OREANDA-NEWS. Fitch Ratings is maintaining International Bank of Azerbaijan's (IBA) Issuer Default Rating (IDR) of 'BB' on Rating Watch Positive (RWP). The agency has also put the IDRs of Demirbank (Demir), Atabank (AB) and AGBank (AGB) on Rating Watch Negative (RWN) and revised the Outlook on Unibank's (Uni) 'B' IDR to Negative from Stable. A full list of rating actions is available at the end of this commentary.

The rating actions on five Azerbaijani banks are driven by the Azerbaijani authorities' decision on 21 December 2015 to abandon the currency peg and move to a floating-rate regime. A sharp decline in the Azerbaijani manat hit local banks' capital ratios via (i) inflation of foreign currency-denominated risk-weighted assets (RWAs), and (ii) in some cases, significant translation losses on unhedged short open currency positions (OCP).

Some banks face the risk of breaching capital ratios, although Fitch believes that some regulatory forbearance is likely to be provided, giving the shareholders time to inject capital and to bring the banks in compliance with regulatory capital adequacy rules. This view is based on a track record of regulatory forbearance being made available to the banking sector after a previous 34% devaluation of the manat in February 2015. In addition, the regulator is planning to lower the minimum capital ratio requirement to 10% by end-2015 from 12% currently, which will help the banks to achieve compliance.

Additional longer-term downside stems from potential asset quality pressure due to significant dollarisation of the loan books (sector average was around 60% after the devaluation), while most of the borrowers have limited access to revenues in foreign currency.

Liquidity may also be challenged if people start withdrawing money, although according to banks deposits were stable in the last several days. In the worst case scenario, Fitch believes that support from the Central Bank may be forthcoming.

KEY RATING DRIVERS - IBA
Fitch's decision to maintain IBA's 'BB' IDR on RWP reflects Azerbaijani authorities' improving propensity to provide support to IBA, due to ongoing asset clean-up programme, and also our expectation that the state will support to offset the impact from recent currency volatility.

Fitch estimates that the pressure on IBA's capital stemming from currency devaluation was largely offset by the release of RWAs following the buyout of AZN2bn problem loans by the authorities in November and early December. The bank converted most sales proceeds into foreign currency, thus also reducing its short OPC, while hedging the remainder. The remaining AZN1bn problem loans buy-out is planned by end-2015 and management has informed Fitch that the authorities may consider other measures, if necessary, to support the bank's solvency. Fitch expects to upgrade IBA's IDR by one notch when the last problem loans transfer has been finalised and upon confirmation of the bank's solvency and capital ratios remaining at reasonable levels, post devaluation.

According to IBA's regulatory accounts at end-11M15 the short balance sheet currency position, although partially reduced by converting the proceeds from problem loan sales into foreign currency, was still significant at around AZN600m (45% of total regulatory capital). However, according to IBA's regulatory accounts, it was fully hedged with the Central Bank and other government bodies and therefore IBA did not take a big direct hit to equity from the devaluation. The AZN1bn bad loans sale in early December (prior to devaluation) did not alter the OCP, as the proceeds were reportedly in the same currency as the sold portfolio.

At end-11M15, IBA's total capital adequacy ratio (TCAR) equalled 16%. The release of RWAs from the sale of bad loans in December should have partially offset the devaluation-driven inflation of foreign-currency RWAs (around 60% of total RWA's at end-11M15). Fitch therefore estimates that TCAR could have reduced by about 350bps, but should still be above the current regulatory minimum of 12%.

The revision of the Rating Watch to Evolving from Positive on IBA's 'b-' VR reflects uncertainty on IBA's capital position and asset quality, as some of Fitch's conclusions/estimates are based on preliminary information from management, while the exact impact from asset sales, hedging and devaluation can only be assessed after the publication of year-end accounts.

The IBA's Support Rating Floor (SRF) of 'BB' and its Support Rating (SR) of '3' continue to reflect potential support from Azerbaijani authorities, in case of need. Fitch's view on the probability of support is based on (i) IBA's high systemic importance, stemming from its large domestic franchise (the bank accounts for 36% of sector assets) and substantial funding from state-owned corporations (around AZN1.5bn or 15% of end-1H15 liabilities); (ii) the bank's majority state ownership; (iii) IBA's fairly small size relative to the sovereign's available resources (assets equal to 15% of GDP at end-1H15); (iv) the potentially significant reputational damage for the authorities in case of IBA's default; and (v) improved track record of support as reflected by IBA's financial rehabilitation programme announced in July 2015.

KEY RATING DRIVRES - UNI, DEMIR, AB AND AGB
The revision of the Outlook on Uni's IDRs to Negative from Stable reflects its weakened loss absorption capacity after devaluation, while risks stemming from the bank's highly dollarised and unsecured retail loan book have increased. Fitch estimates that the bank's Fitch Core Capital (FCC) ratio could drop by 3 pts, down to 8% by end-2015. However, Uni should remain compliant with regulatory capital adequacy rules after the devaluation, with an estimated TCAR of 13% by end-2015.

The RWN on AGBank, Demir and AB reflects the material erosion of their loss absorption capacity as a result of the currency devaluation. Fitch estimates, that FCC ratios at AGB may drop to zero by end-2015, and to a moderate 5%-6% at Demir and AB.

