be revised to Stable, thereby implying a potential reduction of notching between RT and ABB to two notches, if the bank considerably reduces the amount of high-risk assets or the authorities provide sufficient equity to cover the associated credit risks.

VR

Downward pressure on the Viability Rating (VR) could stem from potential further deterioration in asset quality, resulting in renewed weakening of the capital position, or if other significant risks arise as a result of the regulatory review, and these are not promptly addressed by the RT. An upgrade of ABB's VR would require a significant reduction of high-risk assets or a strengthening of capital.

The rating actions are as follows:

Long-Term Foreign and Local Currency IDRs: affirmed at 'BB-', Outlook Negative

Short-Term Foreign Currency IDR: affirmed at 'B'

National Long-Term rating: affirmed at 'A+(rus)', Outlook Stable

Viability Rating: downgraded to 'ccc' from 'b-'

Support Rating: affirmed at '3'

Senior unsecured debt: affirmed at 'BB-'

Senior unsecured debt National rating: affirmed at 'A+(rus)'

AK BARS Luxembourg S. A:

Senior unsecured debt long-term rating: affirmed at 'BB-'

Senior unsecured debt short-term rating: affirmed at 'B'

Subordinated debt: affirmed at 'B'