OREANDA-NEWS. October 13, 2015. Fitch Ratings has affirmed Kereskedelmi es Hitelbank Zrt's (K&H), Erste Bank Hungary Zrt's (EBH) and CIB Bank Zrt's (CIB) Long-term Issuer Default Ratings (IDRs) at 'BBB-'. The Outlook is Positive on K&H, Stable on CIB and has been revised to Positive from Stable on EBH. Fitch has also upgraded the Viability Ratings (VR) of CIB, EBH and K&H by one notch to 'b-', 'b' and 'bb', respectively. All other ratings have been affirmed. A full list of rating actions is at the end of this commentary.

The affirmation of the support-driven IDRs and Support Ratings of K&H, CIB and EBH reflects Fitch's opinion that there is a high probability that they would be supported, if required, by their respective sole shareholders: KBC Bank (A-/Stable/a-), Intesa Sanpaolo (BBB+/Stable/bbb+) and Erste Group Bank AG (Erste, BBB+/Stable/bbb+).

The upgrade of the VRs mainly reflects the improved operating environment for banks in Hungary, and as a result, Fitch's reassessment of the balance of risks at the three institutions.

In Fitch's view, KBC, Intesa and Erste 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 capped Hungarian banks' foreign currency ratings at one notch above the sovereign (BB+/Positive) to reflect the amplified country risks due to the numerous state interventions in the banking sector. 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.

Fitch maintains a two-notch difference between the ratings of Intesa and CIB, as in our view there is some uncertainty with respect to the long-term strategic importance of the Hungarian market for Intesa, given CIB's weak performance and prospects. The Outlook on CIB's Long-term IDRs is therefore Stable.

K&H and EBH could be rated within one notch of their respective parents, if country risks allow, and therefore have Positive Outlooks, in line with the Hungarian sovereign. This reflects better long-term prospects for K&H (due to its notably stronger financial position) and the recent tangible evidence of Erste's commitment to the Hungarian market. The latter includes the attraction of the EBRD and the Hungarian state as minority shareholders of EBH, with planned 15% stakes each, and the acquisition of Citibank's local consumer business. In assessing support, Fitch also considers the high strategic importance of the broader Central and Eastern European region for Erste.

Erste, Intesa and KBC have sufficient resources to support their (relatively small) Hungarian subsidiaries (if needed), either through liquidity or capital injections. Between end-2009 and end-1H15, EBH received HUF314bn (about EUR1bn) and CIB HUF367bn (about EUR1.2bn) of new equity from their owners. K&H was one of the few foreign-owned banks in Hungary that did not require extraordinary support from its parent over the same period.

The VRs of CIB (b-) and EBH (b) reflect their weak credit risk profiles, which are constrained by poor asset quality and profitability. Both banks have reported large annual losses since 2010 and CIB remains unprofitable on an operating basis. The VRs of EBH and CIB also reflect their moderate capital buffers, comfortable funding and liquidity. K&H's much stronger standalone creditworthiness (bb) mainly reflects its relatively resilient asset quality and more moderate risk appetite through the cycle, ample liquidity and stable funding. However, K&H's VR also reflects a fairly high impaired loans ratio and only adequate capitalisation.

Fitch believes that the operating environment in Hungary has improved due to positive developments in the economy and the government's intention to achieve a gradual normalisation of the banking business environment. The latter particularly reflects the government's commitment to the EBRD (in February 2015) to refrain from implementing new onerous banking legislation and its decision to reduce the bank levy in 2016 (and then further in 2017).

The inflows of impaired loans at all three banks materially subsided in 1H15 due to the relatively supportive operating environment and already seasoned legacy loan portfolios. However, a material improvement in loan portfolio quality will be a lengthy process due to muted demand for new credit and the very slow workout of defaulted loans. In 1H15, credit risks in the retail portfolios were significantly reduced by the conversion of foreign currency (FC) residential mortgages into forint and lowered monthly loan installments. The latter was driven by the Act on Settlements coupled with the new rules on loan pricing.

