Fitch Affirms 5 Medium-sized Russian Banks; Revises Outlooks on 3 to Stable
KEY RATING DRIVERS: ALL BANKS' IDRS, NATIONAL LONG-TERM RATING AND VIABILITY RATINGS (VRS)
The banks' IDRs and National Ratings are driven by their standalone financial strength, as reflected in their Viability Ratings. The affirmations reflect (i) only limited deterioration of the banks' credit metrics to date, despite a more difficult operating environment; (ii) generally reasonable capitalisation in light of conservative loan growth plans (somewhat higher at Peresvet) and only limited loan impairment; and (iii) broadly stable funding profiles, limited refinancing risks and reasonable liquidity positions. On the negative side, the ratings continue to be constrained by the banks' fairly narrow franchises resulting in, among other things, significant balance sheet concentrations.
REB's higher IDRs, relative to the other four banks, primarily reflect its stronger performance, benefiting from a high share of granular and cheap current accounts (43% of end-1H15 total liabilities) providing larger capacity to absorb potential losses through income statement.
The revision of the Outlooks on REB, SDM and Peresvet's ratings to Stable from Negative reflects Fitch's expectation that potential asset quality deterioration at these banks will be only gradual due to relatively conservative loan underwriting with a focus on secured lending and/or government-related borrowers, which should limit credit losses to a degree they can be absorbed by pre-impairment profits without eating through capital. Locko and Absolut are more vulnerable to economic recession due to riskier lending and/or weaker performance and therefore the Outlook on their ratings remains Negative.
Fitch continues to expect some asset quality pressure in the banks, due to forecasted 4% GDP contraction in 2015 and only modest 0.5% growth in 2016, falls in consumption, investment and public spending and considerable currency devaluation.
KEY RATING DRIVERS - REB'S IDRS, NATIONAL LONG-TERM RATING AND VR
REB's non-performing loans (NPLs, 90 days overdue) equaled a low 2.9% of end-1H15 gross loans, only slightly up from 2.7% at end-2014. These were 2.3x covered by loan impairment reserves (LIRs). Restructured loans also remain stable at a low 1.9% of end-1H15 total loans (end-2014: 2.0%). Loan concentration is high, with the top 25 exposures making 53% of corporate loans at end-1H15. However, most of the largest exposures are moderate risk working-capital loans to cash generative clients with a long operational track record and low-risk loans to state and state-related companies. Retail loans (24% of gross loans) are of limited risk, as these are mostly mortgages with fairly low average LTVs.
Funding is a rating strength with interest-free current accounts (mostly corporate) comprising a high 43% of end-1H15 liabilities translating into low funding costs of 4.7% in 1H15, only slightly up from 3.5% in 2014. This gives the bank a significant competitive edge, allowing it to attract lower risk borrowers and keep healthy margins. REB's current accounts are rather granular (the 20 largest clients equaled low 11.5% of end-1H15 current accounts) and proved to be rather sticky through the past crisis. Liquidity risk is also mitigated by REB's solid liquidity cushion (RUB51bn at end-8M15), which covered 46% of total customer accounts.
REB's Fitch Core Capital (FCC) ratio was a high 14.6% at end-1H15, up from 12.5% at end-2014 due to limited growth and earnings retention. Loss absorption capacity is also strengthened by solid pre-impairment profit (excluding one-off trading and revaluation gains), equaling 8% of average loans in 1H15 (annualised) and 9% in 2014.
KEY RATING DRIVERS - SDM'S IDRS, NATIONAL LONG-TERM RATING AND VR
SDM's NPLs were a low 1.2% of end-1H15 gross loans with restructured loans accounting for an additional 0.9%, compared with 4.6% LIRs. Despite high concentrations (top 25 borrowers accounted for 60% of end-1H15 corporate loans or 2.1x FCC), Fitch considers the quality of SDM's largest exposures to be generally adequate. The riskier part is exposure to car dealers (38% of end-1H15 FCC), and loans to construction and property rental businesses (62% of FCC), but these are well covered by hard collateral.
SDM's capital position is reasonable, as expressed by 14.7% FCC ratio. Pre-impairment profit (annualised 7% of average loans in 1H15 net of one-off trading and currency gains) benefits from fairly low funding costs (5.3%), reflecting SDM's high share of interest-free corporate accounts (42% of end-1H15 liabilities). Liquidity risks are mitigated by a considerable liquidity cushion, which was sufficient to withstand a substantial 60% reduction in customer funding at end-8M15.
