17:30 - 6.06.2018

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June 6, Fineko/abc.az. Fitch Ratings has affirmed OJSC International Bank of Azerbaijan's (IBA) Long-Term Issuer-Default Rating at 'B-' with a Stable Outlook.

The agency has also resolved the Rating Watch Evolving (RWE) on IBA's Viability Rating (VR) and upgraded the VR to 'b-' from 'ccc'.

The upgrade of IBA's VR reflects improved profitability and reduced pressure on capitalisation stemming from a large short foreign currency position. The VR is also supported by IBA's currently low-risk asset structure and comfortable liquidity position after a restructuring in 2017.

At the same time, the VR also reflects the bank's still considerable exposure to FX risk, the bank's reduced franchise (although the bank remains the largest by total assets and deposits in Azerbaijan) and limited history of operations following the restructuring, and uncertainty about the bank's future ownership (due to privatisation plans), business model and strategy.

IBA's VR was placed on RWE in December 2017 following the publication of the Exposure Draft of Fitch's revised Bank Rating Criteria, which introduced + and - modifiers at the 'CCC'/'ccc' level for international ratings. The resolution of the RWE follows the finalisation and publication of the Criteria in March 2018 and reflects the agency's revised assessment of the bank's credit profile following developments since December 2017.

The upgrade of the VR means the rating is now aligned with IBA's Long-Term IDR and senior debt rating at 'B-'. In November 2017, Fitch upgraded the bank's Long-Term IDR to 'B-', one notch above the 'ccc' VR, based on the view that the probability of the bank defaulting on its senior third-party obligations (which are reference liabilities for bank IDRs) was somewhat lower than it failing (i.e. becoming non-viable, and requiring external support to address a material capital shortfall). However, at the now higher VR level, Fitch believes it is no longer appropriate to maintain a notch difference between the bank's IDR and VR.

IBA reported regulatory Tier 1 and Total Capital ratios at end-1Q18 of 19.2% and 20.5% respectively, broadly in line with Fitch's expectations after the bank completed its restructuring in September 2017. Fitch estimates the Fitch Core Capital ratio was an even higher 25% at end-2017 due to a AZN0.3 billion fair value gain on an USD1 billion low interest bond issued under restructuring. Equity in regulatory accounts improved to a positive AZN0.9 billion at end-2017 from a negative AZN0.7 billion at end-2016 mainly due to a AZN0.6 billion equity injection from the state, a AZN0.4 billion recovery of provisions on bad assets bought out by the state, a AZN0.2 billion haircut gain on the restructuring, and (iv) AZN0.4 billion of net income for 2017 (including a AZN0.1 billion currency revaluation gain).

Fitch still views the bank's capital position as vulnerable due to a large unhedged short foreign currency position at end-1Q18 of USD1.7 billion or 4x regulatory capital or 3x FCC. However, risks from this position have reduced since 4Q17 due to a moderate reduction in the absolute size of the position from USD1.9 billion post-restructuring due to FX purchases by the bank; reduction in the position size relative to capital, from an estimated 9x of total regulatory capital post-restructuring, due to internal capital generation and gains on transfers of bad assets to the government; expected continued FX purchases and internal capital generation, which should further reduce the size of the position both in absolute terms and relative to capital; and higher oil prices reducing the risk of a sharp devaluation of the manat.

Fitch estimates that even in case of a 20% manat depreciation the FCC ratio would be a reasonable 8%. The regulatory capital ratio would fall to the minimum required 10% if the manat depreciates by 12%, but would be about 9pp higher if adjusted for the fair value gains on the bond, and Fitch would expect the bank to benefit from regulatory forbearance in case of a moderate breach of the minimum requirement.

Management intends to close the bank's foreign currency position during the next few months via a hedging arrangement with Ministry of Finance and/or conversion of its manat deposits with the Central Bank of Azerbaijan into US dollars. However, in Fitch's view there is uncertainty about whether these transactions will take place and over the terms of any hedges.

Asset quality is reasonable after completion of the bad assets clean-up in 2017. As per regulatory accounts, net loans and advances accounted for only 17% of total assets at end-1Q18 and were almost equally split between corporate and retail borrowers.

Other assets are represented mainly by low-risk deposits placed with the CBA (AZN3.1 billion, 37% of total assets), short-term placements with other banks (AZN1.4 billion, 17%) and promissory notes guaranteed by the state (AZN1.1 billion, 13%).

In Fitch's view, IBA has become structurally profitable again after the restructuring, supported by low cost of funding, reduced operating expenses and low-risk asset exposures, which should result in limited impairment charges. In 1Q18, the bank's return on average equity, adjusted for non-recurring provision recoveries, was approximately 30%. Profitability could come under pressure in case of FX losses, reduced access to cheap funding or an increase in higher-risk asset exposures.

After the restructuring, IBA is funded mainly with customer deposits, of which more than half were interest-free current accounts, resulting in low overall cost of funding of around 2%. The bank's outstanding debt is a USD1 billion Eurobond issued as part of the restructuring and is held mostly by the State Oil Fund of Azerbaijan. The issue is rated long-term 'B-', in line with the bank's Long-Term IDR, reflecting Fitch's view of average recovery prospects, in case of default.

IBA's liquidity position is comfortable with liquid assets (mainly, cash and cash equivalents and placements with CBA and foreign banks) more than fully covering customer accounts.

Support rating and support floor

The affirmation of the Support Rating of' 5' and Support Rating Floor of 'No Floor' reflects Fitch's view that support from the shareholder, the Azerbaijan sovereign (BB+/Stable), cannot be relied upon in the long term following the bank's recent default. However, in Fitch's view some form of forbearance or support may be made available to the bank in the near term to avoid a repeat default on third-party senior obligations, should its capital be depleted by losses resulting from its FX position.

Rating Sensitivities

IBA's VR and Long-term IDR could be upgraded if the bank is able to hedge its open foreign currency position and if the hedge is viewed by Fitch as effective and reliable. Conversely, if the bank fails to close its foreign currency position and incurs large losses as a result of manat depreciation against the US dollar, then the VR may be downgraded, potentially to 'f' to reflect a material capital shortfall.

Positive rating action on the bank's Support Rating and Support Rating Floor is unlikely in the near term given the bank's recent default.

The rating actions are as follows:

Open Joint Stock Company International Bank of Azerbaijan

Long-Term IDR: affirmed at 'B-', Outlook Stable

Short-Term IDR: affirmed at 'B'

Viability Rating: upgraded to 'b-' from 'ccc', off RWE

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'

Senior unsecured debt: affirmed at 'B-'; Recovery Rating 'RR4'