At end-1H15, the reported asset quality ratios equalled 16% (K&H), 13% (EBH) and 19% (CIB). The ratios for EBH and CIB comprised only loans overdue by 90 days, while the ratio for K&H was based on a broader and more conservative definition. In 1H15, the ratios at EBH and CIB were somewhat reduced as a result of converted impaired mortgages being booked on a net basis in IFRS accounts. Since 2014, CIB and EBH have also accelerated loan book cleaning. All three banks' moderate reserve coverage of impaired loans reflects their largely collateralised lending, which should be viewed against the low liquidity of local real estate market and largely ineffective foreclosure of residential mortgages.

All three banks' performance is likely to continue to suffer from thin margins (driven by a low interest rate environment) and muted credit growth. The stabilisation in risk costs, coupled with the reduced bank levy, should more than offset the potential increase in contributions to the deposit and investor protection funds in 2016. K&H's through-the-cycle resilient revenue generation capacity, reasonable cost efficiency and low risk costs bode well for its future performance. EBH plans to return to profitability in 2016 (after five years of losses), which is realistic in Fitch's opinion. CIB is likely to remain unprofitable (even net of the bank levy) in 2015 and 2016 due to the high share of assets not generating income, costly workout activities and only limited new lending.

Comfortable liquidity and improved funding structures are a rating strength for all three banks. In 1H15, the conversion of FC mortgages substantially reduced FC refinancing needs and improved self-financing capacity. The ratio of gross loans to deposits shrank to 76% (K&H), 109% (CIB) and 99% (EBH) at end-1H15. The largely stable deposit bases, coupled with loan deleveraging, mitigate risks related to growing maturity mismatches due to accelerated repayment of (medium- and long-term) parental funding at CIB and EBH.

CIB's and EBH's capitalisation is relatively weak, while it is only adequate at K&H, due to high legacy impaired loans, moderate reserve coverage and subdued pre-impairment operating profitability. K&H's capitalisation is sounder than peers due to its lower net impaired loans, relatively stronger pre-impairment profitability and lower exposure to risky sectors. However, K&H's capital ratios could be moderately constrained by the bank's policy to upstream all distributable profit to KBC. CIB's inability to generate capital internally weighs on Fitch's assessment of the bank's capital position.

At end-1H15, CET1 ratios equalled 11.7% (K&H, standalone ratio), 13.7% (CIB) and 12.1% (EBH). EBH's capitalisation could significantly strengthen as a result of the planned equity injections by the EBRD and the Hungarian state. All three banks' capital ratios should be viewed in light of quite high regulatory capital requirements under Pillar 2 and the central bank's plan to introduce three new capital buffers in 2016 (no final details available yet) in line with CRD IV and recent EBA guidelines. Fitch's base case expectation is that owners will continue to recapitalise their subsidiaries to ensure compliance with regulatory capital requirements (if ever required).

The Positive Outlooks on K&H and EBH reflect that on the Hungarian sovereign, while the Stable Outlook on CIB mirrors that on its parent. An upgrade of the banks' IDRs would require an upgrade of the sovereign rating (all three banks) and (for CIB) an upgrade of Intesa.

The IDRs of all three banks could be downgraded if i) there was a downgrade of the Hungarian sovereign rating; ii) parental support is delayed when needed, or iii) new onerous domestic bank regulation and weak market prospects make shareholders' commitment to their subsidiaries less certain. CIB's IDRs and Support Rating would also likely be downgraded if Intesa is downgraded.

All three banks' VRs could be upgraded following an extended track record of problem loan recoveries coupled with improved profitability. A positive rating action for K&H's VR would likely also require a further improvement in the operating environment in Hungary.

Conversely, 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 generation.

The rating actions are as follows:

Long-term IDR: affirmed at 'BBB-', Outlook Positive
Short-term IDR: affirmed at 'F3'
Viability Rating: upgraded to 'bb' from 'bb-'
Support Rating: affirmed at '2',

Long-term IDR: affirmed at 'BBB-', Outlook revised to Positive from Stable
Short-term IDR: affirmed at 'F3'
Viability Rating: upgraded to 'b' from 'b-'
Support Rating: affirmed at '2',

Long-term IDR: affirmed at 'BBB-', Outlook Stable
Short-term IDR: affirmed at 'F3'
Viability Rating: upgraded to 'b-' from 'ccc'
Support Rating: affirmed at '2'