Demir's share of foreign currency RWAs was 27%, while its short OCP was a moderate 20% at end-11M15. Fitch estimates that the bank's TCAR should therefore reduce by 2pps to around 11% by end-2015, compared with the current regulatory minimum of 12%, although if the latter is lowered to 10% the bank may still be compliant.

AB's share of foreign-currency RWA's was 36% and its short OCP equalled 1.2x regulatory capital before devaluation at end-9M15. According to management AB's OCP was largely hedged through derivative contracts, although Fitch believes that there is some uncertainty about the efficiency of these hedges. If the hedges are not effective, the bank could have lost around 60% of its capital, taking its regulatory TCAR down to 6% at end-2015.

AGB had already been non-compliant with regulatory capital adequacy rules prior to devaluation. At date of the devaluation, the bank had a large short OCP of 1.9x regulatory capital (of this more than a half was hedged according to management) and a high 40% share of foreign currency RWAs. However, even if the hedges are effective, the devaluation would still lead to TCAR reducing to around 5% from current 9.7%.

The SRFs of 'No Floor' and SRs of '5' for Demir, Uni, AGbank and AB reflect their relatively limited scale of operations and market share. Although Fitch expects some regulatory forbearance to be available for these banks, in case of need, any extraordinary direct capital support from the Azerbaijan authorities cannot be relied upon, in the agency's view. The potential for support from banks' private shareholders is not factored into the ratings.

RATING SENSITIVITIES
IBA
IBA's SRF and IDR would be upgraded by one notch, to 'BB+', if Fitch considers that the propensity to support the bank has improved, which is to be confirmed by completion of the impaired loans transfer and evidence that the capital hit from devaluation is sufficiently mitigated by the authorities.

Conversely, any evidence of weakening of propensity to support, for example, through delays to/cancellation of the remaining bad loans transfer, and/or capital hit from devaluation not being sufficiently offset by state support will result in the affirmation of the ratings at current levels.

Although not a base case scenario, IBA's VR may be downgraded if Fitch views that the bank's stand-alone credit profile has markedly weakened due to the negative impact from devaluation being much larger than expected. This would be manifested in the bank becoming reliant on significant extraordinary support/forbearance and/or delays in finalising the asset clean-up, leading to the bank's asset quality problems not being resolved.

Conversely, if the impact from devaluation on capital ratios is confirmed to be limited, the last bad asset transfer is completed and Fitch takes a view that the quality of IBA's remaining loans is reasonable, some upside potential for VR is possible.

UNI, DEMIR, AB AND AGB
Uni's ratings may be downgraded if asset quality deteriorates beyond what can be absorbed by pre-impairment profit, thus further eroding the bank's weakened capital. Conversely, fairly resilient asset quality and stable performance may help stabilise the ratings at current levels.

The RWN on Demir, AB and AGB will be resolved upon our assessment of the banks' reported capital positions following devaluation and any potential actions taken to support the banks' solvency. The banks could be downgraded if their capital ratios become substantially below regulatory minimum levels and limited action is taken to restore their solvency. Negative rating pressure could also stem from potential asset quality deterioration and/or a liquidity squeeze. However, to a large extent these risks are already factored in the banks' fairly low ratings.

The ratings could be affirmed if the banks' capital positions are not deeply eroded and/or are supported by authorities/shareholders. Fitch believes that a revision of the banks' SR and SRFs is unlikely in the near-term, unless systemic importance at any of these banks markedly increases.

KEY RATING DRIVERS AND SENSITIVITIES - IBA-MOSCOW'S SENIOR DEBT RATING
The expected rating of IBA Moscow's senior debt issues is equalised with that of its parent IBA. This reflects IBA's offer to purchase the bonds in case of a default by IBA Moscow, which represents an irrevocable undertaking and ranks equally with IBA's other senior unsecured obligations. IBA Moscow's senior unsecured debt rating is likely to move in tandem with IBA's IDRs.

The rating actions are as follows:
IBA
Long-term foreign currency IDR: 'BB' maintained on RWP
Short-term foreign currency IDR: affirmed at 'B'
Viability Rating: 'b-', Rating Watch revised to Evolving from Positive
Support Rating: affirmed at '3'
Support Rating Floor: 'BB' maintained on RWP
Senior unsecured debt: 'BB', maintained on RWP

IBA-Moscow
Senior unsecured debt: 'BB(EXP)' maintained on RWP

Unibank:
Long-term foreign currency IDR: affirmed at 'B', Outlook revised to Negative from Stable
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

Demirbank:
Long-term foreign currency IDR: 'B', placed on RWN
Short-term foreign currency IDR: 'B', placed on RWN
Viability Rating: 'b', placed on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at No Floor

Atabank:
Long-term foreign currency IDR: 'B-', placed on RWN
Short-term foreign currency IDR: 'B', placed on RWN
Viability Rating: 'b-', placed on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at No Floor

AGBank:
Long-term foreign currency IDR: 'CCC', placed on RWN
Short-term foreign currency IDR: affirmed at 'C'
Viability Rating: 'ccc', placed on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'