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RA Fitch Downgrades Azerbaijani Unibank to 'RD'; Upgrades to 'CCC'

May 30, 2016
Fitch Ratings has downgraded Azerbaijani-based Unibank Commercial Bank's (Uni) Long-Term foreign currency Issuer Default Rating (IDR) to 'RD' (Restricted Default) from 'B' following a distressed debt exchange (DDE). The bank's Viability Rating (VR) has simultaneously been downgraded to 'f' from 'b'. The IDR has then been upgraded to 'CCC'. A full list of rating actions is at the end of this rating action commentary.

The downgrades follow the completion of the restructuring of USD40m of the bank's wholesale debt obligations. These comprised USD25m contingent convertible bonds held by Uni's minority shareholders - international financial institutions European Bank for Reconstruction and Development (EBRD; AAA/Stable) and Deutsche Investitions-und Entwicklungsgesellschaft (DEG) - and a USD15m private bond placement.

In accordance with Fitch's DDE Criteria, we view the restructuring of Uni's obligations as a DDE because (i) the restructuring imposed a material reduction in terms for the bondholders with respect to the extension of the maturity date compared with the original contractual terms; and (ii) in Fitch's opinion, the restructuring was necessary to avoid a payment default. Fitch estimates that Uni's total available liquidity at the time of the restructuring was approximately equal to or slightly below the total amount of the restructured obligations. Thus the repayment would have completely exhausted the bank's liquidity amid an ongoing deposit run and threatened its ability to continue servicing its other obligations. Uni has now started repaying its restructured obligations in line with the revised schedules.

Following the restructuring, Fitch has maintained Uni's VR at 'f'. This reflects our view that the bank remains non-viable as a result of a material capital shortfall, and requires extraordinary support. At end-1Q16, Uni's consolidated IFRS equity fell to a low AZN2.7m, equivalent to just 0.3% of assets, from around AZN91m (10% of assets) at end-1H15, as a result of losses driven by the manat devaluation. At end-1Q16, the bank's Fitch Core Capital (FCC) became negative (we adjust equity for intangibles and deferred tax assets), compared with a FCC/risk-weighted assets ratio of 11% at end-1H15.

Following large provisions booked in 2H15 and 1Q16, the group's (Uni and its leasing subsidiary) non-performing loans (NPLs, 90 days overdue; 28% of loans at end-1Q16) were fully covered by reserves. However, the risk of further asset quality deterioration is significant, given the steep, post-devaluation rise in NPLs (from 11% at end-1H15) and sizable restructured exposures (15% of the portfolio). A large 54% of Uni's loan book is denominated in foreign currency.

Following the DDE, Fitch has upgraded Uni's foreign currency Long-Term IDR to 'CCC' from 'RD'. The non-default rating reflects the fact that the bank is currently servicing its obligations. However, the low level of the rating reflects Fitch's view that a repeat default by the bank is a real possibility, given its weak capital position, the risk of further asset quality deterioration and significant upcoming funding repayments. The Long-Term IDR is supported by the bank's compliance with regulatory capital requirements, solid pre-impairment profitability (which may help the bank to rebuild its capital over time) and significant cash generation from the bank's loan book, which could help to bolster liquidity ahead of funding repayments.

Uni's reported regulatory Tier 1 and total Capital Adequacy Ratios (CAR) of 7.7% and 10.5%, respectively, at end-4M16 were still compliant with the regulatory minimums of 5% and 10%, albeit only just so in the latter case. This is primarily because the regulatory accounts are prepared on a standalone basis and do not account for the material negative equity of the bank's leasing subsidiary. The ratios also benefit from Uni's significant preferred shares and subordinated debt, which are partially accounted as Tier 1 and Tier 2 capital, respectively, under local standards. Uni's shareholders are considering a possible equity injection, but there are no concrete plans yet.

Uni's IDRs also reflect the bank's moderate liquidity and considerable refinancing needs for 2016. Liquidity deteriorated markedly in 1Q16 following significant funding outflows (Uni lost around 19% of its liabilities). At end-1Q16, Uni's liquidity buffer was only AZN63m, equal to 15% of customer accounts, while wholesale refinancing needs for the next 12 months (including the amortisation of the obligations restructured in April 2016) equalled AZN175m. At the same time, the bank's monthly proceeds from loan repayments were equal to a significant AZN39m in 1Q16, suggesting Uni may be able to deleverage as a means to rebuild its liquidity.

Uni's SRF of 'No Floor' and SR of '5' reflect its relatively limited scale of operations and market share. Fitch believes some regulatory forbearance or liquidity support may be available for the bank from the Azerbaijan authorities, in case of need. However any extraordinary direct capital support from the authorities cannot be relied upon, in the agency's view. Potential for support from the bank's private shareholders is also not factored into the ratings, as it cannot be reliably assessed.

Uni's IDRs could be downgraded in the event of (i) renewed liquidity stress, making it difficult for the bank to service its obligations; or (ii) a breach of minimum regulatory capital ratios due to further impairment losses or the migration of the leasing subsidiary's negative equity on to Uni's standalone balance sheet.

Uni's IDRs could stabilise at their current levels, or ultimately be upgraded, if the bank is able to rebuild its capital and liquidity. The VR could be aligned with the Long-Term IDR when, in Fitch's view, the bank no longer has a material capital shortfall and has regained viability.

Given Uni's limited systemic importance and private ownership, changes in the bank's SR and SRF are unlikely.
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    OJSC Unibank Commersial Bank
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