OREANDA-NEWS. Fitch Ratings has upgraded Uralsib Bank's (UB) Long-term Issuer Default Rating (IDR) to 'B' from 'B-' and removed it from Rating Watch Negative (RWN). The Outlook is Negative. Fitch has also downgraded the bank's Viability Rating (VR) to 'f' from 'b-' and subsequently upgraded the VR to 'b'. The full list of rating actions is provided at the end of this commentary.

KEY RATING DRIVERS - UB'S VR AND IDRS
The downgrade of the VR to 'f' from 'b-' reflects Fitch's view that the bank has failed, following extraordinary financial support from the Russian Deposit Insurance Agency (DIA) and write-off of outstanding subordinated obligations to restore its solvency. The subsequent upgrade of the VR to 'b' reflects the agency's assessment of the bank's credit profile and prospects following the completion of these measures.

The upgrade of the Long-term IDR to 'B' from 'B-' reflects the upgrade of the VR. Fitch has not downgraded the Long-term IDR to 'RD' (Restricted Default) as the IDRs reflect the agency's view of the default risks on senior, rather than subordinated, obligations, which the bank has continued to service. The RWN on the IDRs had reflected the risk that senior creditors may also face losses as a result of the bank's potential failure and rescue.

The bank's 'B' Long-term IDR and 'b' VR capture UB's improved capitalisation, liquidity and provisioning of a large non-core asset following the measures to support the bank. However, the ratings also reflect UB's expected weak performance, still significant non-core assets and that the bank is unlikely in the near term to meet minimum regulatory capital requirements. The Negative Outlook reflects the potential for the weak economic environment, operating losses and further impairment charges on non-core assets to result in pressure on the bank's capitalisation.

The DIA provided financial assistance to UB in the form of RUB67bn 10-year and RUB14bn six-year loans at 0.51% and 6% interest rates, respectively. Based on reference interest rates communicated by management to Fitch, the agency estimates that these loans will result in a RUB35bn fair value gain (after tax) in the bank's IFRS accounts. The bank will also record a RUB15bn gain (after tax) on the write-off of its subordinated liabilities (net of reserves created against potential litigation risks relating to the write-off of 'old-style' subordinated debt). The bank partially utilised this strengthening of its core capital position to create additional impairment provisions, mostly on its equity investment in insurance group SG Uralsib (equal to 1.1x Fitch Core Capital (FCC) at end-1H15), which was almost fully written down.

As a result, Fitch estimates the FCC ratio to have increased to 16% currently from 5% at end-1H15. At the same time, the agency estimates that total non-core assets and related party exposures should have fallen to about 0.5x FCC currently, from 2.8x at end-1H15, reflecting both the SG Uralsib write-down and the increase in the absolute amount of core capital. Exposures to land investments and loans to the previous majority shareholder should have reduced to 30% and 20% of FCC, respectively, from 100% and 65% at end-1H15. Higher provisions on these assets might still be required, in Fitch's view, but even in case of their full write-off (an unduly harsh scenario, as these assets have some value) the FCC ratio would still be broadly consistent with the current rating level.

Fitch expects pre-impairment losses to result in moderate capital erosion in the bank's IFRS accounts. UB's 1H15 pre-impairment loss, annualised, was equal to 10% of estimated post-support FCC. Margins should benefit from a gradual reduction in deposit costs driven by base-rate reductions, but will be burdened by the bank accruing back through the income statement the initial fair-value gain on the DIA funding. UB will need to build up interest-earning assets, refinance high-cost deposits and reduce operating expenses to return to pre-impairment profitability, measures that will take time to implement.

UB's regulatory capital ratios have fallen below minimum levels as Russian accounting standards do not allow for the recognition of fair-value gains on below-market rate funding, while the SG Uralsib investment has been largely written down. At end-November 2015 UB's regulatory tier 1 and total capital ratios were moderately below the 6.625% and 8.625% minimum regulatory levels that are expected to come into force on 1 January 2016. Pre-impairment profitability in statutory accounts should be firmer than under IFRS (due to the low interest accrued on the DIA loans), but internal capital generation is likely to be still limited.

In Fitch's view, the risk of recognition of large loan impairment losses following the bank's rescue is low. This view is based on the bank's recently stable loan delinquency metrics and the solid reserve coverage of overdue loans. Non-performing loans (more than 90 days overdue) made up 14% of gross loans at end-3Q15 and were 95% covered by total loan impairment reserves; reported restructured loans comprised a moderate 4% of the portfolio at end-1H15. At the same time, Fitch believes loan quality for UB, as for other Russian banks, could come under pressure in the weak operating environment, in particular if the bank starts to lend more actively to utilise the DIA funding and support its profitability.

The DIA intervention has helped UB stabilise its liquidity after a significant RUB50bn customer and interbank funding outflow (equal to about 20% of total liabilities) in July-November 2015. Liquid assets were equal to a comfortable 30% of customer deposits at end-November 2015, and wholesale funding comprised a limited 2% of liabilities.

As a condition of DIA support for UB, the previous majority shareholder, Nikolai Tsvetkov, sold an 82% stake to a new investor, Vladimir Kogan, for a nominal amount. Neither the DIA nor other state-controlled entities have acquired an equity stake in the bank, while Mr. Tsvetkov retained 15.2%. Most of UB's senior management have remained in place following the takeover, but some uncertainty remains over the strategy the bank will formulate and implement in the near- to medium-term.

KEY RATING DRIVERS - UB'S SUPPORT RATING AND SUPPORT RATING FLOOR
The affirmation of UB's Support Rating at '5' and Support Rating Floor at 'No Floor' reflects Fitch's opinion that extraordinary support from the state authorities cannot be fully relied upon in the future.
Fitch recognises that the bank's rescue has been structured in a way that avoided losses for senior creditors. However, given the bank's small market shares, possible further erosion of its franchise and the exhaustion of possibilities to write down subordinated creditors, the agency does not assume that such support will be forthcoming again, in case of need.

RATING SENSITIVITIES
The Negative Outlook on UB's Long-term IDR reflects the potential for the ratings to be downgraded if pre-impairment losses, additional provisions on non-core assets and the weaker operating environment result in considerable erosion of the bank's capitalisation. The Outlook could be revised to Stable if pressure on capital is moderate and the operating environment stabilises.

KEY RATING DRIVERS - URALSIB LEASING GROUP'S (ULG) RATINGS
Fitch has withdrawn the ratings of UB's wholly-owned subsidiary ULG because the latter has chosen to stop participating in the rating process. The agency will no longer have sufficient information to maintain the ratings and provide analytical coverage for ULG.

On October 19, 2015 Fitch downgraded ULG's Long-term foreign-currency IDR to 'RD' from 'B', due to the company's default on some of its bank loans, and the Long-term local-currency IDR to 'CCC' from 'B'. The ratings of ULG have been withdrawn without affirmation due to insufficient information to assess whether the restructuring of the defaulted debt has been completed and hence the company's credit profile.

The rating actions are as follows:
Uralsib Bank
Long-term IDR: upgraded to 'B' from 'B-'; off RWN; Outlook Negative
Short-term IDR: affirmed at 'B'; off RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Viability Rating:; downgraded to 'f' from 'b-'; off RWN, upgraded to 'b' from 'f'

Uralsib Leasing Group
The following ratings have been withdrawn without affirmation:
Long and short-term foreign currency IDR: 'RD'
Long term local currency IDR: 'CCC'
Support Rating: '5'