August 10, 2017 / 3:45 PM / 10 months ago

Fitch Downgrades Azerbaijan's Atabank to 'CCC'; Affirms Expressbank at 'B'

(The following statement was released by the rating agency) MOSCOW, August 10 (Fitch) Fitch Ratings has downgraded Azerbaijan-based Atabank OJSC's (AB) Long-Term Issuer Default Rating (IDR) to 'CCC' from 'B-' and affirmed Expressbank Open Joint Stock Company's (EB) at 'B' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS IDRs and VRs ATABANK The downgrade of AB reflects Fitch's view that the post-merger credit profile has turned out to be weaker than previously anticipated and no longer commensurate with the 'B-' rating level (see 'Fitch: Azerbaijani Atabank's Ratings Unaffected by Merger' published on 4 July 2017 on Specifically, asset quality is worse than expected due to additional deterioration in 1H17, offsetting the positive impact from the merger with the stronger-capitalised Caspian Development Bank OJSC (CDB), with the volume of unreserved non-performing loans (NPLs, 90+ days overdue) equaling a high 1.2x Fitch core capital (FCC) at end-1H17. Fitch also estimates that cash-based (excluding non-received accrued interest) pre-impairment profitability was about breakeven in 2016-1H17, which makes reserving of problem loans challenging without external capital support. AB's NPLs increased significantly to 42% of total gross loans at end-1H17, from 14% at end-2015, while the loan book grew 14% in the same period with more than 40% of this growth being uncollected accrued interest. Reserve coverage of NPLs weakened to 26% at end-1H17 from 39% at end-2015 and their additional provisioning could erode the bank's capital position. Even after the merger with CDB in May 2017 and a further AZN20 million equity injection in 1H17, AB's unreserved NPLs were a significant 1.2x FCC at end-1H17 (end-2015: 0.8x FCC). Following a review of the bank's 25 largest corporate exposures Fitch identified that about 26% of gross loans at end-1H17, although not NPLs, were potentially high-risk (project finance, foreign currency loans to unhedged borrowers and non-amortising bullet repayment loans). Loans to related parties (excluding those considered higher-risk) equalled a further 4% of gross loans at end-1H17. The lower-risk corporate loans (15% of gross loans) were mostly guaranteed by the state or fully covered by pledged deposits. The performance of AB's retail portfolio (21% of gross loans) is also weak with around a third of them being NPLs at end-1H17. AB's post-merger regulatory tier 1 and total capital ratios were 21.4% and 22.9%, respectively (regulatory minimums are 5% and 10%) at end-1H17, up from 12.8% and 14.2% at end-4M17. However, this should be viewed together with the bank's significantly increased unreserved NPLs, other high-risk loans and weak core earnings. Fitch estimates that at end-1H17 AB's regulatory capital would allow the bank to reserve only around half of unreserved NPLs. Internal capital generation capacity is weak due to modest earnings (return on average equity (ROAE) of 3.2% in 1H17, -0.6% in 2016) with a sizable part of interest income not received in cash (around 41% in 2016). Fitch estimates that cash-based (excluding not received accrued interest) pre-impairment profit was negative in 2016 and is likely to have remained weak in 1H17 and unable to absorb loan impairment losses to cover NPLs, which in turn would eat into capital. AB's liquidity is tight after funding outflows in 4Q15-1H16. The bank's total available liquidity net of potential debt repayments equaled a low 6.2% of non-related customer accounts (excluding deposits pledged as collateral against loans). This is particularly weak in light of the bank's rather concentrated customer funding and largely long-term nature of the bank's corporate book. EB The affirmation of EB's ratings reflects only limited changes to its credit profile over the last 12 months. The ratings take into account EB's limited franchise in the difficult Azerbaijan operating environment and a high level of related-party lending. Positively, the ratings reflect EB's solid capital buffer, still reasonable, albeit moderately deteriorating, asset quality, limited exposure to foreign currency lending and ample liquidity. The Stable Outlook reflects Fitch's expectation that, despite the potential for some further asset quality deterioration, this should be covered by pre-impairment profits and additionally mitigated