OREANDA-NEWS. Fitch Ratings has revised the Outlooks on the Long-term Issuer Default Ratings (IDRs) of Russian leasing companies Europlan CJSC (BB), Carcade LLC (BB-) and Baltic Leasing OJSC (BaltLease; B+) to Negative from Stable. The companies' ratings have been affirmed. A full list of rating actions is at the end of this commentary.

The rating actions reflect Fitch's expectation that the sharp deterioration in the Russian operating environment will negatively impact the companies' credit profiles in 2015.

KEY RATING DRIVERS - IDRS AND NATIONAL RATINGS
The revision of the Outlooks reflects Fitch's expectation that economic recession, significantly increased funding costs, declining car sales and rising inflation will weigh on the companies' credit profiles. At the same time, the affirmation of the companies' ratings reflects their moderate resilience to the weaker operating environment, as financial metrics are currently reasonable.

The companies are the leading private leasing companies in Russia. Europlan and Carcade are pure retail, predominantly autoleasing companies (passenger cars, trucks and light commercial vehicles (LCV) made up 79% to 92% of their lease books at end-1H14), while BaltLease has a more diversified, albeit less liquid lease book (passenger cars, trucks and LCV made up only 45% of the lease book at end-1H14, with the remainder represented by special-purpose equipment).

Asset quality metrics have been reasonable to date, with credit losses after collateral foreclosures not exceeding 1% for each of the companies in 1H14. The companies mainly target the SME segment, which in Fitch's view is likely to be more vulnerable to an economic downturn. Default rates (probability of default on leases) at Europlan and Carcade reached 24% and 18% during the 2008-2009 crisis, but robust collateral coverage (all companies require a down-payment of around 25%) underpins the recovery process, resulting in moderate final losses at 3.8% and 5.7%, respectively.

The companies are predominantly bank funded. Refinancing risk arises due to the current stress and greater risk aversion in the Russian banking system. However, this is mitigated by the short tenors of lease books, which largely match funding maturities. Nonetheless, a sharp deleveraging scenario could significantly undermine company franchises and weaken performance. Europlan and Carcade have diversified bank loan portfolios, but are more dependent on market funding than BaltLease, which at end-1H14 raised 56% of its liabilities from banks affiliated to Otkrytie group.

The historically high profitability of the leasing sector contracted in 2014 due to competitive pressure from state-owned companies and large banks. Net income divided by average earning assets softened at Europlan and Carcade to a still reasonable 3.2% and 2.4% in 1H14 from 3.9% and 4% in 2013. BaltLease's ratio was a still solid 4.3% in 1H14. However, Fitch expects some further deterioration in performance due to (i) the adverse economic environment in Russia, which will probably result in higher default rates; (ii) declining car sales, which will likely restrict volumes in the high-yielding retail business; and (iii) more expensive funding.

Capitalisaiton is generally satisfactory, albeit somewhat stronger at Europlan and Carcade (debt-to-equity ratios of 4.6x and 5.2x, respectively, at end-1H14) compared with BaltLease (6.5x). Leasing companies' capital adequacy is not regulated in Russia, but funding covenants set maximum debt-to-equity ratios at 6x for Europlan and Carcade and 9x for BaltLease. Each of the companies can sustain moderate losses without breaching these covenants, in particular in light of potential deleveraging.

KEY RATING SENSITIVITIES - IDRS AND NATIONAL RATINGS
The companies could be downgraded if (i) the weaker operating environment translates into significant deterioration of their financial metrics; or (ii) prospects for Russia's economy and macroeconomic stability weaken further beyond Fitch's current expectations. The ratings could stabilise at current levels if the Russian economy performs better than currently anticipated and the companies' performance remains sound.

KEY RATING DRIVERS AND SENSITIVITIES: SENIOR UNSECURED DEBT RATINGS
Senior debt ratings are currently aligned with the companies' IDRs and National ratings. The ratings could be downgraded in case of a lowering of the IDRs/National ratings, or a marked increase in the proportion of pledged assets, potentially resulting in lower recoveries for the unsecured senior creditors in a default scenario. At end-1H14, Europlan and BaltLease had pledged around 60% of net investments in leases, compared with 32% at Carcade.