Fitch Affirms 3 Russian Banks; Downgrades APB to 'CCC', Puts on RWN
November 21, 2016
Fitch Ratings has revised JSC BystroBank's and SKB-bank's (SKB) Outlooks to Stable from Negative, while affirming their Long-Term Issuer Default Ratings (IDRs) at 'B' and 'B-', respectively. It has also affirmed Uraltransbank (UTB) at 'B-' with Negative Outlook.
At the same time Fitch has downgraded the IDRs of JSC Asian-Pacific Bank (APB) to 'CCC' from 'B-' and placed them on Rating Watch Negative (RWN). Fitch has also withdrawn BystroBank's ratings for commercial reasons. Accordingly, Fitch will no longer provide ratings or analytical coverage for BystroBank.
A full list of rating actions is available at the end of this rating action commentary.
KEY RATING DRIVERS
ALL BANKS' IDRS, NATIONAL RATINGS AND VIABILITY RATINGS (VRs)
The revision of the Outlooks on BystroBank's and SKB's ratings to Stable reflects the moderation of credit losses to a level where they are now sufficiently covered by pre-impairment profits, reducing the risk of capital erosion. The Negative Outlook on UTB's ratings reflects weaker asset quality, resulting in the bank reporting net losses for six years in a row and, which, if continued, could put further pressure on already tight regulatory capitalisation.
More generally, the three banks' low ratings in the 'B' category reflect their small and potentially vulnerable franchises, modest core bottom-line profitability, but reasonable liquidity profiles. BystroBank's IDR is one-notch higher than those of the other two banks due to a better capital cushion and smaller credit losses. SKB's ratings are constrained by a large related party exposure to Sinara group (SG, 3x of Fitch core capital, FCC), largely extended by the recently acquired failed Gazenergobank (GEB) using proceeds from the state rescue package, as well as some other high-risk items, which, in Fitch's view, undermine the quality of the bank's capital.
The downgrade of APB's IDR to 'CCC' reflects increased pressure on the bank's asset quality and capital from the large RUB9.6bn (88% of proforma combined Tier 1 capital at end-1H16) net exposure to related parties of rather weak quality and RUB6.5bn (63% of APB's Tier 1) of APB's placements (on a stand-alone basis) in a defaulted 100%-owned banking subsidiary, M2M Private Bank (M2M), which also has solvency problems. Shareholders of M2M are currently discussing a bail-in of creditors to improve its capitalisation.
The RWN on APB's IDRs reflects high contagion risks from M2M's default and significant uncertainty regarding APB's rescue plan for M2M, which if not supported by the creditors and approved by the regulator, may lead to APB having to write-off at least some of its interbank placements in M2M. This could result in APB's own capital ratios breaching regulatory requirements, although, according to management, the Central Bank (CBR) may allow APB some temporary forbearance to increase reserves gradually. The risk of deposit outflows is also present, although this is to an extent mitigated by ABP's significant liquidity buffer covering 34% of customer accounts as of 10 November 2016.
Non-performing loans (NPLs, overdue more 90 days) made up 15% of BystroBank's loans at end-9M16 (0.9x reserved) and were mainly attributable to retail loans (90% of total loans). Annualised credit losses (calculated as an increase in NPLs plus write-offs, divided by the average performing loans) shrank to 7% in 6M16 from 8% in 2015. This being below the core pre-impairment profit (8% of average performing loans) has allowed the bank to show a small profit.
FCC ratio was a solid 17% at end-1H16. Regulatory Tier 1 capital ratio was a lower 9.8% (6% required minimum) due to positive hyperinflation adjustment on IFRS equity and higher provisions in regulatory accounts. Fitch estimates the bank has the capacity to book additional impairment reserves equal to 4% of gross loans without breaching capital requirements.
BystroBank is mainly funded by retail deposits (90% of liabilities at end-6M16), which are sticky due to the bank's strong market positions in its home region Udmurtia. Liquid assets (cash and equivalents, short-term net interbank placements and bonds eligible for repo funding with the CBR) net of 12 months wholesale repayments comfortably covered customer accounts by 27% at end-9M16.
NPLs declined to 13% of gross loans at end-1H16 (17% at end-2015) and were fully covered by impairment reserves. The decrease in NPL ratio was mainly due to consolidation of GEB and sale of overdue loans with a profit, which was used as a tool of capital support by the shareholder. However, due to limited transparency Fitch views these gains as low quality.
