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Fitch Affirms Bank Ochrony Srodowiska at 'BBB'; Outlook Negative

April 11, 2015
Fitch Ratings has affirmed Poland-based Bank Ochrony Srodowiska's (BOS) Long-term Issuer Default Rating (IDR) at 'BBB', its National Long-Term Rating at 'A(pol)', its Support Rating (SR) at '2' and Support Rating Floor (SRF) at 'BBB'. The bank's Viability Rating (VR) was affirmed at 'bb'. The Outlook is Negative.
A full list of rating actions is available at the end of this rating action commentary.

BOS's IDRs, National Ratings, SR and SRF reflect Fitch's view of a currently high probability of support from the Polish sovereign (A-/Stable) in case of need. This view reflects the state's indirect majority shareholding in the bank, BOS's important role in financing the country's environmental protection projects and potential reputational damage for the state should the bank default. At the same time, the ratings also take into consideration BOS's limited systemic importance, the absence of any direct state participation in the bank's capital, and its rather narrow policy role.

The Polish sovereign controls BOS through the state-owned National Fund for Environment Protection and Water Management (the fund), which had a 56.6% stake in the bank at end-2014. The fund considers BOS a strategic investment and cannot reduce its shareholding in the bank without government approval.

The Negative Outlook reflects the high likelihood that BOS's state support-driven ratings will be downgraded by end-1H15. This is based on further progress being made in implementing the legislative and practical aspects of enabling effective bank resolution frameworks, which is likely to reduce implicit sovereign support for banks in the EU. This is likely to occur through national implementation of the provisions of the Bank Recovery and Resolution Directive (BRRD).

Fitch expects BOS's Long-term IDR and the senior debt issued by BOS Finance AB to be downgraded to the 'BB' category (and the National Long-term and senior debt ratings to the 'BBB'(pol) category) following the likely downward revision of BOS's SRF.

Fitch could still continue to factor in some form of state sponsorship into the bank's ratings; however, this will depend on the agency's view of the constraints to state support imposed by Poland's implementation of BRRD and by EU State Aid rules. If Fitch concludes that the combination of BRRD and State Aid rules do not constitute a severe constraint and there is a moderate probability of sovereign support flowing through to BOS, the SR is likely to be downgraded to '3' and the SRF revised lower to the 'BB' category. However, if we conclude that potential support would be heavily constrained, the SR and the SRF would likely be downgraded and revised to lower levels, reflecting a limited probability of support or less. In that case, the Long-term IDR would be driven by the VR, and so is likely still to remain in the 'BB' category (at 'BB', given the bank's current VR of 'bb').

BOS's SRF, and hence currently its IDRs, could also be revised lower and downgraded, respectively, if the fund's stake falls below 50% - which Fitch considers unlikely - or if timely support is not made available to BOS if required.

BOS's VR is the anchor rating for the bank's subordinated debt, as we believe that sovereign support, while possible, cannot be sufficiently relied upon to flow through to subordinated debt securities. The rating of BOS's subordinated debt is notched down once from the bank's VR for loss severity and mapped to the Polish national scale.

The ratings of BOS's subordinated instruments are primarily sensitive to changes in BOS's VR.

BOS's VR of 'bb' is driven by its weak market franchise and acceptable, albeit weakening, asset quality. It also reflects the bank's only adequate capitalisation - in view of considerable single-name loan concentrations and low reserve coverage of impaired loans - and weak profitability. Fitch has also considered the bank's significant reliance on fairly price-sensitive retail term and corporate customer deposits and wholesale debt markets.

At the same time, the bank's VR is underpinned by its sound liquidity position and rather moderate overall risk appetite - as evidenced by moderate loan growth and material concentration in the low-risk public finance sector.

BOS's impaired loans ratio increased to 8.2% at end-2014, from 6.7% at end-2013, driven by the Asset Quality Review conducted by the Polish FSA in 2H14 and the bank's stricter classification of restructured exposures. However, BOS takes a conservative approach to impaired loan reporting. The bank reports all exposures showing evidence of impairment as impaired, whereas the industry standard is to account only for loans with identified actual impairment. Using the industry standard approach, BOS's impaired loans ratio would have been 7.1% (2013: 5.5%). Loans overdue by more than 90 days are significantly below impaired loans at 4.1% of total gross loans, after an only modest increase in 2014.

