OREANDA-NEWS. Fitch Ratings has downgraded Russian Standard Bank's (RSB) Long-term Issuer Default Ratings (IDRs) and senior debt to 'B-' from 'B'. At the same time, the agency has downgraded the bank's Viability Rating (VR) to 'ccc' from 'b' and subordinated debt rating to 'CC' from 'B-'. The Outlooks on the IDRs are Negative. A full list of rating actions is available at the end of this commentary.

KEY RATING DRIVERS - IDRS, VR, NATIONAL RATING AND DEBT RATINGS
The downgrade of RSB's VR to 'ccc' reflects the ongoing deterioration of its core capital position amid a weakening operating environment, which has resulted in a marked deterioration in asset quality and pre-impairment profitability. As a result, under regulatory accounts RSB's core retail business has been loss-making since 4Q14 and is not expected to return to breakeven in the near future, meaning that pressure on the capital position is likely to remain.

RSB's Long-term IDRs, senior debt rating and National rating are driven by the bank's standalone creditworthiness, as expressed by its VR. The downgrades of these ratings reflect the downgrade of the VR. However, the Long-term IDRs and senior debt rating are notched up once from RSB's VR, reflecting the considerable protection offered to senior creditors by RSB's loss-absorbing junior debt. Fitch estimates that at end-5M15 RSB's 'new style' subordinated debt with loss-absorption features was equal to 9% of regulatory risk-weighted assets. If RSB approaches non-viability this debt may be fully or partially written off to help restore the bank's solvency. Total subordinated liabilities, including 'old style' non-loss-absorbing debt and a subordinated loan from Vnesheconombank (VEB), were equal to 15% of risk-weighted assets at end-5m2015. In Fitch's view, it is less likely that facilities apart from the 'new style' subordinated debt would be used to help restore the bank's core capital.

The downgrade of RSB's 'new style' subordinated debt rating to 'CC' from 'B-' reflects the downgrade of the bank's VR. The subordinated debt rating is one notch lower than the VR due to expected weak recovery prospects for the debt in case of the bank reaching non-viability.

RSB's Fitch Core Capital (FCC) ratio dropped to below 1% at end-2014, and Fitch estimates that this would have turned negative by end-5M15. FCC (RUB1bn at end-2014) is significantly lower than RSB's reported Basel II Tier I capital (RUB13bn), as Fitch deducts RSB's investment in the treasury shares of its holding company (RUB5.5bn at end-2014), deferred tax assets (RUB5.2bn) and intangibles (RUB1.2bn) from RSB's IFRS equity to calculate FCC. RSB's regulatory Tier 1 capital ratio is supported by the non-deduction of these assets, but was only marginally above the regulatory minimum of 6% at end-5M15.

RSB's weak core capital position is further undermined by (i) the bank's RUB10bn of net non-core corporate loans, of which RUB3.6bn to related parties; (ii) the RUB12bn difference at end-2014 between the carrying value and the fair value of RSB's sizeable portfolio of held-to-maturity securities (equal to 25% of end-2014 assets), although this difference is likely to have reduced significantly since; and (iii) a RUB3.8bn investment (net of reserves) in the equity of a related alcohol company, contributed as new equity in 2Q15. These exposures were equal to a combined 7% of regulatory risk-weighted assets at end-5M15.

RSB's 2014 IFRS accounts indicated a further significant deterioration of asset quality in retail lending, as credit losses (defined as generation of non-performing loans (90 days overdue) divided by average performing loans) reached 29% in 2H14 (24% for FY2014), up from 20% in 1H14 and 14% in 2013. This compares with RSB's breakeven loss rate of 12% in 2014. Continued significant provisioning of the loan book in regulatory accounts in 5M15 suggests asset quality has yet to stabilise.

Pre-impairment profitability has weakened considerably as a result of increased funding costs and sluggish new loan production, as the portfolio contracted by 20% in 5M15 in order to reduce capital pressure. Fitch estimates RSB's operating loss in 5M15 regulatory accounts at RUB9.5bn (equal to 24% of end-2014 statutory equity), only partially offset by the RUB3.8bn contribution of the alcohol company stake. Fitch expects RSB to report a further loss in 2H15, notwithstanding a likely gradual reduction in funding costs as the policy rate comes down.

In Fitch's view, RSB has sufficient liquidity to meet the put option on its USD525m senior unsecured eurobond on 11 July 2015. If this facility is repaid in full, remaining liquidity will be equal a moderate 8% of retail deposits. However, customer funding has been reasonably stable to date and cash generation from shrinking loan book remains significant.

SUPPORT RATING AND SUPPORT RATING FLOOR
RSB's '5' Support Rating reflects Fitch's view that support from the bank's private shareholder cannot be relied upon. The Support Rating Floor of 'No Floor' also reflects the agency's view that support from the Russian authorities cannot be relied upon to the extent that this would prevent losses for senior creditors, given the bank's still small size and lack of overall systemic importance. However, some support, for example in the form of regulatory forbearance or facilitation of a takeover of the bank, is possible, given its considerable retail deposit franchise (RUB162bn at end-5M15).

RATING SENSITIVITIES
IDRS, NATIONAL RATINGS AND SENIOR DEBT
As the Long-term IDRs and senior debt ratings are notched up from RSB's VR, they and the National rating are sensitive to a downgrade of the VR.

The notching up of the IDRs and senior debt above the VR is sensitive to changes in Fitch's view on RSB's potential capital requirements, and the extent to which a write down of the bank's subordinated debt could be sufficient to meet these. The notching could also be widened or eliminated if it becomes clearer that senior creditors will not/will be required to take losses as part of any resolution process required by the bank.

VR AND SUBORDINATED DEBT
Further deterioration of RSB's capital position could lead to a downgrade of the VR. If RSB breaches minimum regulatory capital adequacy ratios without any prospect of its solvency being restored, then its VR is likely to be downgraded to 'f'. A stabilisation of performance and the capital position would reduce downward pressure on the VR and subordinated debt rating.

SUPPORT RATING AND SUPPORT RATING FLOOR
RSB's Support Rating could be upgraded if it is acquired by a more highly-rated entity. An upward revision of the Support Rating Floor is unlikely given the bank's limited systemic importance.

The rating actions are as follows:

Long-term foreign and local currency IDRs: downgraded to 'B-' from 'B'; off Rating Watch Negative (RWN); Outlook Negative
National Long-term Rating: downgraded to 'BB-(rus)' from 'BBB-(rus)'; off RWN; Outlook Negative
Short-term foreign currency IDR: affirmed at 'B'; off RWN
Viability Rating: downgraded to 'ccc' from 'b'; off RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt (including that issued by Russian Standard Finance SA) downgraded to 'B-' from 'B', Recovery Rating 'RR4'; off RWN
Subordinated debt (issued by Russian Standard Finance SA) Long-term rating: downgraded to 'CC' from 'B-', Recovery Rating 'RR5'; off RWN.