OREANDA-NEWS. July 11, 2011. Standard & Poor's Ratings Services commented on its CreditWatch placement of Russian bank JSC VTB Bank (VTB) and subsidiaries. The 'BBB' long-term counterparty credit ratings on VTB and its subsidiaries VTB-Leasing and VTB-Leasing Finance remain on CreditWatch, where we placed them with negative implications on March 1, 2011. We are also maintaining the 'ruAAA' Russia national scale ratings on VTB and VTB-Leasing on CreditWatch with negative implications. At the same time, we affirmed the 'A-3' short-term ratings on VTB and VTB-Leasing, reported the press-centre of KASE.

The Central Bank of Russia (CBR) and Deposit Insurance Agency (DIA) announced a rehabilitation plan, to prevent Bank of Moscow's (BoM; not rated) bankruptcy. In the first quarter, VTB purchased, for RUB (Russian ruble) 103 billion, a 46.5% direct stake in BoM and 25% plus one share of Metroplitan Insurance Group (not rated), which itself owns 17.3% in BoM. We placed the long-term ratings on VTB on CreditWatch negative at that time to take into account the potential negative impact on VTB's capital, uncertainties about BoM's asset quality, and the risks of integrating BoM into the VTB group.

The CBR's recent negative revelations about BoM have prompted us to extend our CreditWatch placement. The central bank's announcements indicate fraudulent activities and potential losses that might be large enough to make BoM unable to meet minimum regulatory capital requirements. In broad lines, the announced rehabilitation plan calls for the CBR to make a five-year deposit of RUB295 billion (USD10 billion) with an annual interest rate of 0.5%, below the market rate, in the DIA. Concurrently, the DIA is to deposit the same amount at an interest rate of 0.51% in BoM for 10 years. VTB has announced that BoM will invest the proceeds in Russian government bonds and that BoM will be able to "book a profit with an economic effect of RUB150 billion." As part of the plan, VTB has stated it will commit to provide BoM additional capital of up to RUB100 billion by year-end 2012.

The DIA has named two VTB group members - VTB Pension Administrator and VTB Debt  Center--as administrators of BoM during the rehabilitation. Under the rules of the rehabilitation, the administrators must have a minimum 75% shareholding in BoM. Consequently, VTB intends to increase its stake in BoM to at least 75% over the coming weeks.

While the rehabilitation plan demonstrates significant support for BoM from the government via the DIA, it also means that VTB is increasing its ownership in a large bank with a much higher concentration of impaired loans than originally anticipated. In our opinion, the recent events surrounding BoM illustrate lingering asset quality problems from the 2009 recession and gaps in the supervision of large financial institutions in Russia.

We believe that the integration of BoM, the fifth-largest bank in Russia, will strengthen VTB's business position in the Moscow region, the country's wealthiest economic area. BoM has 9 million retail customers and a large base of corporate and institutional clients including the City of Moscow. Still, the acquisition of BoM, combined with the less material purchase of TransCreditBank (BB/Stable/B; ruAA) in 2011, will weaken VTB's capital, in our view. The integration of BoM within VTB group also carries execution risks.

Under our methodology, VTB is a government-related entity (GRE). In our opinion, the probability that the Russian government would provide timely and sufficient extraordinary support to VTB in case of need is extremely high, due to VTB's critical role and very strong link to the Russian government. Consequently, VTB's long-term rating incorporates four notches of uplift above its stand-alone credit profile, which we assess at 'bb-'.

We will resolve the CreditWatch in the coming weeks after we review BoM's loan portfolio, VTB's plans to integrate BoM, and VTB's capital management in light of the rehabilitation plan for BoM.  At this stage, if we were to lower the long-term ratings on VTB and its subsidiaries following our review, we would likely lower them by no more than one notch.