Fitch affirms five Azerbaijan privately-owned banks

12.03.2014 18:00

Fitch Ratings has affirmed the Long-term foreign currency Issuer Default Ratings (IDRs) of Azerbaijan-based Unibank (UB) and Demirbank (DB) at 'B', and Atabank (AB), AGBank (AGB) and Bank Technique (BT) at 'B-'. The Outlooks on UB and DB have been revised to Positive from Stable. The Outlook on AGB has been revised to Stable from Negative. The Outlooks on AB and BT are Stable. A full list of rating actions is at the end of this commentary.

KEY RATING DRIVERS: IDRs AND VIABILITY RATINGS (VRs)

The affirmations reflect the banks' largely stable credit metrics and currently favourable broader economy, which is supported by high oil prices. The spill-over effects of high oil prices on the non-oil economy coupled with significant government spending supported the gradual resolution of post-crisis asset quality problems. Additionally, the banks' bottom lines (particularly at UB and DB) have benefited from rapid expansion in higher margin retail and micro-lending.

Liquidity across the sector has been stable, underpinned by fairly sticky funding and stable deposit growth. Wholesale funding of private banks is mainly sourced either from the government or from development institutions, remains limited in volume and reasonably diversified by maturity (for more details on the operating environment see "Fitch: Azerbaijan's Banking Sector Broadly Stable; Structural Vulnerabilities Remain" dated 6 March 2014 at www.fitchratings.com).

All five banks face capital pressure resulting from weak profit generation (except for UB) driven by margin compression in corporate lending, small operational scale, still significant impairment charges and limited new equity injections. ROAE was a moderate 5% at AGB and 10% at AB in 2013. However, DB and UB appear better positioned to improve capitalisation from internal sources, as both banks' ROAE was commensurate with loan growth in 2013.

UB and DB reported fast retail growth of around 80% and 36%, respectively, in 2013, although both have managed credit risks fairly well so far, as reflected by low credit losses in 2013 (below 3.5% of average loans in 2013 at both banks). Fitch believes that further growth of reasonable quality in retail and micro-lending is possible in the sector due to currently low consumer indebtedness and low credit penetration (retail loans/GDP equal to 11% at end-2013). However, loss rates are likely to increase as loan books season and market saturation increases.

Credit risks relate mainly to slowly-amortising corporate loan books, which are particularly highly concentrated at AGB, AB and BT, with the largest 20 borrowers accounting for around 30%-40% of total loans or around 1.7x-2.1x end-2013 statutory equity in each case. AB's asset quality is currently reasonable, with non-performing loans (NPLs; loans 90+ days overdue, reported net of accrued interest) standing at 4.4% in end-2013 statutory accounts, but a higher 10.5% and 24.2%, respectively at AGB and BT. BT's unreserved NPLs were equal to a high 1.7x IFRS equity at end-1H13, but Fitch expects this to decrease gradually based on reasonable collateral against some exposures and management's reasonable track record of impaired loan recoveries.

The Positive Outlooks on UB and DB reflects Fitch's base case scenario that their performance will remain reasonable as loan books season, and that their more robust business models, growth strategies and internal capital generation will therefore warrant upgrades. The banks' profitability benefits from higher margin retail/small business lending, the moderate (compared with peers) volatility of their impairment charges through the cycle, and the lower amount of legacy impaired and non-core assets (which are particularly high at BT and AGB).

The revision of AGB's Outlook to Stable from Negative reflects the stabilisation of asset quality and significant improvement of operating performance. In 2013, AGB reported positive, albeit moderate, pre-impairment profit in its statutory accounts of AZN3.6m (8% of starting equity) net of non-received interest. Loan impairment charges were a moderate 1.3% of average loans. At the same time, Fitch continues to consider the amount of accrued, but not received, interest income as substantial relative to capital (0.6x tangible statutory equity at end-2013). Part of this relates to performing loans with grace periods on interest payments.

RATING SENSITIVITIES - IDRs and VRs

UB and DB could be upgraded if they show an extended track record of reasonable asset quality and manage to defend their profitability amid more intense competition and greater market saturation in their lending segments. Conversely, a marked weakening of profitability and/or deterioration of asset quality would likely result in the revision of the Outlooks to Stable.

Upside potential for the ratings of BT, AGB and AB is unlikely in the near term, as reflected by their Stable Outlooks. However, gradual improvements in the operating environment, further recoveries of legacy impaired loans and the strengthening of the banks' internal capital generation could give rise to moderate upward rating pressure over time.

The ratings of all five banks could come under downward pressure if there was a large and sustained drop in oil prices, although this scenario is not expected in the near term. Sharp deterioration in asset quality and/or liquidity at any of the banks could also cause a downgrade.

KEY RATING DRIVERS AND RATING SENSITIVITIES - SUPPORT RATINGS (SRs) and SUPPORT RATING FLOORS (SRFs)

The SRFs of 'No Floor' and '5' Support Ratings for each of the banks reflect their relatively limited systemic importance, as a result of which extraordinary support from the Azerbaijan authorities cannot be relied upon, in Fitch's view. The potential for support from private shareholders cannot be reliably assessed. Fitch does not expect any revision of the banks' SRFs or Support Ratings in the foreseeable future.

The rating actions are as follows:

Unibank:

Long-term foreign currency IDR: affirmed at 'B', Outlook revised to Positive from Stable

Short-term foreign currency IDR: affirmed at 'B'

Viability Rating: affirmed at 'b'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at No Floor

Demirbank:

Long-term foreign currency IDR: affirmed at 'B', Outlook revised to Positive from Stable

Short-term foreign currency IDR: affirmed at 'B'

Viability Rating: affirmed at 'b'

Support Rating: affirmed at '5'