OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) of Kereskedelmi es Hitelbank Zrt (K&H) and Erste Bank Hungary Zrt (EBH) at 'BBB' and of CIB Bank Zrt (CIB) at 'BBB-'. The Outlooks on the Long-Term IDRs are Stable.

Fitch has also upgraded the banks' Viability Ratings (VR) to 'bb+' from 'bb' (K&H), to 'b+' from 'b' (EBH) and to 'b' from 'b-' (CIB). A full list of rating actions is available at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS AND SUPPORT RATINGS

The affirmation of IDRs of K&H, EBH and CIB reflects Fitch's unchanged view of the ability and propensity of their respective parents - KBC Bank (KBC; A-/Positive/a-), Erste Group Bank AG (Erste; BBB+/Stable/bbb+) and Intesa Sanpaolo (Intesa; BBB+/Stable/bbb+) to provide support, in case of need.

In Fitch's view, KBC, Erste and Intesa will continue to have a high propensity to support their Hungarian subsidiaries because the central and eastern European region remains strategically important for each of them. However, Fitch has maintained the cap for Hungarian banks' foreign currency ratings at one notch above the sovereign (BBB-) to reflect the country risks they face. In case of a sovereign default these risks could limit the banks' ability to service their debt or their parents' propensity to continue providing support, or both.

EBH is rated one notch below Erste. The minority participation of the Hungarian government and EBRD in EBH (each holding 15% stake from July 2016) does not affect Fitch's view of Erste's propensity to support EBH as Erste's commitment to the Hungarian market remains unchanged. The Stable Outlook on EBH reflects that on Erste. K&H could also be rated within one notch of its parent, if country risks allowed. The Stable Outlook for K&H reflects that for the Hungarian sovereign.

Fitch maintains a two-notch difference between the ratings of Intesa and CIB, as in our view, there is some uncertainty with respect to Intesa's long-term commitment to the Hungarian market, given CIB's still weak, albeit improving, performance and prospects. The Stable Outlook on CIB's Long-Term IDR is in line with that on Intesa.

VRS

The upgrades of the banks' VRs reflect the stabilisation of the operating and regulatory environments for Hungarian banks, resulting in decreased asset quality and profitability pressures. This was the main factor driving the upgrade of K&H's VR (bb+), which also reflects the bank's stronger standalone creditworthiness than peers'. The bank is supported by a more balanced business model and lower risk appetite through the cycle, resulting in its more resilient asset quality and profitability.

The upgrade of EBH and CIB reflects strengthened capitalisations of both banks following recent capital injections by their respective parents and, in the case of EBH, also takes into account the bank's visible progress in the clean-up of its problem commercial real estate (CRE) portfolio. The VRs of EBH (b+) and CIB (b) remain constrained by the weak asset quality, as their stock of legacy impaired loans remains sizeable, and modest, albeit slowly improving, profitability.

All VRs also consider the three banks' comfortable funding and liquidity.

Impaired loans were 28.6% of total gross loans (CIB, at end-2015 and these were largely unchanged at end-1H16), 13.4% (EBH, end-1H16) and 9.4% (K&H, end-1H16). These were largely legacy CRE exposures and retail mortgages (originally disbursed mainly in foreign currency), while inflows of new problem loans were limited during 2015-1H16.

CIB's high impaired loans ratio also reflects the bank's only moderate loan write-offs and significant loan book contraction to date. K&H's distinctly better loan book quality is also due to the bank's limited exposure to the CRE sector. Reserve coverage of impaired loans is moderate at all three banks (end-1H16: EBH: 68%; K&H: 42%; CIB: 58.7% at end-2015), reflecting high reliance on loan collateral. This, however, should be viewed against largely ineffective foreclosure of residential mortgages.

