Fitch Ratings says International Bank of Azerbaijan's (IBA, BB/Negative/f) capital support needs have increased significantly as a result of substantial losses posted in the bank's end-2016 regulatory accounts.

IBA's 'BB' Long-Term Issuer Default Rating (IDR) and senior debt rating reflect Fitch's view that the bank should continue to receive sufficient support from the Azerbaijan authorities to ensure it can service its obligations to creditors. The bank's 'f' Viability Rating reflects our view that the bank had failed and required support even before the latest losses.

IBA reported a AZN1.4 billion net loss for 2016 and negative AZN0.7 billion equity at end-2016. The losses were mostly driven by AZN1.1 billion of currency translation losses resulting from the bank's large short unhedged currency position (AZN6 billion at end-2016). AZN depreciated 13% against USD during 2016 (including a 10% drop in 4Q16). A further 5% fall in January 2017 means that IBA may need to book additional translation losses of around AZN300 million.

IBA's external wholesale funding was a significant USD2.2 billion at end-2016. The majority of these funding facilities, including a USD500 million Eurobond issue, contain financial covenants related to compliance with regulatory capital ratios; at end-2016, IBA's regulatory capital ratio was negative, and therefore less than the 10% minimum level.

IBA's liquidity buffer at end-2016 comprised around USD400 million in foreign currency and AZN5 billion (USD2.7 billion equivalent) in local currency, although IBA's ability to exchange these deposits into foreign currency (and thus improve the bank's FX position and foreign currency liquidity) is currently uncertain. The Central Bank of Azerbaijan (CBA) currently provides only limited amounts of foreign currency to the banking sector to reduce pressure on the exchange rate.

Fitch believes that capital and liquidity support from the authorities should continue to be available for IBA given its state-ownership (which increased to 91% after a AZN600 million equity contribution in January 2017) and high systemic importance. IBA remains the largest deposit-taker in the country and holds substantial amounts of funding from state-owned entities. The track record of support has improved considerably after the authorities launched the financial recovery of IBA in 2015, primarily through purchases of problem assets from the bank's balance sheet.

Forthcoming state support includes a further AZN5 billion of loan transfers in 1H17 (in addition to AZN10 billion of loans transferred in 2016) and various measures to reduce IBA's currency mismatch, including a buyout of AZN-denominated loans for foreign currency and the provision of an off-balance sheet hedge to close out the remaining FX position. Fitch expects IBA's equity to remain negative after the January injection, and so IBA is currently negotiating an additional capital contribution from the authorities in 1H17.

CBA's FX reserves were USD5.7 billion at end-November 2016, while an additional USD35.8 billion of assets (equal to more than 90% of GDP) were held by the State Oil Fund of Azerbaijan (SOFAZ) at end-3Q16, indicating that Azerbaijan (BB+/Negative) has sufficient financial flexibility to provide support to IBA. According to SOFAZ's 2017 budget, it will transfer around USD4.5 billion of assets to CBA to ensure macroeconomic stability and provide banking sector support.

If IBA suffers renewed delays with provision of capital or liquidity support (not Fitch's base case) then the bank's ratings may be downgraded. Although IBA has received considerable assistance from the authorities during the last two years, it has yet to receive required support in foreign currency, which results in moderate uncertainty in respect to support prospects. The Negative Outlook on IBA reflects that on the Azerbaijan sovereign.

IBA's 'f' VR reflects the bank's very weak capitalisation, loss-making pre-impairment performance (even before FX losses) and large short open currency position (see Fitch Affirms International Bank of Azerbaijan at 'BB'/Negative; Downgrades VR to 'f' dated 22 November 2016 at www.fitchratings.com). Fitch will upgrade the VR when IBA receives sufficient capital support to be once more viewed as a viable entity.

IBA's ratings are as follows:

Long-Term IDR: 'BB'; Outlook Negative

Short-Term IDR: 'B'

Viability Rating: 'f'

Support Rating: '3'

Support Rating Floor: 'BB'

Senior unsecured debt: 'BB'
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