OREANDA-NEWS. Fitch Ratings has assigned Mongolia-based State Bank LLC a Long-Term Issuer Default Rating (IDR) of 'B' with a Negative Outlook. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS - IDRS, SUPPORT RATING (SR) and SUPPORT RATING FLOOR (SRF)

The IDRs, SR and SRF of State Bank reflect Fitch's view that it would be the domestic bank most likely to receive state support in case of need. This assessment reflects State Bank's strong relationship with the government as evidenced by its 100% state-ownership and the Ministry of Finance has seconded personnel to take up key positions at the bank. Furthermore, State Bank is Mongolia's fourth-largest bank with a 13% share of total system deposits. It maintains a comparatively strong nationwide retail banking presence and the authorities have designated it one of the country's six systemically important banks.

State Bank emerged from the government's efforts to maintain banking sector stability by bailing out two failed banks: Zoos Bank, which failed in 2009, and Savings Bank in 2013.

KEY RATING SENSITIVITIES - IDRS, SUPPORT RATING and SUPPORT RATING FLOOR

The IDR is driven by the SRF and as such State Bank's ratings are sensitive to Fitch's assessment around the likelihood for government support. Fitch applies a one-notch differential between the Long-Term IDR of the sovereign (B+/Negative) and State Bank's SRF. A potential change in the government's ownership, which is not yet reflected in these ratings, could lead to a wider notching if Fitch believed this would impact the state's willingness to provide support.

The Negative Outlook indicates that a downgrade of Mongolia's sovereign rating would result in a downgrade of State Bank's IDR, SRF and SR.

Positive action on the IDR could derive from the sovereign's stronger ability and propensity to provide support or from a substantial improvement in State Bank's intrinsic financial strength, as expressed in the Viability Rating (VR). In accordance with Fitch's bank rating methodology, the IDR is the higher of the SRF or the VR.

KEY RATING DRIVERS - VIABILITY RATING

State Bank's VR reflects the bank's leading franchise and adequate asset quality, characterised by limited foreign currency lending (2.3% of total loans at end-November 2014). The rating also captures the bank's limited loss absorption capacity, moderate profitability and Fitch's assessment of corporate governance, which is considered weaker than privately-owned peers' due to the lack of external or international shareholder representation.

The bank's Fitch core capital ratio of 13.8% at end-1H14 compares favourably with peers'. This calculation applies a 100% risk weighting to zero-risk weighted loans under the government subsidy scheme for which the credit risks reside with the banks. State Bank's capital, however, also benefits from substantial property revaluation reserves (1.2% of regulatory risk-weighted assets at end-2014), which render the tight regulatory total capital ratio particularly susceptible to fluctuations in property prices. The regulatory total capital ratio was 15.1% at end-2014 compared to the minimum requirement of 14%.

Liquidity is adequate with the bank maintaining a low 83.8% loan-to-deposit ratio at end-1H14 compared with peers'. Profitability is weakened by low revenue contribution from non-loan businesses and high operating costs from managing its large branch network. In addition the bank incurred non-recurring expenses related to performing structural adjustments and improving bank practices following the takeover of Savings Bank's non-problematic assets. Furthermore, the regulator's 60% net loan to asset cap constrains State Bank's growth and profitability.

RATING SENSITIVITIES - VIABILITY RATING

An upgrade of the VR would result from a substantial improvement in capital and an extended track record in performance and loan quality. The ratings could be downgraded if there is material erosion of capital, including from fluctuations in property prices. Intensifying pressure on the corporate loan portfolio from a further deterioration of the operating environment, resulting in a significant weakening of loan quality, could also result in a downgrade.

The rating actions are as follows:

Long-Term Foreign Currency IDR assigned at 'B'; Outlook Negative
Long-Term Local Currency IDR assigned at 'B'; Outlook Negative
Short-Term Foreign Currency IDR assigned at 'B'
Support Rating assigned at '4'
Support Rating Floor assigned at 'B'
Viability Rating assigned at 'b-'