We expect generally stable asset quality trends in 2016-2017 on the back of continued economic growth and subsiding asset quality pressures in the retail segment (as the conversion of Swiss-franc mortgages into forint in 2015 has also provided some debt relief for retail borrowers). The recovering local property market is also supportive of the banks' balance sheet clean-up process. The introduction of a regulatory systemic risk buffer from 2017, which is linked to the volume of distressed CRE exposures, will also motivate banks to accelerate sale-down/write-offs of these exposures over the coming months.

EBH and CIB reported positive results at the operating level in 1H16, after several years of heavy losses, reflecting long-term deleveraging and asset quality problems. The recent recovery was driven largely by one-off effects, including net reversals of impairment provisions and a lower bank tax. K&H's performance has been more resilient through the cycle, due to the bank's more stable revenue generation and lower risk costs. It was one of the few banks in Hungary that has remained profitable since the onset of the financial crisis (except for 2014).

Future performance of the three banks will largely depend on the success of the problem loans' work-out efforts (in particular at CIB) and business growth in a low-interest rate environment, while the high taxes and regulatory pressures on banks have now abated. We expect credit expansion to remain challenging due to generally muted demand, while loan portfolios continue to amortise despite accelerating new lending in the housing and consumer finance segments.

At end-1H16, regulatory common equity Tier 1 ratios stood at 14.4% (EBH; adjusted by a capital increase in July 2016) and 14.1% (K&H); CIB's regulatory total capital ratio was 19.5% at end-1Q16. The capital ratios should be viewed in light of increasing regulatory capital requirements (in line with CRD IV and recent EBA guidelines) and unreserved impaired loans. The latter were particularly large at CIB (around 63% of Fitch Core Capital (FCC) at end-2015 adjusted by capital increase in 1H16), moderate at K&H (around 30% at end-1H16) and lower at EBH (around 19% at end-1H16). Fitch's base case expectation is for the banks' owners to recapitalise them, if required, to ensure compliance with regulatory requirements.

Refinancing risks at all three banks are limited due to their stable deposit funding, limited reliance on wholesale funding and sizeable liquidity buffers. At end-1H16, loans/deposits (L/D) ratios fell below 100% for all banks, reflecting their shrinking loan books and repayment of parental funding. The latter was also due to decreased needs in foreign currency funding following the foreign currency mortgage conversion in 2015.

RATING SENSITIVITIES

IDRS AND SUPPORT RATINGS

An IDR upgrade would require (for K&H) an upgrade of the Hungarian sovereign rating or a positive change in Fitch's perception of country risks the Hungarian banks face; (for EBH) an upgrade of the Hungarian sovereign rating or a positive change in Fitch's perception of country risks, coupled with an upgrade of the parent bank; and (for CIB) a parent bank upgrade.

The IDRs of EBH and K&H would likely be downgraded if the Hungarian sovereign is downgraded. The IDRs of EBH and CIB would likely be downgraded if their respective parents are downgraded.

VRS

EBH's and CIB's VRs could be upgraded following a further reduction of problem assets coupled with improved profitability and maintained solid solvency metrics. Upside for K&H is currently limited and will require a substantial improvement in the operating environment and a broadening of the bank's domestic franchise.

The banks' VRs could come under pressure in case of a worsening of the operating environment and capital pressure from additional credit losses on legacy problem exposures or new impaired loans.

The rating actions are as follows:

K&H

Long-Term IDR: affirmed at 'BBB', Outlook Stable

Short-Term IDR: affirmed at 'F2'

Support Rating: affirmed at '2'

Viability Rating: upgraded to 'bb+' from 'bb'

EBH

Long-Term IDR: affirmed at 'BBB', Outlook Stable

Short-Term IDR: affirmed at 'F2'

Support Rating: affirmed at '2'

Viability Rating: upgraded to 'b+' from 'b'

CIB

Long-Term IDR: affirmed at 'BBB-', Outlook Stable

Short-Term IDR: affirmed at 'F3'

Support Rating: affirmed at '2'

Viability Rating: upgraded to 'b' from 'b-'