Retail loan performance has improved. Annualised NPL origination ratio in retail decreased to 6% in 1H16 from 10% in 2015, mainly due to a refocus on higher segment clients (monthly salary of RUB40,000-60,000) and those who have positive credit history with the bank. As a result the risk-adjusted margin in the retail book (calculated as net interest income minus operating costs and credit losses divided by average performing loans) improved to 4% in 1H16 from around zero in 2015.
Corporate book is dominated by related-party exposures (80%), while the rest are of moderate quality. Also Fitch views a RUB2bn bond exposure and RUB0.9bn bank placements as potentially high-risk.
Fitch views the acquisition of failed GEB in 2016 as neutral to the ratings, because it was made with the help of Deposit Insurance Agency (DIA), which provided GEB with RUB23bn almost interest-free 10 years deposit resulting in it booking a RUB16bn fair value gain sufficient to cover a previous RUB12bn capital shortfall. However, GEB on-lent the proceeds to SG, the majority of which was passed on to PJSC TMK for refinancing its foreign-currency loans. Although this transaction was reportedly approved by the DIA/CBR, eliminating regulatory risk, and TMK exposure is of reasonable credit quality, the ballooned level of related-party lending (3x of FCC) remains a source of risk.
SKB's core net profit was about zero in 1H16, as pre-impairment profit (equal to 5% of gross loans) was only enough to cover the credit losses. At the same time the bank's net profit was supported by RUB0.2bn (RUB3.3bn in 2015) gains on sale of overdue loans to some collection companies (as discussed above), and RUB1.1bn gain on the acquisition of GEB, so the net result was a RUB1.1bn profit in 1H16.
FCC ratio stood at 8.3% at end-1H16. In 3Q16 the bank received new RUB1.3bn equity and RUB0.7bn perpetual subordinated loans from SG companies. As a result FCC ratio should improve to a reasonable 10%. SKB's standalone regulatory Tier 1 capital ratio was 8.6% at end-3Q16, allowing reserving for an additional 4% of gross loans before breaching capital ratios.
Contingent risk exists over capital associated with the purchase in 2013 by SG of a 25% stake in SKB from EBRD. This is because the purchase was partially financed with a loan from a third party bank, which could undermine SKB's capitalisation should the bank upstream dividends to serve this facility. However, the majority of its loan was already repaid and also SG could use DIA's funds received through GEB or dividends from TMK to repay this debt.
SKB is funded mainly with customer accounts, which represented 91% of total liabilities at end-1H16, 70% of which were retail deposits. Cushion of liquid assets net of wholesale debt maturing the next 12 months was sufficient to withstand an outflow of 25% of customer accounts, which Fitch deems adequate.
UTB's asset quality remains under pressure. NPLs increased to 33% at end-1H16 from 29% at end-2015, including overdue loans transferred to collection agencies, where UTB retained credit risk. NPLs' coverage decreased to 96% at end-1H16 from full at end-2015, but viewed by Fitch as still reasonable, as at least partial recoveries of some exposures are possible.
Additionally there were several reportedly performing corporate loans that Fitch views as potentially high-risk (combined net exposure was 0.7x of FCC). Reported related-party lending was a low 4% of gross loans at end-1H16. However, Fitch identified several other borrowers that are potentially connected with the bank's shareholder, adding another 6% of gross loans.
Net interest margin jumped to 10.5% at end-1H16 from 6.8% in 2015, as UTB now keeps almost all its free liquidity (about 40% of total assets) on overnight deposits with CBR. Also UTB's pre-impairment profitability is underpinned by healthy commission income (32% of gross revenues) and by lower operating expenses (cost-income ratio improved to 77% in 1H16 from 100% in 2015), so pre-impairment profit became a positive 3.3% of gross loans in 1H16. Impairment charges were modest relative to the increase in NPLs, which allowed the bank to show a small net profit, but this may not be sustainable.
FCC stood at a reasonable 18% at end-1H16 (up from 17% at end-2015) due to moderate deleveraging and absence of losses. However, regulatory Tier 1 ratio was much tighter at 6.8% at end-3Q16 (6% required minimum), mostly due to significant operational risk component and different weightings of loans under regulatory rules, allowing UTB to additionally reserve only 1% of gross loans without breaching the required minimum.
UTB is fully funded by customer accounts, and had large cushion of liquid asset covering customer accounts by 54% at end-10M16.
