Standard & Poor's Ratings Services today said it assigned its 'B/B' long- and short-term counterparty credit ratings to Russia-based Commercial Bank Sudostroitelny Bank LLC (SB Bank). The outlook is stable. At the same time, we assigned our 'ruA-' Russia national scale rating to the bank.
The ratings on SB Bank incorporate the structurally elevated economic and industry risks factored into our 'bb' anchor, our starting point for assigning ratings to a domestic bank operating in Russia. They also reflect SB Bank's "weak" business position, "moderate" capital and earnings, "moderate" risk position, "average" funding, and "adequate" liquidity, as our criteria define these terms. We assess the bank's stand-alone credit profile (SACP) as 'b'.
Our assessment of SB Bank's business position as weak is based on our view of its limited market share and customer franchise, with quite significant concentrations in the loan book. SB Bank is a midsize credit institution that had assets of Russian ruble (RUB) 65.7 billion (US$2.0 billion) on Sept. 30, 2013, making it 78th in the Russian banking sector. SB Bank has changed its strategy to focus more on midsize enterprises and increase their share of the corporate loan book to 55% by the end of 2014 from 30% at the end of 2012.
We recognize that this strategic shift is designed to avoid further erosion of margins and profitability, which have been falling for the past three years because of tough pricing competition in Russia and SB Bank's modest commercial franchise and branch network, which makes it difficult to attract the most creditworthy borrowers. But we still see the move as risky in the current operating environment in Russia, and SB Bank's management team has yet to prove its ability to manage possible risks arising from such a strategy.
The bank's ownership is split among 12 individuals comprising the former and current management team. The two largest shareholders, Leonid Tyukhtyaev and Andrey Ivanchikhin, control 33.1% between them and provide support to the bank mostly in the form of subordinated loans. So far, this very diverse ownership structure has not complicated the decision-making process and has prevented the emergence of governance issues.
Our assessment of SB Bank's capital and earnings as moderate reflects our view of the bank's gradually declining capital position, as its earnings capacity is lower than most peers', and prevents internal capital build up. This assessment is based primarily on our expectations that the risk-adjusted capital (RAC) ratio before adjustments for concentration and diversification will remain in a range of 5.0%-5.5%, down from 7.0% at the end of 2012, due to our projection of increasing risk-weighted assets and modest retained earnings. Our forecast is based on the assumption of relatively stable loan portfolio growth of 13%-15% over the next two years with a net interest margin of 2.8%-3.0%.
In our view, SB Bank's overall risk position is moderate. Concentrations on the balance sheet are comparable with local peers', although high compared with those of banks in other countries with similar economic and industry risks. The top 20 borrowers accounted for 33% of the loan book as of Sept. 30, 2013, 2.2x of adjusted total equity. Nonperforming loans (NPLs) have been consistently lower than the system average and should remain at or below 3% in 2013 and 2014. We also view positively the ample coverage of NPLs by reserves, which we expect to exceed 200% in 2013 and 2014. Still, we believe the bank's increasing exposure to the risky small and midsize enterprise (SME) segment and to the real estate sector (15% of the loan book) could impair the bank's credit risk profile, especially if economic slowdown intensifies in Russia.
We consider SB Bank's funding to be average and its liquidity adequate. The bank's funding base is quite diversified with bonds issued on the local market (17% of total liabilities as of Sept. 30, 2013), an outstanding amount at LORO accounts (accounts held by a second bank on behalf of a third party) from regional banks (13%), and clients' deposits (60%) almost equally split between corporate and individual clients. We note that reliance on short-term wholesale funding has substantially declined over the past years, in line with active deposit collection. We expect the bank's funding profile to be more balanced in the future, with a loan-to-deposit ratio of 110%-120% in 2013-2014 compared with 140% in 2010-2011. Concentrations are high in a global context, but in line with local peers'. The top 20 depositors accounted for 28% of total customer funds as of Sept. 30, 2013. We believe that SB Bank's liquidity cushion is adequate, with broad liquid assets constituting almost 30% of the balance sheet.
The outlook reflects our expectation that the SB Bank will continue following its strategy to further develop as a universal commercial bank by focusing on the SME segment while keeping capitalization and loan portfolio quality at, or only marginally below, current levels.
We could lower the ratings if SB Bank's NPLs increased significantly, leading to deterioration in earnings and capitalization and our projected RAC ratio falling below 5%. We might also consider a negative rating action if the bank experienced a loss of counterparty confidence leading to deterioration in its liquidity.
Although it is unlikely in the next 12 months, we would consider a positive rating action if the bank substantially strengthened its business position by developing its client franchise and significantly reducing concentrations on both the asset and liability side of the balance sheet.