Fitch Downgrades Demirbank's IDR to 'B-' & VR to 'ccc'; Maintains on RWN
KEY RATING DRIVERS
IDRS AND VR
The downgrades of Demir's ratings reflect Fitch's view that the bank's credit profile has significantly weakened compared with the previous review in November 2015. According to the bank's regulatory accounts at end-1H16, its asset quality, profitability and capital position have deteriorated markedly compared with end-1H15, the latest date for which the bank published IFRS accounts.
Demir's VR of 'ccc' reflects the bank's weak asset quality, vulnerable capital position and negative pre-impairment profitability on a cash basis. However, the bank's VR benefits from its satisfactory liquidity position, supported by access to funding from international financial institutions (IFIs), including the bank's minority shareholders, European Bank for Reconstruction & Development (25% stake, AAA/Stable) and FMO (10% stake).
The one-notch uplift of Demir's IDR of 'B-' relative to its VR reflects Fitch's view that the probability of the bank defaulting on its senior obligations (which are reference liabilities for bank IDRs) is somewhat lower than it failing (i. e. becoming non-viable, and requiring external support to address a material capital shortfall,). This view in turn reflects the bank's recent announcement of a planned AZN50m equity injection, which could moderately reduce risks for senior creditors, at least in the near term.
The RWN on the VR reflects the risk of the rating being downgraded to 'f', indicating that the bank has failed, if Fitch takes the view that the planned equity injection is necessary to address a material capital shortfall. This assessment will in part be based on the asset quality disclosures, loan impairment reserves and capital position reported in the bank's 2015 and 1H16 IFRS accounts, which Fitch understands will be published in the next two months.
The RWN on the IDRs reflects (i) the risk that the bank's asset quality and capital position, even after the planned equity injection, will warrant a lower rating than 'B-'; and (ii) the risk that the equity injection will not take place.
At end-1H16, Demir reported in its regulatory accounts that the principal amount of non-performing loans (NPLs; 90 days overdue) was equal to a high 28% of gross loans (up from 8% at end-2015). In addition, interest accrued, but not received in cash, made up a further 17% of gross loans (up from 11%). Together, these two items were only 22% covered with impairment reserves. Fitch believes that some recoveries on these exposures are probable given the fact that most loans are reportedly secured with real estate, but there is significant uncertainty with respect to the quality and liquidity of this collateral.
Demir continued to comply with regulatory capital requirements at end-1H16, reporting Tier 1 and total ratios of 6.7% and 11.6%, respectively. However, the bank's capital position is undermined by its sizable unreserved NPLs and accrued interest, which together were equal to 2.8x regulatory capital. The difference between Tier 1 and total capital ratios is mainly driven by subordinated debt contributed by IFIs, including the bank's IFI shareholders. However, Demir has not yet announced whether this may be used to help strengthen the bank's core capital.
Reported pre-impairment regulatory profitability is reasonable, equal to an annualised 6.3% of average total assets in 1H16. However, a large 60% of interest income for 1H16 was accrued without being received in cash, and net of this the bank was loss making on a pre-impairment basis. Reported net results were at break-even, as the bank created only moderate loan impairment reserves.
Fitch views Demir's liquidity position as reasonable given that the liquidity cushion covered around 13% of total liabilities at end-1H16. This is above Demir's wholesale refinancing needs over 2H16-1H17 (10% of total liabilities).
SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
Demir's SRF of 'No Floor' and SR of '5' reflect the bank's limited scale of operations and market shares. Fitch expects some regulatory forbearance to be available for Demir, in case of need, but any extraordinary direct capital support from the Azerbaijan authorities cannot be relied upon, in the agency's view. Support from the bank's private or IFI shareholders is possible in Fitch's view, but cannot be relied upon in all circumstances.
IDRs AND VR
Fitch will downgrade the VR to 'f', indicating that the bank has failed, if the agency takes the view that the planned equity injection is necessary to address a material capital shortfall. The VR would then be upgraded (re-rated), primarily based on an assessment of the bank's asset quality and capital position after the injection.
The VR could be affirmed at 'ccc' or upgraded, if the agency concludes external support is not necessary to address a material capital shortfall.
The Long-Term IDR will probably be aligned with the bank's VR following the planned equity injection.
SR AND SRF
Positive rating action on the bank's SR and SRF is unlikely in the near term given the bank's limited systemic importance.
The rating actions are as follows:
Long-Term foreign currency IDR: downgraded to 'B-' from 'B', maintained on RWN
Short-Term foreign currency IDR: 'B', maintained on RWN
Viability Rating: downgraded to 'ccc' from 'b', maintained on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'