Fitch Affirms Sberbank's European Subsidiaries; Outlooks Negative
A full list of rating actions is available at the end of this rating action commentary.
KEY RATING DRIVERS - IDRS AND SUPPORT RATINGS
Both banks' IDRs and Support ratings reflect Fitch's view that the banks are likely to be supported by their ultimate parent, Sberbank of Russia (SBRF, BBB-/Negative/bbb-), in case of need. The Negative Outlook on the IDRs is driven by that on SBRF's ratings.
SBRF's Long-Term IDRs are driven by the bank's standalone strength, reflected in the 'bbb-' Viability Rating (VR), and are also underpinned by potential support from Russia (BBB-/Negative). The Negative Outlook on SBRF's ratings mirrors that on the sovereign and reflects both a potential weakening of support and the downside pressure for the VR, which is now at the same level as the sovereign, due to risks relating to a weaker Russian economic environment.
Fitch's view on the probability of support for SBRF's subsidiaries is based on: (i) the strategic commitment of SBRF to support its European subsidiaries in line with its strategy of international business development, (ii) SBRF's track record of providing capital and funding support to date (particularly to SBEU); (iii) full ownership and common branding, (iv) high reputational risks for SBRF from any potential default of its subsidiaries given the parent's presence in international markets and (v) the subsidiaries' small size relative to the parent, limiting the cost of any potential support.
The equalisation of the ratings of SBS with SBRF takes into account the subsidiary's high integration with the parent; limited operational independence; and its role in providing complimentary services to core group clients, in particular commodity exporters, by providing trade finance services and participating in structured lending as well as client settlements.
The one-notch differential between the Long-Term IDRs of SBEU and SBRF reflects SBEU's lower integration, higher operational independence and lesser reliance on the parent for business origination compared with SBS.
The recent disposal of Sberbank Slovensko (a Slovak-based subsidiary of SBEU) and the gradual evolution of SBEU's strategic focus are unlikely to impair SBRF's propensity to support. Fitch believes that SBRF is still committed to providing support to the subsidiaries for as long as they are owned by SBRF.
KEY RATING DRIVERS - VR
The affirmation of SBEU's VR at 'b+' reflects limited changes to the bank's credit profile over the last 12 months. The VR continues to reflect SBEU's modest franchise and limited pricing power; legacy asset quality problems and weak pre-impairment profitability. Positively, the VR reflects SBEU's sound liquidity and funding profiles and recently improved core capitalisation.
At end-1Q16, non-performing loans (NPLs, 90 days overdue and impaired loans), most of which are legacy exposures, equalled a high 11% of gross loans and were only 45% covered by impairment reserves. The track record of recoveries from the legacy NPLs has been limited to date, although, positively, the inflow of new NPLs is low, reflecting the generally reasonable quality of new lending. Loan concentrations are high, although the 20 largest exposures (2.5x Fitch Core Capital (FCC) at end-1Q16) are of adequate quality, in Fitch's view. SBEU's Ukrainian exposure was limited to 1% of gross loans, and therefore presents limited additional risk.
Profitability is dampened by weak operating efficiency and thin margins that are under pressure from a low interest rate environment and a high portion of low-yielding liquid assets. SBEU managed to be profitable in 1H16 for the first time since its acquisition by SBRF in 2012, although pre-impairment profit in 1H16 was still weak and equalled to less than 1% of gross loans (annualised). Therefore, Fitch continues to view SBEU's performance as vulnerable and offering limited capacity to absorb credit losses in a credit downcycle.
After the conversion of EUR370m of subordinated debt from the parent in 1Q16, the estimated FCC ratio increased to 14% of risk-weighted assets at end-1Q16 and further to 15% at end-1H16 following the de-consolidation of the Slovak subsidiary. The remaining EUR320m of loss-absorbing subordinated debt from SBRF is equal to a further 4% of risk-weighted assets. We estimate that at end-1H16 SBEU's FCC buffer was sufficient to increase loan impairment reserves by EUR500m (around 5% of gross loans), thereby increasing coverage of existing NPLs by reserves to 90% (from the current 47% which is fairly modest) while still maintaining a double-digit FCC ratio.
Funding and liquidity is a rating strength and is supported by the steady inflow of granular, although price-sensitive, retail deposits and by contingent access to liquidity from SBRF in case of need. At end-1Q16 SBEU was 60% customer-funded. Reliance on parent funding has reduced to 5% of total liabilities over recent years. The liquidity buffer was substantial at EUR3.5bn, which is sufficient to repay all wholesale funding due in 2016 and 2017 and still cover around 18% of customer funding with remaining liquid assets.
IDRS AND SUPPORT RATINGS
The support-driven ratings of both banks are likely to change in tandem with the parent's IDRs.
The IDRs of SBEU could be upgraded to the level of SBRF, thereby eliminating the one-notch difference, in the event of (i) significantly higher integration with the parent, (ii) an increase in the proportion of business devoted to servicing core group clients and (iii) an extended track record of profitable operations, reinforcing the parent's long-term strategic commitment to its subsidiary.
Both banks' support-driven IDRs are sensitive to a change in SBRF's support propensity, for example, in case of plans to dispose of either of the banks. Under this scenario, the notching between the parent and the subsidiaries may be widened.
An upgrade of SBEU's VR would require an extended track record of limited inflow of new asset quality problems and profitable performance. Conversely, a marked deterioration of SBEU's asset quality resulting in significant bottom-line losses may result in a downgrade.
Fitch may assign a VR to SBS if it develops a more significant independent franchise and reduces the reliance on the parent in terms of funding and new business origination.
The rating actions are as follows:
Long-Term IDR: affirmed at 'BB+'; Outlook Negative
Short-Term IDR: affirmed at 'B'
Support Rating: affirmed at '3'
Viability Rating: affirmed at 'b+'
Long-Term IDR: affirmed at 'BBB-'; Outlook Negative
Short-Term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'