APB's NPLs decreased to around 20% at end-1H16, from around 23% at end-2015, due to RUB4.5bn (around 5% of end-2015 gross loans) of write-offs. Most (81%) NPLs are from the unsecured retail book, where the NPL ratio was a high 34% at end-1H16. Positively, the NPL origination rate in this book moderated to around 10% in 1H16 from a high 26% in 1H15. APB's corporate, SME and mortgage loan books had lower NPL rates of 5%, 12% and 6%, respectively, at end-1H16. Overall, NPLs were 88% covered by reserves at end-1H16, which is reasonable.
However, NPL metrics do not capture the bank's high-risk exposures to related parties and M2M, which are the bank's key weakness. Furthermore, as APB only completed the acquisition of M2M in 3Q16, the 1H16 accounts do not consolidate the latter. M2M's gross loan book was equal to 18% of APB's at end-3Q16 (based on regulatory accounts), and Fitch estimates that around 70% of the portfolio is either non-performing or restructured.
APB's and M2M's combined net exposure to related parties consists of loans to the holding company (RUB7.5bn at end-1H16) and shares in a gold mining company (RUB2.1bn), which together were equal to 88% of proforma combined Tier 1 capital at end-1H16. Most of these loans are unsecured and, as Fitch understands from management, issued to finance other businesses of shareholders, some of which are quite leveraged, while others are weakly performing. Risk of further pressure on capital also exists due to potential buyouts of foreign minority shareholders.
On a stand-alone basis, APB also has a RUB6.5bn (63% of Tier 1 capital) exposure to M2M, which defaulted last week for liquidity reasons. Fitch believes the CBR had imposed constraints on liquidity support from APB to its subsidiary to protect the credit profile of the former. M2M also has solvency problems as reflected by its breach of capital ratios on 1 November 2016 due to additional reserves created in line with the CBR requirement.
At the same time, APB's ability to provide capital support to its subsidiary is limited and may be subject to regulatory restrictions. Fitch understands from management that a bail-in of some of M2M's creditors, which could generate sufficient equity, is currently being considered. However, significant execution risk exists, and M2M's asset quality problems may ultimately require further provisioning.
APB's FCC ratio was 14.2% at end-1H16, but regulatory capitalisation was much tighter, with Tier 1 and total capital ratios at 7.6% and 10.4%, respectively, mainly due to higher statutory reserves and risk-weights. This small buffer could allow the bank to reserve only about 2% of gross loans without breaching minimal capital adequacy requirements, which is low in light of significant net exposure to M2M and other related parties.
APB's profitability is moderate. Annualised pre-impairment profit was equal to 6.9% of average loans, which is a decent buffer given asset quality risks. In 1H16, the bank created small reserves equal to 2% of average loans (59% of pre-impairment profit), resulting in moderate net income of RUB1bn (12.7% return on average equity).
Due to negative news around M2M APB faces the risk of outflows. Positively, APB has accumulated a significant liquidity cushion, which, net of potential debt repayments due within 12 months, covered 28% of customer funds as of 10 November 2016.
IDRS, VRS, NATIONAL LONG-TERM RATINGS OF SKB, UTB AND APB
Rating upside for SKB and UTB is limited, although gradual improvement of asset quality metrics resulting in sustainably profitable performance and a strengthening of capital could be positive, and in UTB's case could result in a revision of the Outlook to Stable. Conversely, deterioration in asset quality leading to capital erosion may result in negative rating actions.
Fitch plans to resolve the RWN on APB's ratings upon resolution of the issues around M2M. A materialisation of contagion risks from M2M resulting in a capital shortfall or a liquidity squeeze at APB would likely lead to a downgrade. A downgrade may also follow a further material increase of related-party exposures or greater regulatory risks in respect of existing exposures.
If the issues around M2M are resolved without a material weakening of APB's capital or significant liquidity stress, the ratings will likely be affirmed at their current levels. An upgrade of the ratings would require a significant reduction of related-party risks or a strengthening of capitalisaiton.
ALL BANKS' SUPPORT RATINGS AND SUPPORT RATING FLOORS
The '5' Support Ratings and 'No Floor' Support Rating Floors of the four banks reflect their small size and limited franchises, making extraordinary capital support from the state, in case of need, less likely. In Fitch's view, support from the banks' private shareholders also cannot be relied upon. An upgrade of these ratings is unlikely in the foreseeable future, although acquisition by a stronger owner could lead to an upgrade of a bank's Support Rating.
Company — Uraltransbank