OREANDA-NEWS. April 21, 2015. Fitch Ratings has downgraded Russia-based Home Credit & Finance Bank's (HCFB) Long-term Issuer Default Ratings (IDRs) to 'B+' from 'BB-' and its Kazakhstan-based subsidiary SB JSC Home Credit and Finance Bank (HCK) to 'B' from 'B+'. The Outlook is Negative for HCFB and Stable for HCK.

The agency has also placed the 'B' Long-term IDRs of Russian Standard Bank (RSB) and Orient Express Bank (OEB) on Rating Watch Negative (RWN).

A full list of rating actions is available at the end of this commentary.

KEY RATING DRIVERS - IDRS, VIABILITY RATINGS (VRs) AND NATIONAL RATINGS (HCFB RSB and OEB)

The rating actions reflect the banks' weakening credit profiles amid negative trends in the operating environment.

The core consumer finance business of all three banks' has been loss-making since at least mid-2014 due to further credit losses, resulting in gradual capital erosion. The magnitude of bottom-line losses increased in 1Q15, due to higher funding costs for the sector after the Central Bank of Russia (CBR) rate hike in December 2014, and may increase further due to asset quality risks stemming from rouble devaluation, increased inflation, a fall in people's real incomes and rising unemployment.

Sector loan growth prospects are sluggish due to capital constraints at most banks and limited inflows of less leveraged clients with an at least moderate credit risk profile. Fitch expects unsecured retail lending in Russia to fall 10% in 2015.

The RWN on RSB's and OEB's ratings reflects the weak core regulatory capitalisation as reflected by their regulatory Tier 1 (N1.2) ratios of, respectively, 6.4% at end-2014 and 6.7% at end-1Q15, which were only marginally above the regulatory minimum of 6%. The RWN also reflects the currently loss-making performance, which if continues at this pace and not reversed and/or alleviated by capital injections, puts the banks at risk of breaching regulatory capital ratios by end-1H15, according to Fitch estimates.

KEY RATING DRIVERS AND SENSITIVITIES - HCFB

HCFB posted a RUB4.5bn (8.7% of average equity) loss in its IFRS accounts for 2014, which was mainly a function of larger credit losses (calculated as loans 90 days overdue originated in the period divided by average performing loans), which reached a high 23% in 2014, up from 17% in 2013. Although they fell slightly to 22% in 4Q14 from 25% in 3Q14, this was still substantially above Fitch-estimated break-even level of 16%. We do not expect any near-term improvements in asset quality, as management's efforts to shift lending focus to somewhat lower-risk clients may be largely offset by negative trends in the operating environment.

Losses widened in 1Q15, with the bank losing around 13% of its equity, according to local accounts, and its regulatory Tier 1 and Total capital ratios falling to, respectively 8.4% and 13.9%, from 9.4% and 15% at end-2014. However, they still offer moderate headroom for potential further erosion. HCFB's IFRS capital buffer is stronger (Fitch Core Capital (FCC) ratio of 15.5% at end-2014), reflecting punitive risk-weighting of high-margin retail loans in regulatory accounts.

Funding and liquidity is a rating strength. Refinancing requirements for 2015 are limited to a moderate 9% of end-2014 liabilities) while liquidity buffer is sufficient to withstand a 12.5% deposit outflow after all refinancing needs are met. Additional liquidity could be sourced from the bank's rapidly amortising loan book.

The Negative Outlook reflects Fitch's expectation that the bank's credit profile will be under pressure from the challenging operating environment. The ratings could be downgraded further if HCFB's capital position deteriorates significantly as a result of its performance continuing to weaken. They could stabilise at the current levels if gradual stabilisation of the operating environment results in improvements in asset quality, profitability and capital.

KEY RATING DRIVERS AND SENSITIVITIES - OEB

OEB's asset quality weakened sharply with credit losses reaching 27% in 2014 (17% in 2013), while pre-impairment profit allowed the bank to absorb only 18% of the losses (2013: 16%). As a result, OEB reported a large RUB10.7bn loss (40% of end-2013 equity) in 2014 IFRS accounts, putting additional pressure on its already moderate capitalisation (FCC ratio fell to 7.8% at end-2014 from 13% at end-2013). Based on regulatory accounts the bank posted a further RUB5.7bn loss in 1Q15 (RUB2.8bn in 2014).

