Fitch Ratings-Moscow/London-16 August 2018: Fitch Ratings has affirmed Azerbaijan-based Pasha Bank's (PB) Long-Term Issuer-Default Rating (IDR) at 'B+'. The Outlook is Stable. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The ratings of PB are driven by its standalone profile, as captured by its 'b+' Viability Rating (VR). The ratings remain constrained by the bank's exposure to the vulnerable operating environment, dependence of the bank's business model and performance on the stability of cheap related-party funding, and the limited track record of the bank's sizable foreign operations in Turkey and Georgia (equal to 10% and 4% of PB's end-2017 consolidated assets, respectively).
Positively the ratings reflect the bank's reasonable financial metrics, comfortable capital (albeit somewhat weaker on a standalone basis) and liquidity positions in the last 12 months. They also factor in PB's systemic importance (market shares of 13% by total assets and 18% by deposits at end-1Q18).
The Stable Outlook reflects our expectations that PB's pre-impairment profitability should allow the bank to absorb potential asset quality impairment without losses eroding capitalisation.
PB's loan book remains small - only around 27% of end-2017 standalone assets - but is concentrated. The 25 largest exposures amounted to around 63% of loans or 1.5x Fitch Core Capital (FCC). Non-performing loans (NPLs, defined as loans over 90 days overdue; unconsolidated statutory reporting) increased to around 15% of loans at end-1H18, from around 13% at end-1Q17 (the date of the last review), while restructured loans contracted to 5% of loans from 7%. The coverage of NPLs by specific loan loss allowances was reasonable at 40% as around two thirds of NPLs were represented by cash-covered loans to related-parties. PB's large share of foreign currency loans (around 55% of total loans at end-1H18) remains a source of heightened credit risk as borrowers are largely unhedged.
Assets outside of the loan book are of good quality; at end-2017, most of interbank placements (54% of assets) and investments in debt securities (11%) were rated 'BB+' and higher.
PB's solid performance (on a consolidated basis), with a return on average equity (ROAE) of 18% in 2017, is supported by low funding costs of 2.7% (market average of around 3.5%), as the share of cheap related-party funding remains large at over 40% of total liabilities at end-2017. FX dealing gains made up over 30% of pre-impairment profit in 2017. Net of these gains and uncollected accrued interest (a further 30% of pre-impairment profit), core earnings remain reasonable, with adjusted pre-impairment profit equalling around 8% of average equity. Loan impairment charges were negligible in 2017, underpinning PB's bottom line.
According to PB's IFRS-based standalone management accounts for 1H18, profitability was slightly weaker (annualised ROAE of around 14%) due to lower FX dealing gains.
We estimate PB's FCC ratio (consolidated basis) was around 19% at end-May 2018, down from 22% at end-2017, following an AZN61 million dividend payment from 2017 profits (payout ratio of 69%). We expect FCC ratio to be managed at close to current levels in 2018 as planned aggressive loan growth (over 25% in 2018) will largely be supported by Pasha Holding's (PB's key shareholder) direct capital injection of TRY245 million in May 2018 (equivalent of AZN95 million) into PB's Turkish subsidiary and continued earnings generation. The group plans no further dividends in 2H18-2019, according to the bank's management.
PB's regulatory capital position at end-1H18 was notably weaker - Tier 1 and total capital ratios of 17.7% and 11.4%, respectively, versus regulatory minimum limits of 5% and 10% - mainly because PB's investments in two foreign subsidiaries are deducted from the bank's total regulatory capital.
PB is funded mostly by customer accounts (around 90% of total liabilities at end-2017; standalone basis), which are highly concentrated by name; account balances of the 10 largest customers represented 60% of customer accounts, including 31% from five related-party depositors. Liquidity risks are mitigated by PB's large liquidity cushion, which comfortably covers around 80% of the bank's end-2017 customer accounts.
Fitch has stopped factoring in support from the Azerbaijan authorities into local banks' ratings (including those of PB) after the default of International Bank of Azerbaijan (IBA; B-/Stable/b-) on its foreign currency non-deposit obligations in May 2017. In Fitch's view, the default of IBA, which is the largest bank in the country and government-owned, means that state support for less systemically-important, privately-owned banks cannot be relied upon. However, Fitch views PB's systemic importance as significant, as the bank is part of the largest privately-owned banking group in the country, and together with its sister Kapital Bank, holds over 30% of sector deposits.
Marked weakening of the bank's asset quality or high asset growth resulting in capital pressures may cause PB's ratings to be downgraded. Upside would probably require an improvement in the operating environment, stronger asset quality, a track record of moderate risk appetite during periods of aggressive credit growth as well as preservation of solid capital ratios. Further development of PB's franchise resulting in a marked increase in the bank's systemic importance, or improved track record of sovereign support for the banking sector as a whole, could also be credit-positive.
The rating actions are as follows:
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'
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