OREANDA-NEWS. Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) of Sberbank Europe AG (SBEU), Sberbank Slovensko a.s. (SBSK) and Kazakh-based Subsidiary Bank Sberbank of Russia, JSC (SBK) at 'BBB-' with a Negative Outlook. The agency has also affirmed the Long-term IDR of Sberbank (Switzerland) AG (SBS) at 'BBB', with a Negative Outlook.

The affirmation of SBK's debt applies to all debt issued prior to 1 August 2014.

The banks' IDRs, National and Support ratings reflect Fitch's view of the high probability that the banks would be supported by their ultimate parent, Sberbank of Russia's (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 its 'bbb' Viability Rating (VR), and are also underpinned by potential support from the Russian Federation (BBB/Negative). The Negative Outlook on SBRF's ratings mirrors that on the sovereign and reflects both a potential weakening of support and the potential for the VR, which is at the same level as the sovereign, to be downgraded due to risk of a weakening operating environment, as SBRF is exposed to the broader Russian economy.

Fitch's view on the probability of support is based on: (i) strategic importance of the European and CIS markets for SBRF given its focus on international expansion; (ii) its track record of providing capital and funding; (iii) high reputational risks for SBRF from any potential default of its subsidiaries given the parent's presence on international markets and (iv) the subsidiaries' small size relative to the parent limiting the cost of any potential support.

The equalisation of the ratings of SBS with SBRF also takes into account the subsidiary's high integration with the parent, limited operational independence and its role in servicing 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, SBSK and SBK, and SBRF reflects these subsidiaries' lower integration, higher operational independence and lesser reliance on the parent for business origination.

The subsidiary banks' IDRs are likely to change in tandem with the parent's IDRs. Ratings of notched subsidiaries could be upgraded to the level of SBRF in case of significantly higher integration with the parent, an increase in the proportion of business devoted to servicing of core group clients and an extended track record of profitable operations, reinforcing the long-term strategic commitment to these markets.

The Support Ratings of SBEU, SBSK and SBK would be downgraded if SBRF's IDR is downgraded provided the notching between subsidiaries' and parent's IDRs is unchanged. A downgrade of SBS's Support rating would result from SBRF's IDR being downgraded by more than one notch.

The affirmation of SBEU's 'b+' VR reflects limited changes in the bank's stand-alone profile over the last 12 months and is driven by the bank's modest, albeit developing, franchise, weak profitability and legacy asset quality problems. At the same time, the rating positively considers the improving profile of the bank's largest borrowers, sound liquidity and a reasonable funding mix.

SBEU's profitability (minus 9% return on average equity in 1H14 after breaking even in 2013) has been pressured by one-off Hungary-related costs (EUR21m in 1H14), high operating expenses relative to generated revenue (cost/income of 79% in 1H14) due to expanding staff costs and the continued integration process with the parent, and tight, albeit slightly improved, margins. Fitch sees limited potential for the net interest margin (3.1% in 1H14) to improve in the near term in light of a low interest rate environment, and the need to gain market share and fund a rapidly growing loan book. Profitability should improve, however, as previous investment in staff and infrastructure starts paying off, but is likely to remain weak unless SBEU significantly increases its scale of operations.

The bank's non-performing loans (NPLs, 90 days overdue) ratio improved to 10.3% of gross loans at end-1Q14 (from 11% at end-2013 and 14.7% at end-2012), driven by strong 10% loan growth in the beginning of 2014 and problem loan recoveries in 2013. At the same time, coverage of NPLs by provisions was somewhat moderate at 52% at end-1Q14, considering the significant 6% share of restructured exposures, reflecting the bank's reliance on collateral. After the acquisition by SBRF, SBEU gained access to higher-profile clients, which resulted in improved quality of the new largest exposures, most of which are low-risk, in Fitch's view.

SBEU's sound liquidity position is underpinned by large holdings of unpledged liquid securities and moderate near-term repayments. The bank's highly liquid assets covered a solid 15% of customer accounts at end-1H14 after adjusting for potential cash uses over the following 12 months. Additional liquidity could be drawn from SBRF in case of need. SBEU is primarily funded by local deposits, which have proved to be sticky so far (deposit outflow since the introduction of sanctions on Russia was a manageable 1%). Parent funding was equal to a moderate 17% of end-1H14 liabilities and should further decrease, along with the currently high 144% loans-to-deposits ratio, as SBEU develops deposit collection through a direct bank in Germany.

Capital injections by the parent helped keep SBEU's Fitch Core Capital (FCC) ratio at a reasonable 10.6% at end-1H14 (but down from 11% at end-2013 due to losses in 1H14), while total regulatory capital adequacy ratio was a healthy 16.1%. At the same time SBEU's capital position is pressured by its weak performance, and achieving growth targets would be contingent on further timely capital support.

An upgrade of SBEU's VR would result from a continued expansion of the bank's franchise and a track record of profitable performance. Continued losses and/or asset quality deterioration could result in a downgrade of the VR.

The affirmation of SBSK's VR at 'bb-' reflects stabilisation of asset quality and lower risk appetite than under the previous owner of the bank. SBSK's VR is supported the bank's healthy liquidity and low refinancing risks, with market funding being limited. Nevertheless SBSK's small size and modest franchise, only adequate capital base given the bank's growth and weak profitability as well as borrower concentration risk in its loan book, constrain the bank's ratings.

Deposit outflows as a result of the conflict between Russia and Ukraine were moderate in 1Q14 and stabilised during 2Q14.

The bank's profitability is still low and profit growth is constrained by low interest rates, competition and a fairly high cost base. High loan loss provisions, mostly driven by a loan book review by SBRF following the acquisition of SBSK, had a negative effect on SBSK's performance results during 2012-H113, which were also hit by the Slovakian bank levy. The bank returned to profitability at in 2H13 on lower loan impairment charges relative to 1H13 and loan growth. Loan growth continued through 1H14, driven mostly by retail loans.

SBSK's weak asset quality reflects the past focus on sectors such as real estate project financing. NPLs (loans overdue by more than 90 days) were stable at around 5.8% of gross loans at end-1H14, albeit somewhat above the sector average of 5.2%. NPLs coverage by provisions was strong 90%, although this ratio varies for different NPL categories, reflecting the bank's significant reliance on collateral. Restructured loans, which would have been in default were it not for prolongations, accounted for a material 5.1% of loans at end-1H14, which suggests a potential need for further loan impairment charges in the medium term.

SBSK's FCC ratio improved to 12.9% at end-H114 from 8% end-2012, due to an equity injection and conversion of preferred shares into ordinary stock in 2012 and 2013 totalling EUR115m. Fitch views the bank's capitalisation as only adequate at present in view of the bank's considerable loan growth above internal capital generation.

Upside potential for SBSK's VR is currently limited. The bank's risk profile would benefit from franchise diversification, a reduction in portfolio concentrations, and stronger profitability. Should the bank suffer large losses as a result of deterioration in loan quality without this being offset by equity injections, the VR could be downgraded.

SBK's senior debt ratings are aligned with the bank's Local currency IDR and National Long-term rating respectively. The ratings for subordinated debt are notched off one level from the local currency IDR and National Long-term rating, in line with Fitch's criteria for rating such instruments. Changes to SBK's Local currency IDR and National ratings will translate into changes in the respective debt ratings.