KEY RATING DRIVERS - PERESVET'S IDRS, NATIONAL LONG-TERM RATING AND VR
Peresvet's business origination benefits from association with the Russian Orthodox Church (ROC) and the Chamber of Commerce and Industry of the Russian Federation (CCI), who are the main shareholders with 49.7% and 24.4% stakes, respectively. Reported NPLs were low 0.5% at end-1H15 and 1.4x covered by reserves. The largest borrowers are mostly companies benefiting from government contracts and Fitch believes that their revenues and hence Peresvet's asset quality are somewhat less cyclical compared with the broader economy.
The bank's capitalisation remained reasonable, as expressed by 13.5% FCC ratio at end-1H15. Fitch estimates that Peresvet could increase reserves by 5.1% of gross loans at end-1H15 before breaching regulatory capital adequacy requirements. An additional 3.4% of gross loans can be absorbed through pre-impairment profit.
The liquidity position is comfortable with highly liquid assets net potential wholesale repayments for the next year covering 42% of total deposits at end-8M15.
KEY RATINGS DRIVERS - ABSOLUT'S IDRS, VR
Absolut's credit profile benefits from a strong commitment of its majority shareholder, Non-State Pension Fund Blagosostoyanie, ultimately controlled by JSC Russian Railways (BBB-/Negative), in assisting the bank in its development. There is a track record of the Fund providing considerable funding and equity capital to the bank, the latter's significant involvement in servicing companies related to the Fund, and the Fund's facilitating a merger of Absolut with another small lender, KIT Finance Investment Bank with cleaning up of the latter's balance sheet prior to the merger.
Absolut NPLs were 3.0% at end-1H15, only moderately up from 2.5% at end-2014. However, restructured loans spiked to a high 23% from a moderate 9%, including a risky, albeit not NPL, exposure to a recently failed Russian airline amounting to 2.6% of gross loans, of which the bank expects to recover only a small amount.
Due to a shareholder equity injection in September 2015, the bank's FCC ratio improved to 16% at end-9M15, although this would have been a more moderate 14% if the airline exposure was fully reserved. The total regulatory capital ratio was a tighter 13.7% at end-9M15 due to higher regulatory risk-weighted assets rather than in IFRS. This benefited from a RUB6bn subordinated loan from the Deposit Insurance Agency under the state recapitalisation programme. Capitalisation is vulnerable to potentially high loan impairment charges, especially due to modest pre-impairment profitability of 1.4% of average gross loans in 1H15 (2% for 2014).
The bank's funding and liquidity position is adequate, although there is a high reliance on funding from related entities, which accounted for a quarter of customer accounts at end-1H15. At end-9M15, refinancing risk was manageable as wholesale funding of RUB22bn (11% of end-1H15 liabilities) maturing within a year, including RUB10bn of bonds with put options, was significantly below Absolut's liquid assets, which equaled RUB49bn (24% of end-1H15 liabilities).
KEY RATING DRIVERS - LOCKO'S IDRS, NATIONAL LONG-TERM RATING AND VR
Locko's NPLs comprised 6.4% of gross loans at end-1H15 (6.2% at end-2014), while restructured loans increased to 4.4% from: 2.7%. Fitch believes that additional asset quality pressure may stem from significant exposure to the construction sector (at least 70% of end-1H15 FCC) as some of the projects are not yet completed; and RUB0.3bn (2.5% of end-1H15 FCC) high risk exposure to a debt collection agency buying bad loans from the bank.
FCC ratio is a reasonable 16.7%, although regulatory capitalisation is tighter. Locko's Tier 1 and total regulatory capital ratios were 11.2% and 13.0%, respectively, at end-9M15 translating into ability to additionally create reserves equivalent to only a moderate 5% of gross loans. Pre-impairment profit, equaling 9% of average loans in 1H15 (annualised) provides additional capacity for loss absorption. However, earnings were boosted by significant non-recurring securities gains, while core profitability is under pressure due to tighter margins and elevated costs of risk.
