OREANDA-NEWS. Fitch Ratings has downgraded the Long-term Issuer Default Ratings (IDRs) of Russia-based Uralsib Bank (UB) and its subsidiary, Uralsib Leasing Group (ULG), to 'B' from 'B+'. The Outlook on UB is Stable and Negative on ULG. A full list of rating actions is at the end of this commentary.

KEY RATING DRIVERS AND RATING SENSITIVITIES - UB's RATINGS
The downgrade of UB's Viability Rating (VR), and consequently its IDRs, reflects continued pressure on the bank's capitalisation, and weaker prospects for an improvement in solvency given the more difficult operating environment. In Fitch's view, increased funding costs and impairment charges, in line with market trends, are likely to further undermine UB's already weak profitability and internal capital generation. At the same time, the VR considers UB's limited near-term wholesale funding repayments and stable deposit franchise.

UB's regulatory core Tier 1 ratio was a moderate 6.9% at end-February 2015, down from 7.7% at end-3Q14, while the Fitch Core Capital (FCC)/risk-weighted assets ratio stood at 9.5% at end-1H14, based on the bank's latest IFRS accounts. Fitch views capitalisation as weak because of the bank's large holdings of non-core assets and related party exposures, in total equal to 1.4x FCC at end-1H14. These include investments in insurance company SG Uralsib (SGU, equal to 0.6x FCC) and real estate (0.6x FCC), and related party exposures (0.2x FCC). In Fitch's view, the investment in SGU and some of the real estate holdings are aggressively valued, and prospects for sales/work-outs have further weakened in the current operating environment, meaning additional provisioning may be required.

UB makes annual deductions from its regulatory core Tier I capital equal to 20% of the bank's investment in SGU, with the last such deduction made in January 2015. Offsetting this and supporting regulatory capitalisation was a RUB4bn subordinated debt issue in December 2014 (converted into a perpetual in February 2015), a RUB5bn exchange of 'old style' subordinated debt into 'new style' debt in January 2015, some deleveraging, and regulatory forbearance with respect to using end-3Q14 exchange rates for the calculation of foreign currency risk-weighted assets (about 25% of the total). As a result, the total regulatory ratio slightly improved to 11.7% at end-February 2015 from 10.8 at end-3Q14, notwithstanding the weakening in the core Tier I ratio.

The announced likely withdrawal of regulatory forbearance in July 2015 and UB's weak performance mean that pressure on capitalisation is likely to remain significant. UB's statutory pre-impairment profitability deteriorated to around break-even level in 4Q14 and became moderately negative in 2M15, and bottom line performance has been negative in recent years. UB's possible participation in the state recapitalisation programme could result in moderate support for capital ratios.

Impairment charges of RUB3.5bn (equal to 2% of gross loans) in regulatory accounts for 2H14-2M15 suggest that there has been some deterioration of asset quality since end-1H14, when NPLs (loans overdue by more than 90 days) and non-overdue impaired loans were 11.5% and 3.5% of the portfolio, respectively, 90% covered by total IFRS reserves.

UB's liquidity position remains stable, with highly liquid assets (cash and unencumbered government bonds), net of short-term interbank borrowings, covering customer deposits by 10% at end-February 2015. Bank placements and non-government bonds represent additional potential sources of liquidity. The liquidity position also benefits from limited near-term debt maturities, highly granular deposits, a large quickly amortising retail loan book and a relatively broad retail franchise.

UB's IDRs have been downgraded to the level of the bank's Support Rating Floor (SRF). The SRF and Stable Outlook on the Long-term IDRs reflect Fitch's view that in case of the bank's failure, state support would likely be sufficient to avert losses for senior creditors. This view takes into account UB's broad deposit franchise and network, its limited foreign liabilities and the recent track record of state-supervised rescues of Russian banks smaller than UB. At the same time, significant uncertainty regarding state support for a relatively small (accounting for 0.5% of sector assets at end-2014) privately-owned bank means that Fitch maintains a multi-notch differential between the sovereign's 'BBB-' Long-term IDR and UB's SRF.

UB's IDRs and Support Rating (SR) of '4' could be downgraded and the SRF lowered should state support not be forthcoming in case of further deterioration in the bank's credit profile. The bank's Long-term IDR and SR could be upgraded should UB be acquired by a financially stronger institution.

UB's VR could be further downgraded if reported capital ratios and/or the quality of capital erode further due to either deterioration of performance, downward adjustments to asset valuations, increased reserve requirements for some of the bank's risky/related party exposures, a change of treatment by the CBR of the bank's non-core exposures resulting in increased deductions from regulatory capital, or any new material capital withdrawals by the shareholder. A major liquidity squeeze could also lead to a downgrade. The VR could stabilise at its current level if the bank strengthens capitalisation and core profitability, thereby reducing vulnerability to future capital deductions or losses on non-core assets.

KEY RATING DRIVERS AND RATING SENSITIVITIES - ULG's RATINGS
The downgrade of ULG's Long-term IDRs reflects UB's reduced ability to support its subsidiary, as reflected by the downgrade of the bank's VR. The Negative Outlook on ULG's Long-term IDRs reflects Fitch's view that UB's VR remains under downward pressure, and ULG could be downgraded further in case of a lowering of UB's VR. In Fitch's view, any potential state support to UB would not necessarily flow through to support creditors of the leasing subsidiary, and hence ULG's ratings do not benefit from UB's SRF.

The alignment of ULG's ratings with UB's VR reflects Fitch's view of the parent's still high propensity to support its subsidiary, given the track record of support to date, high managerial integration and tight parent supervision, and significant reputational risks for UB in case of a default by ULG.