Fitch does not expect a recovery in asset quality and hence the bank will likely remain significantly loss-making for the rest of 2015, requiring capital support in order not to breach regulatory capital ratios.

Funding and liquidity is of limited risk due to modest refinancing needs (RUB11bn in 2015) and a reasonable liquidity buffer (RUB34bn at end-February 2015).

According to management, OEB expects to receive fresh equity from its shareholders by end-May 2015. The RWN will be resolved once there is more clarity with regard to the timing and amount of the potential equity injection. Depending on the sufficiency of support relative to the bank's performance, the ratings could be affirmed or downgraded, possibly by more than one notch, if no or insufficient capital is received.


KEY RATING DRIVERS AND SENSITIVITIES - RSB

RSB has not yet prepared IFRS accounts for 2014 (these are planned for publication in the coming weeks), but Fitch estimates credit losses to have exceeded 20% of average performing loans, (20% in 1H14), based on the bank's regulatory filing. This should result in 2H14 losses being at least as large as the RUB4.8bn reported in 1H14 and, consequently, RSB's FCC ratio, which was already a thin 4.4% at end-1H14, declining even further.

In 1Q15 regulatory accounts RSB posted a further large RUB6.5bn loss, although only about RUB3bn of this was related to core activities, while the rest was RUB2bn due to currency translation and around RUB1bn of fees paid to subordinated bondholders for extending the bonds' maturity. This resulted in its regulatory tier 1 (N1.2) capital ratio approaching the minimum threshold. Performance may get a boost from a significant portfolio of securities (RUB170bn or 42% of assets at end-February 2015), some of which the bank has purchased recently, potentially in anticipation of a CBR rate cut. However, due to most of the securities being classified as held-to-maturity it is difficult to estimate the potential impact, as well as whether this will be sufficient to offset likely losses from core activities.

Refinancing needs for 2015 are significant, including a large USD400m eurobond put option in July 2015. However, RSB maintains a sizeable liquidity buffer against these repayments. Fitch estimates that net of wholesale funding repayments RSB's liquidity buffer is sufficient to withstand a 13% fall in customer funding.

The RWN on RSB's ratings will be resolved with a downgrade if (i) RSB's 2014 IFRS accounts confirm a significant further weakening of performance/asset quality; or (ii) the bank's capital is not strengthened by an earnings boost (potentially stemming from securities revaluation) and/or by an equity injection in the next couple of months. Conversely, performance improvement and/or sufficient recapitalisation may result in RSB's ratings being affirmed.

KEY RATING DRIVERS AND SENSITIVITIES - HCK

The downgrade of HCK's IDRs and National rating follows the downgrade of the parent, HCFB. In Fitch's view a one-notch difference between the ratings of the two banks is appropriate and reflects the cross-border nature of the parent-subsidiary relationship and uncertainty regarding the performance of the unsecured consumer finance market in Kazakhstan and the strategic importance of the subsidiary for HCFB over the longer-term.

At the same time Fitch continues to view HCFB's propensity to support HCK as high given the importance of the subsidiary to date (the latter remained profitable in 2014 while the parent reported significant losses), HCK's moderate size (around 10% of HCFB's assets at end-2014), HCFB's full ownership, common branding and reputational risk for HCFB and broader group in case of HCK's default.

HCK's VR of 'b' is constrained by the bank's exposure to a potentially highly volatile unsecured consumer finance market in Kazakhstan and a weak funding profile. The latter is reflected in its dependence on the parent's facilities (30% of end-2014 liabilities) and high depositor concentrations (the largest two accounted for 16% of liabilities). The rating positively considers HCK's reasonable (given high margins) asset quality so far, with credit losses at 15% of average performing loans in 2014, slightly up from 13% in 2013. Net profitability is strong (ROAA of 7% in 2014, down from 12% in 2013), supporting capitalisation (FCC ratio of 25% at end-2014).