Single-name loan book concentrations have been fuelled by BOS's wind farm project financing, which is part of a "green" loan portfolio (26.5% of total gross loans at end-2014). Credit risks related to this form of financing are amplified by regulatory risks as wind farms rely on state subsidies. The bank's total credit exposure to wind farm developers amounts to around PLN1.4bn (including PLN0.6bn off-balance sheet), which equals a significant 103% of end-2014 Fitch core capital (FCC).

BOS has moderate exposure to Swiss franc residential mortgages (10% of total gross loans at end-2014). The portfolio is vulnerable to a sharp and prolonged weakening of the Polish zloty, an increase in the market reference rate (CHF LIBOR) and higher unemployment. At present, we do not expect immediate pressure on asset quality due to the rapid Polish zloty depreciation against the Swiss franc in mid-January 2015, as the impact on monthly instalments has been largely absorbed by a negative LIBOR and reduced FX bid-ask spread charged by the bank. However, the weaker zloty is a drag on collateralisation and inflates the already high loan-to-value levels, and consequently it could result in somewhat higher impairment charges due to weaker recovery expectations.

Fitch considers BOS's capitalisation as only adequate in view of its substantial unreserved impaired loans (equal to 53% of FCC at end-2014), single-name loan book concentrations and modest internal capital generation. The bank's regulatory capital adequacy ratios must be viewed against a high 100% risk weight applied to foreign currency residential mortgages required by the Polish FSA. Fitch believes that BOS's majority shareholder is committed to maintaining the bank's capital adequacy ratio (CAR) above 12% of total risk weighted assets.

BOS's weak profitability reflects its limited franchise and small overall size, which have weighed on its funding costs and operational efficiency, and the bank's historical focus on low-yield loans to the public sector. In Fitch's view the bank's efforts to increase the share of retail deposits and refinance its eurobonds may further increase the overall cost of funding. BOS's brokerage house subsidiary, DOM Maklerski BOS S.A., contributed a material 32% to the bank's consolidated net profit in 2014 (2013: 17%).

At end-2014, the majority (70%) of the bank's funding came from customer deposits, with an increased 55% of these coming from private individuals. A high 70% of total deposits were term accounts, which tend to be less stable. The corporate deposit base is fairly concentrated. However, BOS has accumulated sizeable liquidity buffers, which can absorb even significant deposit fluctuations. During 2014 and 1Q15 the bank faced a long-expected withdrawal of funds by public finance entities (around PLN0.6bn, or 3% of end-2013 total liabilities) and by the Polish Power Exchange (PLN1bn; 6%). Nevertheless, at end-2014, BOS's pool of highly liquid assets totalled PLN3.8bn, which covered 21% of total liabilities.

BOS sources a material 14% of total funding from senior debt securities issued. The bank faces a substantial maturing eurobond (PLN1bn equivalent, or 6% of total funding) in May 2016, which it aims to refinance in 2015 and 2016.

Risks on the bank's VR are tilted to the downside. Pressure on BOS's capitalisation from continued loan quality deterioration and rising single-name concentrations would likely result in a downgrade of BOS's VR. Any significant pressure on the bank's funding costs, further undermining profitability, could also lead to a downgrade. Upside potential for the VR is limited due to BOS's weak franchise and considerable credit risk concentrations.

BOS is a small universal bank in Poland with a strong environmental focus. At end-2014, it represented 1.2% of the sector's total loans and retail deposits. The bank has been listed on the Warsaw Stock Exchange since 1997.

The rating actions are as follows:

Long-term IDR: affirmed at 'BBB', Outlook Negative
Short-term IDR: affirmed at 'F3'
National Long-term Rating: affirmed at 'A(pol)', Outlook Negative
National Short-term Rating: affirmed at 'F1(pol)'
Viability Rating: affirmed at 'bb'
Support Rating: affirmed at '2'
Support Rating Floor: affirmed at 'BBB'
PLN2bn senior unsecured bond programme: affirmed at 'A(pol)'
PLN2bn senior unsecured bond programme: affirmed at 'F1(pol)'
PLN83m subordinated debt: affirmed at 'BBB-(pol)'
EUR250m long-term senior unsecured eurobonds issued by BOS Finance AB: affirmed at 'BBB'
  • Full name
    Bank Ochrony Srodowiska SA (BOS SA)
  • Registration country
  • Industry