OREANDA-NEWS. April 13, 2016. Fitch Ratings has downgraded Carcade LLC's Long-term Issuer Default Ratings (IDRs) to 'B+' from 'BB-' and removed them from Rating Watch Negative (RWN). The Outlook is Negative. A full list of rating actions follows at the end of this commentary.

KEY RATING DRIVERS
The downgrade reflects Carcade's (i) weaker performance, driven by a narrower interest margin and reduced cost efficiency; (ii) extended track record of significant asset quality problems, reflected in an above-peers cost of risk; and (iii) a more vulnerable funding profile and liquidity position. At the same time, the ratings also consider the company's reasonable franchise, diversified lease book and acceptable leverage.

Fitch placed Carcade's ratings on RWN in December 2015 due to risks related to the expected sale of the company to Forus group (see "Fitch Places Carcade on Rating Watch Negative" dated 23 December 2015). The transaction was subsequently cancelled, and so the ratings have been removed from RWN. Carcade's shareholder, Getin Holding, has informed Fitch that it currently does not intend to exit the company in the next two to three years, is committed to providing liquidity support in case of need and is now refocusing Carcade on organic growth after some changes in senior management.

Carcade is one of the leading privately-owned leasing companies in Russia. It is a pure retail auto leasing company, with passenger cars, light commercial vehicles and trucks making up 96% of the lease book at end-2015. The lease book is well-diversified, with the largest 10 lessees accounting for 2% of the total portfolio.

Carcade's performance in 2015 was subdued, as a result of (i) a weaker interest margin, driven by higher funding costs following the policy rate increase in Russia; (ii) lower operating efficiency as costs increased and the lease portfolio contracted, reflecting reduced demand for vehicles in the tougher operating environment; and (iii) higher default and loss rates, due to the impact of the weaker economy on the company's core SME segment.

The company reported close to zero net income in 2015, but net of one-off items (the up-front recognition of a government subsidy and a gain on the non-cash sale of non-performing leases), would have recorded a loss of up to 10% of equity, Fitch estimates. A reduced focus on operational management, driven by the shareholder's attempts to sell the company, may also have impacted performance.

Carcade's asset quality metrics remained weaker than peers in 2014-2015: default rates in the lease book were at around 12%, albeit still notably below the 2008-2009 maximum levels of about 20%. Final credit losses were a much smaller at 3.3% (2.5% in 2014), supported by sales of fairly liquid collateral. The stock of foreclosed assets on the balance sheet is significant (equal to a third of equity at end-2015), but residual/collateral value risks are mitigated by low loan-to-value ratios and rouble inflation of the underlying assets.

Solvency, as expressed by the net debt-to-tangible equity ratio, was 5.4x (equity is adjusted for a receivable from the shareholder, which is expected to be netted against future dividends). Carcade's proven ability to deleverage quickly without material losses should support capital positions in a stress scenario. However, poor internal capital generation means any potential growth of the lease book could push leverage up.

Carcade maintains a modest liquidity cushion, but its assets are granular and generate largely stable and predictable cash flows. Very short-term liquidity is tight in view of a RUB1.1bn bond repayment due on 25 April 2016, which exceeds currently available liquidity. However, Fitch believes that portfolio cash generation, coupled if necessary with available additional funding sources (including from the shareholder), should be sufficient to meet this payment.

Carcade's funding profile is weaker than that of its peers, with funding maturities marginally shorter than asset tenors. The average cost of funding increased 220bps in 2015 and Carcade has now higher concentrations by funding sources. FX risks are usually negligible, as the company operates with an essentially rouble balance sheet.

The senior debt ratings are aligned with the company's IDRs and National rating. The Recovery Rating of 'RR4' reflects Fitch's view of average recovery prospects for creditors in case of default.

RATING SENSITIVITIES
The Negative Outlook reflects the weak operating environment, and the potential for this to result in further deterioration of the company's financial metrics. The ratings could be downgraded if profitability remains weak, leverage increases significantly - as a result of renewed business growth but still weak internal capital generation - or if liquidity remains tight.

The Outlook could be revised to Stable if performance improves, liquidity becomes more comfortable and any renewed growth does not result in a marked increase in leverage.

The rating actions are as follows:
Long-term foreign and local currency IDRs: downgraded to 'B+' from 'BB-', Negative Outlook; off RWN
Short-term foreign currency IDR: affirmed at 'B'
National Long-Term rating: downgraded to 'A-(rus)' from 'A+(rus)', Negative Outlook; off RWN
Senior unsecured debt: downgraded to 'B+'/'A-(rus)' from 'BB-'/'A+(rus)', Recovery Rating 'RR4', off RWN