Standard & Poor's: Russia-Based REGION Investment Company ZAO Assigned 'B-/C' Ratings; Outlook Stable
November 20, 2013 Standard & Poor's
Standard & Poor's Ratings Services said today that it assigned its 'B-/C' long- and short-term counterparty credit ratings and 'ruBBB' Russia national scale rating to Russia-based REGION Investment Co. ZAO (REGION). The outlook is stable.
The ratings on REGION, a holding company, reflect our assessment of the creditworthiness of the wider REGION Group of Companies (REGION group), which primarily focuses on brokerage and flow-trading in fixed-income instruments, asset management, and debt capital markets services.
Our ratings on REGION reflect the 'b-' group credit profile (GCP), which reflects the creditworthiness of the consolidated REGION group. We do not believe that there are any material barriers to cash flows from the main operating subsidiaries to the holding company. We therefore do not notch down the ratings on REGION from our view of the GCP.
Our assessment of REGION's GCP balances our view of its well-established position in its key markets with fairly high operational risks that are inherent to the Russian financial market. REGION is the largest dealer in the secondary bond market in Russia and ranks seventh among asset managers. We believe that REGION's close connections with its largest clients lead to elevated single-name revenue concentrations.
We understand that the REGION group plans to focus on institutional clients and does not seek to expand into less familiar business lines. We do not expect any material changes in the group's business operations following the change in the regulator in September 2013.
We consider that the financial profile of REGION group reflects relatively high leverage compared with peers, confidence-sensitive funding--which in our view is inherent to the broker business model--high single-name concentrations on the balance sheet, and exposures to less liquid assets. The group's fairly stringent risk management system partly mitigates these weaknesses, however.
REGION's ratio of adjusted total equity (reported equity adjusted for goodwill and intangibles) to adjusted assets was a relatively low 3.4% at year-end 2012. This compares with more than 10% for the average of REGION's peers, according to our calculations. We note, however, that the group's internal capital generation is strong, with a return on equity of around 30% in the 2011-2012 period. Earnings retention has been moderate so far, however, as about 30% of profits are distributed as bonuses or dividends. We expect similar levels of internal revenue generation and capitalization in the medium term.
We believe that high single-name concentrations on the group's balance sheet, which result from client-tailored transactions, are the major weakness for the group.
We assess REGION's enterprise risk management framework as adequate compared with local peers. The group's risk management is centralized at the level of REGION Investment Co. ZAO. Additional committees function at the level of asset management companies.
The main risks to the group are market and liquidity risks, which are controlled through a stringent system of limits. The group's management of operational risk is still at an early stage, however. We note, however, that REGION has undertaken some measures to address potential rogue trading. For example, it has established a system that prevents trading that falls outside of the pre-set limit for securities or counterparties. We understand that the company has also set up tight control over deal prices.
The short-term nature of the group's funding, which is inherent to its business model, makes the continuity of operations vulnerable to a downturn in the Russian money markets. We view this as another weakness to the rating.
The management team owns the group. We do not take into account extraordinary parental support in our assessment of REGION's credit profile as we consider it to be uncertain. In addition, we do not incorporate any uplift for extraordinary government support into the GCP as we do not believe that the Russian government, or the regulator, are likely to support even the largest securities companies.
The stable outlook reflects our view that REGION's fixed-income franchise is gradually developing amid the competitive and high-risk environment in Russia.
The outlook also reflects our belief that the group will continue to generate profits from its core institutional brokerage in the medium term.
We could raise the ratings on REGION if we see a substantial and sustainable improvement in the group's capitalization and funding profile. A sustainable improvement in the Russian operating environment could also potentially result in a positive rating action, provided that the group keeps its risk appetite under control.
We could lower the ratings if we see that the new regulatory regime for nonbank financial institutions poses significant restrictions to the group's operations or its key client segment in the asset management market--non-state pension funds. We could also lower the ratings if we see the company exhibiting a higher proprietary risk appetite or substantial disruption to counterparty confidence, or if another prolonged market downturn takes place.
Company — Region Investment Company
Full nameREGION Investment Co. AO