HCK's Long-term IDRs and National rating are currently underpinned by the bank's standalone strength and will move in tandem with the bank's VR. A track record of reasonable performance supported by a more diversified funding base would be positive for the standalone profile. A significant deterioration of the operating environment in Kazakhstan, or weaker performance of the loan book diminishing HCK's ability to absorb further losses would be negative and could lead to downward pressure on the VR.

KEY RATING DRIVERS - HCFB'S, RSB'S AND OEB'S SUPPORT RATINGS AND SUPPORT RATING FLOORS

The '5' Support Ratings of HCFB, RSB and OEB reflect Fitch's view that support from the banks' private shareholders cannot be relied upon. The Support Ratings and Support Rating Floors of 'No Floor' also reflect that support from the Russian authorities, although possible (particularly in the form of regulatory forbearance) given the banks' increased deposit franchises, also cannot be relied upon due to the banks' still small size and lack of overall systemic importance. Accordingly, the banks' IDRs are based on their intrinsic financial strength, as reflected by their VRs.

KEY RATING DRIVERS AND SENSITIVITIES - ALL BANKS' SENIOR UNSECURED AND SUBORDINATED DEBT

The banks' senior unsecured debt is rated in line with their Long-term IDRs and National Ratings (for domestic debt issues), reflecting Fitch's view of average recovery prospects, in case of default. The subordinated debt ratings of HCFB and RSB are notched off their VRs (the banks' VRs are in line with their IDRs) once, in line with Fitch's criteria for rating these instruments.

Changes to the banks' Long-term IDRs and National Ratings would likely impact the ratings of both senior unsecured and subordinated debt. Debt ratings could also be downgraded in case of a further marked increase in the proportion of retail deposits in the banks' liabilities, resulting in greater subordination of bondholders. In accordance with Russian legislation, retail depositors rank above those of other senior unsecured creditors.

The rating actions are as follows:

HCFB:
Long-term foreign and local currency IDRs: downgraded to 'B+' from 'BB-'; Outlooks Negative
Short-term foreign currency IDR: affirmed at 'B'
Viability Rating: downgraded to 'b+' from 'bb-'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt: downgraded to 'B+' from 'BB-'; Recovery Rating 'RR4'
Subordinated debt (issued by Eurasia Capital SA) Long-term rating: downgraded to 'B' from 'B+'; Recovery Rating 'RR5'

RSB:
Long-term foreign and local currency IDRs: 'B'; placed on Rating Watch Negative
National Long-term Rating: 'BBB-(rus)'; placed on Rating Watch Negative
Short-term foreign currency IDR: 'B'; placed on Rating Watch Negative
Viability Rating: 'b'; placed on Rating Watch Negative
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt (including that issued by Russian Standard Finance SA) 'B', Recovery Rating 'RR4'; placed on Rating Watch Negative
Subordinated debt (issued by Russian Standard Finance SA) Long-term rating: 'B-', Recovery Rating 'RR5'; placed on Rating Watch Negative

OEB
Long-term foreign and local currency IDRs: 'B'; placed on Rating Watch Negative
National Long-term Rating: 'BBB(rus)'; placed on Rating Watch Negative
Short-term foreign currency IDR: 'B'; placed on Rating Watch Negative
Viability Rating: 'b'; placed on Rating Watch Negative
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Senior unsecured debt Long-term rating: 'B', Recovery Rating 'RR4'; placed on Rating Watch Negative
Senior unsecured debt National Long-term Rating: 'BBB(rus)'; placed on Rating Watch Negative

HCK
Long-term foreign and local currency IDRs: downgraded to 'B' from 'B+'; Outlooks Stable
Short-term foreign currency IDR: affirmed at 'B'
National Long-Term Rating: downgraded to 'BB+ (kaz)' from 'BBB (kaz)'; Outlook Stable
Viability Rating: affirmed at 'b'
Support Rating: affirmed at '4'
Senior unsecured debt Long-term rating: downgraded to 'B' from 'B+', Recovery Rating 'RR4'
Senior unsecured debt National Long-term rating: downgraded to 'BB+ (kaz)' from 'BBB (kaz)'