Banks suffered greatest losses from devaluation in Azerbaijan revealed

Baku. 11 March. REPORT.AZ/ Fitch Ratings has affirmed the Long-term foreign currency Issuer Default Ratings (IDRs) of Azerbaijan-based Unibank (Uni), Demirbank (DB) and Express Bank (EB) at 'B' and Atabank (AB) at 'B-'. The Outlooks on all four banks are Stable. The agency has also put the 'B-' Long-term IDRs of AGBank (AGB) and Bank Technique (BT) on Rating Watch Negative (RWN). A full list of rating actions is at the end of this commentary.

KEY RATING DRIVERS: IDRs AND VIABILITY RATINGS (VRs)
The affirmations of Uni, DB, EB and AB reflect the so far only moderate deterioration of the banks' credit profiles amid the weakening operating environment driven by the sharp drop in oil prices, and limited direct impact from the recent 34% local currency devaluation due to moderate open short FX positions and/or sufficient capital buffers to absorb the shock (see "Fitch: Azerbaijan Currency Devaluation to Hurt Banks' Capital" dated 25 February 2015 at www.fitchratings.com).

Fitch has revised the Outlooks on Uni and DB to Stable from Positive, as the more challenging environment may exert pressure on asset quality and profitability, especially considering significant dollarisation of balance sheets. This will likely offset recent improvements in franchise and pre-impairment profitability, which have been particularly evident at Uni.

The RWN on BT and AGB reflects the risk of them breaching regulatory capital ratios as a result of the currency devaluation in February. Both banks had sizable, largely unhedged, short open balance-sheet foreign currency positions equalling 100% and 87%, respectively, of their equity at end-2014 and therefore incurred considerable one-off currency revaluation losses of around AZN21m (31% of end-2014 prudential equity) and AZN10m (19%), respectively. According to Fitch's calculations, both banks' total regulatory ratios could have fallen below 8% (compared to the regulatory minimum of 12%).

Uni's and DB's capital ratios of 16.5% and 15.9%, respectively, at end-2014 could have declined by about up to 3pts as a result of devaluation, but would have remained above the regulatory minimum, according to Fitch's estimates. The banks' short on-balance sheet open foreign currency positions were below 25% of equity as at devaluation date, so the direct impact from FX losses was probably just over 1pt, while a close to 2pts decrease could have resulted from inflation of risk-weighted assets, as around 35% of the banks' total assets were in US dollars.

AB benefited from substantial long open balance-sheet foreign currency position as at devaluation date offsetting the impact from inflation of risk-weighted assets, while EB's open currency position was negligible and balance sheet dollarisation was limited to only moderate 13%. Consequently both banks' capital positions (total ratios of 16.2% and 44.5%, respectively, at end-2014) are likely to have proved more resilient.

Asset quality is reasonable at Uni (NPLs of 6.8%, 90% reserved) and Demir (6.0%, 80%), although moderate deterioration is already evident, and this may continue, given the high share of FX lending (over 30% of total loans at both banks, including some in unsecured retail books). EB has better ratios (NPLs of 1.4%, 164% covered), but much higher borrower concentrations, including the largest exposure (54.4% of Fitch core capital; FCC) to a related party. BT and AGB have weak asset quality with NPLs (mostly legacy) of 27% and 30%, respectively, of total loans at end-2014, while reserve coverage was only 37% and 41%. Banks' asset quality may deteriorate due to the weaker operating environment and/or if banks increase dollar lending in response to increasing dollarisation of deposits.

Profitability is healthy at Uni (ROA of 4.6% in 2014) and EB (5.3%), moderate at DB (1.3%) and AB (1.5%), and weak at AGB (0.5%) and BT (0.5%), especially considering high shares of accrued but not received interest at the latter four banks. Some further pressure on profitability is likely in the near term due to an increase in deposit rates following moderate funding outflows in February, and additional hedging costs, as deposits have been converting into foreign currency.

Liquidity is very strong at EB (liquid assets equalled 55% of liabilities at end-2014), supported to a significant extent by related party funding, and acceptable at other banks (ratios of around 8-19%), although in the case of BT it is contingent on the stability of the Central Bank funding (around 15% of its liabilities). For Uni and DB, liquidity is also underpinned by the quick turnover of their retail loan books. All banks faced moderate retail funding outflows (up to 4% of liabilities) in late February; the situation seems to have stabilised in March, but remains potentially vulnerable. Refinancing risk is low due to the moderate share of foreign funding other than that sourced from international development institutions.

RATING SENSITIVITIES - ALL BANK'S IDRs AND VRs
The RWN on AGB and BT will be resolved depending on the banks' reported capital positions following devaluation and any actions taken to support the banks' solvency. The banks could be downgraded if their capital ratios remain deeply below regulatory minimum levels and no or limited action is taken to restore their solvency. However, the ratings could be affirmed if shareholders and/or government authorities provide sufficient capital support.

The ratings of all six banks could be downgraded if the worsening of the operating environment results in significant asset quality deterioration and/or a liquidity squeeze. However, Fitch's base case expectation is that these risks are already sufficiently reflected in the banks' single 'B' category ratings.

Upside potential for the ratings is limited at present, given the negative side of the credit cycle. However, selective positive rating actions are possible if capital and asset quality positions demonstrate strong resilience to the deterioration of the operating environment. Upside rating potential is slightly stronger at Uni, which in Fitch's view is somewhat better positioned to weather the economic downturn. However, an upgrade would require an improvement of Uni's capital position and extended track record of reasonable profitability and adequate asset quality.

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 scale of operations and market share. Although Fitch expects some regulatory forbearance being available for these banks, in case of need, any extraordinary direct capital support from the Azerbaijan authorities cannot be relied upon, in the agency's view. The potential for support from banks' private shareholders is not factored into the ratings.

The rating actions are as follows:

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

Expressbank:
Long-term IDR: affirmed at 'B', Outlook Stable
Short-term IDR: affirmed at 'B'
Viability Rating: affirmed at 'b'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'

Atabank:
Long-term foreign currency IDR: affirmed at 'B-', Outlook 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

AGBank:
Long-term foreign currency IDR: 'B-', placed on RWN
Short-term foreign currency IDR: 'B', placed on RWN
Viability Rating: 'b-', placed on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'

Bank Technique:
Long-term foreign currency IDR: 'B-', placed on RWN
Short-term foreign currency IDR: 'B', placed on RWN
Viability Rating: 'b-', placed on RWN
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'