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Russia-Based Bank Petrocommerce 'B+/B' And 'ruA' Ratings Affirmed On Improving Core Capital; Outlook Remains Negative

November 17, 2014 Standard & Poor's
Nov. 14, 2014--Standard & Poor's Ratings Services said today that it had affirmed its 'B+' long-term and 'B' short-term counterparty credit ratings on Russia-based Commercial Bank Petrocommerce OJSC. The outlook remains negative.

At the same time, we affirmed our 'ruA' Russian national scale rating on Bank Petrocommerce.

The affirmation reflects Bank Petrocommerce's proactive measures to boost its core capital ratios at a time when the pressure on its asset quality and profitability are increasing due to economic slowdown in Russia. Bank Petrocommerce recently renegotiated the terms and conditions of its two subordinated loans, totaling $303 million, to create perpetual subordinated debt instruments that the Central Bank of Russia (CBR) recognizes as core Tier 1 capital. We consider this to be an opportunistic exchange--according to our criteria--undertaken by the bank's shareholders.

We understand that the deeply subordinated instruments contain new features:
• Mandatory interest cancellation and principal write-down in accordance with the CBR's 395-p regulation; and
• An additional cancellation-of-interest clause activated by a capital event trigger or at the bank's discretion.

We think that the optional interest-cancellation feature provides Bank Petrocommerce with loss-absorption capacity while the bank is a going concern. We understand the bank has full flexibility to cancel the coupon at its sole discretion. The debt instruments are perpetual and we understand that Bank Petrocommerce cannot repay them during the first 10 years of their inclusion in its Tier 1 capital, and only with prior permission from the CBR. Based on our understanding of Bank Petrocommerce's management's intent and the instruments' documentation, we consider the instruments to be permanent in nature. Consequently, we do not anticipate early redemption of these debt instruments, even if Otkritie Holding acquires Bank Petrocommerce.

The new features allow us to treat these instruments as having intermediate equity content, in accordance with our criteria for bank hybrid capital. This means that the maximum amount of these instruments eligible for inclusion in total adjusted capital, our measure of a bank's capitalization, is 33% of Bank Petrocommerce's consolidated adjusted common equity, which amounted to Russian ruble (RUB) 19.8 billion (about $585 million) on June 30, 2014.

The transaction has a positive effect on our view of Bank Petrocommerce's core capital position. In particular, we expect our risk-adjusted capital (RAC) ratio for the bank to remain higher than 6.0% over the next 12-18 months, which is a considerable improvement from 5.2% at year-end 2013.

Nevertheless, we are mindful that rapid weakening of economic conditions in Russia continues to pose significant threats to Bank Petrocommerce, notably through deteriorating credit quality of many counterparties. We also note that Bank Petrocommerce's increased reliance on short-term operations with the CBR makes it vulnerable to interest rate shocks. Bank Petrocommerce has almost doubled the amount of repurchase transactions with the CBR this year.

We also take into account uncertainties regarding the future ownership of Bank Petrocommerce. We understand that, as part of Otkritie Holding's planned acquisition of the bank, Bank Petrocommerce may eventually merge with Bank Otkritie Financial Co (BOFC). We note, however, that the acquisition is still pending, owing to the need for regulatory approval from the National Bank of Ukraine because Bank Petrocommerce owns a Ukrainian bank. We do not expect the acquisition to be finalized before 2015, and the exact integration mechanism of Bank Petrocommerce with BOFC is still to be determined. We therefore do not factor this transaction into our forecasts because it will likely occur beyond our 12-month outlook horizon for Bank Petrocommerce.

The negative outlook reflects the possibility of a downgrade over the next 12 months if Bank Petrocommerce's credit profile weakens, despite its recent capital strengthening initiative, as a result of Russia's deteriorating macroeconomic environment, asset quality pressures, and challenging operating conditions for banks, notably on the funding side.

We may take a negative rating action over the next 12-18 months if Bank Petrocommerce's capitalization shrinks, with the RAC ratio falling below 5% for a long period. This may result from weaker performance of the bank's loan portfolio than we expect, in particular, with credit costs substantially higher than the 2%-2.5% we forecast for 2014-2015. A downgrade may also follow if Otkritie Holding's acquisition of Bank Petrocommerce, which in our view is very likely to happen, erodes Bank Petrocommerce's customer franchise, especially if key clients that contribute most of the profits were to leave.

We could consider revising the outlook to stable if the economic and operating pressures on Russia's banking sector, notably on asset quality, recede. Although a remote scenario in the next 12 months, we may also consider a positive rating action if the planned acquisition occurs sooner than expected and there is a clear roadmap for the integration of Bank Petrocommerce into BOFC. In such a case, we might consider that Bank Petrocommerce could benefit from group support, depending on its new owner's strategic plans and the stability of BOFC's credit quality. It is unlikely, however, that we would include an uplift in the long-term rating on Bank Petrocommerce if it remains a sister company of BOFC and is owned solely by Otkritie Holding.
Company — Petrocommerce Bank
  • Full name
    Open Joint-Stock Company Commercial bank "Petrocommerce"
  • Registration country
  • Industry