At end-8M15, a liquidity cushion net of wholesale repayments covered a high 43.5% of customer accounts. Refinancing risk is moderate, as Locko needs to repay only RUB4.9bn (mostly local bonds, 6% of end-1H15 liabilities) in the next 12 months.
RATING SENSITIVITIES - ALL BANKS' IDRS, NATIONAL LONG-TERM RATINGS AND VRS
Negative rating action is possible if asset quality at any of the banks deteriorates significantly and erodes the banks' profitability and capital positions. These risks are more significant at Absolut and Locko, as reflected by their Negative Outlooks. Significant liquidity outflows and/or considerable uplift in funding costs hurting the bank's pre-impairment profitability could also be credit negative.
Positive rating action would require the improvement in the operating environment and solid track record through the negative side of the credit cycle.
KEY RATING DRIVERS AND SENSITIVITIES: SENIOR UNSECURED DEBT
The senior unsecured debt of Peresvet, SDM, Locko and Absolut is rated in line with the banks' Long-term IDRs, reflecting Fitch's view of average recovery prospects (corresponding to a Recovery Rating of '4'), in case of default. Any changes to the banks' VRs would likely impact their debt ratings.
SDM's expected senior unsecured debt ratings have been affirmed and withdrawn as the issue is no longer planned.
KEY RATING DRIVERS AND SENSITIVITIES - SUPPORT RATINGS AND SUPPORT RATING FLOORS
The '5' Support Ratings (SRs) of all five banks reflect Fitch's view that support from the banks' private shareholders cannot be relied upon. The SRs and Support Rating Floors of 'No Floor' also reflect that support from the Russian authorities, cannot be relied upon due to their narrow franchise and lack of systemic importance. Fitch believes that any changes in the banks' SRs and SRFs are unlikely in the near term, although if any of the banks was sold to a higher-rated investor, it may result in changes to the SRs.
The rating actions are as follows:
REB
Long-term foreign and local currency IDRs: affirmed at 'BB-'; Outlooks revised to Stable from Negative
Short-term IDR: affirmed at 'B'
Viability Rating: affirmed at 'bb-'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
National Long-term rating: affirmed at 'A+(rus)', Outlook revised to Stable from Negative
SDM
Long-term foreign and local currency IDRs: affirmed at 'B+'; Outlooks revised to Stable from Negative
Short-term foreign currency IDR: affirmed at 'B'
Viability Rating: affirmed at 'b+'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
National Long-term Rating: affirmed at 'A-(rus)'; Outlook revised to Stable from Negative
Senior unsecured debt: affirmed at 'B+'
Senior unsecured debt National Rating: affirmed at 'A-(rus)'
Senior unsecured debt expected ratings: affirmed at B+(exp) and A-(rus)(exp) and withdrawn
Peresvet Bank
Long-Term foreign and local currency IDRs: affirmed at 'B+'; Outlooks revised to Stable from Negative
Short-Term IDR: affirmed at 'B'
National Long-Term Rating: affirmed at 'A-(rus)'; Outlook revised to Stable from Negative
Viability Rating: affirmed at 'b+'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt: affirmed at 'B+'/'A-(rus)'; Recovery Rating 'RR4'
Locko
Long-term foreign and local currency IDRs: affirmed at 'B+', Outlooks Negative
Short-term foreign currency IDR: affirmed at 'B'
Viability Rating: affirmed at 'b+'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
National Long-term Rating: affirmed at 'A-(rus)', Outlook Negative
Senior unsecured debt: affirmed at 'B+'/Recovery Rating 'RR4' and 'B+(EXP)'/Recovery Rating 'RR4(EXP)'
Senior unsecured debt National Long-term Rating: affirmed at 'A-(rus)'/Recovery Rating 'RR4' and 'A- (rus)(EXP)'/Recovery Rating 'RR4(EXP)'
Absolut Bank
Long-term foreign and local currency IDRs: affirmed at 'B+'; Outlooks Negative
Short-term foreign currency IDR: affirmed at 'B'
Viability Rating affirmed at 'b+'
Support Rating affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
National Long-Term Rating affirmed at 'A-(rus)'; Outlook Negative
Senior unsecured debt: affirmed at 'B+'/Recovery Rating 'RR4'
Senior unsecured debt National Long-term Rating: affirmed at 'A-(rus)'
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