OREANDA-NEWS. S&P Global Ratings today affirmed its 'BB-/B' long - and short-term counterparty credit ratings on Russia-based Promsvyazbank. The outlook is negative.

We also affirmed our 'ruAA-' Russia national scale rating on the bank.

The affirmation reflects our view that Promsvyazbank's tier 1 capital increases of Russian ruble (RUB) 12.1 billion (about $190 million) in the first half of 2016 and RUB 15.7 billion in 2015, should reduce short-term pressure on the bank's capital ratios, somewhat offsetting weakened profitability.

However, we continue to view Promsvyazbank's capital and earnings as weak, reflecting our belief that the bank's risk-adjusted capital (RAC) ratio (as measured by S&P Global Ratings' RAC framework) will remain within the 3.0%-3.3% range in the next 12-18 months, despite recent initiatives to strengthen core capital. We also believe that downside risks to this forecast could be material.

The weakened economic conditions in Russia and high concentrations in the bank's loan book resulted in higher credit costs and therefore a weaker overall reported financial performance in 2015, with net losses of RUB16.4 billion and credit costs of 5.8% of the bank's average gross loan portfolio for 2015. We note that for the first six months of 2016, Promsvyazbank posted a net profit of RUB1.6 billion, largely supported by the positive revaluation (plus RUB8.4 billion for the first six months of 2016) of investment property received from the major shareholder, rather than core profitability improvements. We note that recent initiatives to strengthen the bank's capital are partly offsetting potential losses. However, the bank's prospective capital position will also depend on future asset quality and net interest margin recovery.

In our view, internal capital generation continues to constrain the bank's credit quality, because we do not believe that earnings retention alone will boost capitalization sufficiently. In addition, we believe that noncore assets, notably investment property and assets held for sale (about 7% of total assets as of June 30, 2016), tie up capital and limit the bank's financial flexibility considerably. We believe that these assets increase the bank's vulnerability to market risk, due to the change in valuations and liquidity risk, which are a result of the illiquid nature of these assets. Should this exposure increase further, it might lead us to revise the bank's risk position downward.

The bank's annualized credit costs for the first six months of 2016 stabilized at about 4%, and we expect they will remain within the 3.5%-4.0% range in 2016. As of the same date, the bank's nonperforming loans (NPLs; loans overdue by 90 days or more) increased to 7.8% from 4% at end-2015. However, we continue to assess Promsvyazbank's risk position as adequate, because we believe that the bank's risk profile is not materially different from the average risk profile of a Russia-based financial institution. Our opinion is also supported by NPLs' provisioning coverage of 110%. We note that, in 2015, the bank managed to attract large higher-quality borrowers, benefitting from increased demand for corporate loans in an environment where external markets are closed to top-tier Russian corporations. This could curb the bank's credit risk, in our view.

In 2015, the bank's majority parent Promsvyaz Capital B. V. acquired Vozrozhdenie Bank, with total assets of about RUB223 billion as of June 30, 2016. We understand the banks will continue to operate as separate legal entities and will not be merged in the next 12-18 months.

We consider Promsvyazbank to have moderate systemic importance in Russia's banking sector, given its strong market presence and well-developed branch network nationwide. The bank's customer deposit market share is about 1.8%, which we consider sizable, given the market's high concentration. Among the bank's key clients are large Russian corporate entities, including government-related entities, which we believe also signals the bank's relative importance in the context of Russia's banking sector. Therefore, we incorporate one notch of uplift to the bank's stand-alone credit profile of 'b+' for the moderate likelihood of extraordinary government support that might be available for the bank if needed.

The negative outlook primarily reflects our concerns about the high operating risks in Russia, as well as potential downside risks to the bank's asset quality and capital position, which we believe could materialize in the next 12-18 months.

We could take a negative rating action if the bank's asset quality deteriorates by more than we currently expect, or the workout of problem assets becomes more prolonged. A negative rating action could also follow if the RAC ratio falls below 3% due to higher-than-expected growth, higher reported losses, or other one-time effects, such as a risky merger or acquisition, which could put downward pressure on the bank's financial profile.

An outlook revision to stable would depend on the stabilization of operating conditions in Russia and of the bank's own financial profile.