by the bank's solid capital buffer. EB's corporate loan book (55% of gross loans at end-1Q17) is reportedly performing with zero NPLs. It almost entirely consists of exposures to the bank's main corporate shareholder and its subsidiaries (79% of FCC), including a large construction company engaged in infrastructure construction and to a start-up diversified production plant, the development of which is supported by the government. In addition, EB issued a AZN30 million uncovered guarantee in favour of these related companies (around 22% of FCC). Positively, total related-party exposure decreased to AZN139 million (101% of FCC) at end-1Q17 from AZN192 million (138% of FCC) at end-2015, and may decrease further due to the gradual phasing-in (by mid-2018) of the regulatory deduction of related-party exposures from Tier 1 capital for capital adequacy purposes. These borrowers reportedly target repaying foreign currency loans first, thus also reducing EB's foreign currency risks. Retail NPLs decreased significantly to 6% of total retail loans (almost fully covered by reserves) at end-1Q17 from a high 20% at end-1H16, due to large write-offs. However, NPL generation - a good proxy for credit losses and calculated as the net increase in NPLs plus write offs and divided by average performing loans,- increased in 1Q17 to 17% (annualised) from 11% in 2016, indicating ongoing deterioration. EB's robust capital position, as expressed by its high FCC ratio, further improved to around 50% at end-2016 from 43% at end-2015 following a moderate 14% deleveraging. Near-term loan growth potential is limited, and the FCC ratio is unlikely to significantly decrease in the next couple of years. However, regulatory capitalisation is lower due to deduction of half of related-party exposure at end-1Q17. The bank plans to reduce the related-party exposure to avoid taking a bigger hit on regulatory capital. EB is funded by customer deposits (87% of total liabilities at end-1Q17) and liquidity risks are mitigated by a sizeable net liquidity buffer, which was sufficient to repay a high 44% of customer funding at end-1Q17, and by rapid retail loan turnover. Wholesale funding (11% of end-1Q17 liabilities) is sourced domestically and likely to be rolled over. SUPPORT RATINGS (SR) AND SUPPORT RATING FLOORS (SRF) AB and EB The SRFs of 'No Floor' and SRs of '5' for both banks reflect their limited scale of operations and market shares. Although Fitch believes some regulatory forbearance may be available for these banks, in case of need, any extraordinary direct capital support from the Azerbaijan authorities is very uncertain. This view is also supported by the recent default of International Bank of Azerbaijan (IBA; 'Restricted Default'; See 'Fitch Downgrades International Bank of Azerbaijan to 'RD'' on 24 May 2017 on, which is the largest bank in the country and government-owned, meaning that state support for less systemically-important privately-owned banks cannot be relied upon. The potential for support from the banks' private shareholders is not factored into the ratings. RATING SENSITIVITIES Positive rating action for EB would be contingent on substantial franchise development through growth of third-party business, a reduction in volumes of operations with affiliated parties and a moderation of asset quality risks. At both banks, capital depletion as a result of further asset quality deterioration (more likely in AB) may lead to negative rating actions. Negative rating pressure for AB could also stem from a further liquidity squeeze. Fitch believes that positive rating actions on the banks' SR and SRFs are unlikely in the near-term. The rating actions are as follows: Expressbank: Long-Term IDR: affirmed at 'B', Outlook Stable Short-Term IDR: affirmed at 'B' Viability Rating: affirmed at 'b' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Atabank: Long-Term IDR: downgraded to 'CCC' from 'B-' Short-Term IDR: downgraded to 'C' from 'B' Viability Rating: downgraded to 'ccc' from 'b-' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Contact: Primary Analyst Ruslan Bulatov Associate Director +7 495 956 9982 Fitch Ratings CIS Limited 26 Valovaya Street Moscow 115054 Secondary Analyst Maria Kuraeva Associate Director +7 495 956 9901 Committee Chairperson James Watson Managing Director +7 495 956 6657 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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