OREANDA-NEWS. Fitch Ratings has revised the Outlooks on 20 mid-sized and small Russian banks to Negative from Stable. The action reflects Fitch's expectation that the sharp deterioration in the Russian operating environment will negatively impact the banks' credit profiles in 2015.

The banks are Credit Bank of Moscow (CBOM, BB), Bank Saint Petersburg OJSC (BSPB, BB-), Bank Zenit (Zenit, BB-), Chelindbank (Chelind, BB-), Rosevrobank (REB ,BB-), Locko-bank (Locko, B+), Primsotsbank (B+), Novosibirsk Social Commercial Bank Levoberezhny, OJSC (Levoberezhny ,B+), Sovcombank (SCB, B+), Tinkoff Credit Systems (Tinkoff, B+), JSC SDM-Bank (SDM, B+), JSC Asian-Pacific Bank (APB, B+), Absolut Bank (Absolut, B+), Evrofinance Mosnarbank (EMB, B+), JSC Bystrobank (Bystro, B), SKB-Bank (SKB, B), Expobank LLC (Expobank, B), JSC Spurt Bank (Spurt, B), Pervobank (PB, B), Uraltransbank (UTB, B-).

At the same time, the agency has affirmed the Long-term Issuer Default Ratings of two Russian banks - Novikombank and Russian Universal Bank - at 'B' with Stable Outlooks, and withdrawn without affirmation the ratings of Promsvyazbank (PSB).

Most rated Russian banks not covered in this commentary are already on Negative Outlook, either because their ratings are linked to those of the Russian sovereign (BBB/Negative) or because of bank-specific negative trends in their stand-alone credit profiles.

The revision of the banks' Outlooks to Negative reflects Fitch's expectation that economic recession, significantly increased funding costs, sharp rouble depreciation, closed wholesale funding markets, a challenging liquidity situation and rising inflation will weigh on the banks' credit profiles. At the same time, the affirmation of the banks' ratings reflects (i) their moderate resilience to the weaker operating environment, as financial metrics are for the most part currently reasonable; and (ii) sovereign support for the sector, in the form of regulatory forbearance, liquidity provision and potential capital injections, which should reduce near-term pressures.

Asset quality is a key driver for all banks on Negative Outlook. Most of them had non-performing loan (NPL) ratios in single digits at end-1H14 (APB, Tinkoff, Bystro, SKB and UTB had higher ratios, reflecting their retail/small business focus), notwithstanding moderate growth in NPL ratios by 1-6 pct in 1H14, and these were well covered (at least by 80%) by reserves. However, economic recession (we forecast GDP to contract by 2.8% in 2015, and the downturn may be even more severe in the case of tightened sanctions, accelerated capital flight or a further fall in oil prices), higher interest rates and the weaker rouble are likely to lead to a more marked deterioration in corporate asset quality. Already large credit losses in retail-focused banks (Tinkoff, SCB, SKB, Bystro and APB) are also likely to further widen due to a reduction in real household incomes resulting from high inflation and rouble devaluation.

Banks' generally moderate capitalisation (although more solid at Tinkoff, Chelind and EMB) will be hit by sizable mark-to-market losses on bond portfolios, an upward revaluation of foreign currency risk-weighted assets and, over the long-term, by increased impairment charges, although regulatory forbearance will to varying degrees prevent these effects from being recognised in statutory accounts. The authorities have also announced planned recapitalisation measures, including up to RUB1trn of non-cash subordinated loans and preference shares via Depository Insurance Agency, although it is not yet clear whether this will be available to all medium-sized and smaller banks and on what terms.

Profitability has moderated in 2014 due to higher impairment charges and funding costs, and both are likely to significantly increase further, especially the latter after the recent Central Bank of Russia interest rate hike to 17% from 10.5%. Banks are likely to find it difficult to pass on higher funding costs to borrowers without compromising asset quality, in Fitch's view. Banks with a higher share of current accounts in their liabilities (REB, SDM, Spurt, PB) may be more resilient to funding cost increases, although it may be more difficult to retain such free funding in a higher rate environment.

Liquidity risks have increased, as significant rouble devaluation has triggered a wave of deposit withdrawals/currency conversions. The reviewed banks on average experienced outflows (adjusted for exchange rate effects) equal to 5-6% (the lowest being 1% and the highest above 10% at some banks) of their customer funding in the first half of December, although they had sufficient liquidity buffers to cover these. Banks have already increased deposit rates and cut new lending to retain customers and preserve liquidity. The authorities also doubled the limit for insured deposits to RUB1.4m from RUB0.7m to restore customer confidence. The liquidity squeeze has eased somewhat in the last few days as the rouble stabilised, but remains potentially volatile. The CBR has relaxed collateral requirements for its secured loans and committed to provide liquidity facilities (including in FX) to support the sector, if needed.

Refinancing risks are generally limited, as most of the reviewed banks are deposit-funded. Of those banks with substantial market borrowings (CBOM, 24% of total liabilities; Locko, 30%; Zenit, 14%; and Tinkoff, 40%) only Locko and Tinkoff have material repayments (around 25% of liabilities) in 2015 but which are mitigated by reasonable liquidity buffers and, in the case of Tinkoff, additionally by a rather short-term loan book. CBOM and Zenit have longer-term maturities with amount falling due in 2015 not exceeding 11% of liabilities. However, if access to wholesale funding is closed for a prolonged period of time and if banks need to deleverage to make repayments, this could have negative implications for profitability and asset quality.

The banks on Negative Outlook could be downgraded if (i) the weaker operating environment translates into deterioration of their financial metrics; (ii) prospects for Russia's economy and macroeconomic stability continue to deteriorate significantly; or (iii) banks become considerably more dependent on regulatory forbearance or support from the Russian authorities.

The affirmations of Novikombank and Russian Universal Bank with Stable Outlooks reflect their expected greater resilience to the more challenging operating environment. For Novikombank this is derived from the benefits of support from majority shareholder, state corporation Rostec, and for Russian Universal Bank from its large capital and liquidity buffers and niche franchise. The ratings of Novikombank could come under downward pressure from failure to receive timely support when required and in the case of  Russian Universal Bank from its niche franchise being subject to regulatory pressure.

Fitch has also withdrawn the ratings of PSB without affirmation, as the issuer has chosen to stop participating in the rating process. Therefore, Fitch will no longer have sufficient information to maintain the ratings. Accordingly, Fitch will no longer provide ratings (or analytical coverage) for PSB. In Fitch's view, the bank is likely to face similar pressures on its stand-alone credit profile as other banks covered in this commentary. However, as a larger and systemically important institution, PSB may be more likely to benefit from government support, in case of need.

The banks' senior unsecured debt is rated in line with their Long-term IDRs and National Ratings (for domestic debt issues). The subordinated debt ratings of CBOM and BSPB are notched down one level from their VRs (the banks' VRs are in line with their Long-term IDRs), in line with Fitch's criteria for rating these instruments.

Changes to the banks' Long-term IDRs, VRs and National Ratings would likely impact the ratings of both senior unsecured and subordinated debt.

All banks' '5' Support Ratings reflect Fitch's view that support from their private shareholders cannot be relied upon. The Support Ratings and Support Rating Floors of 'No Floor' also reflect that support from the Russian authorities, although possible, is not factored into the ratings due to the banks' still small size and lack of overall systemic importance.

The Support ratings may be upgraded if the banks are acquired by stronger institutional shareholders.