Ukrainian Law Blog: Fitch affirms PrivatBank and Bank Pivdennyi at 'CCC'

Fitch Ratings has affirmed PJSC CB PrivatBank's (Privat) and Bank Pivdennyi's (PB) Long-Term Foreign Currency Issuer Default Ratings (IDR) at 'CCC', reads a posting on the rating agency's website.

"The IDRs are driven by the banks' respective standalone creditworthiness, as expressed by the 'ccc' Viability Ratings (VRs). The VRs reflect weak asset quality, limited additional loss absorption capacity and modest core profitability that makes the banks' credit profiles highly vulnerable to further recognition of asset impairment. The VRs also consider the banks' relatively stable regulatory capital levels compared to direct peers - given moderate additional provisioning requirements so far identified in the sector asset quality review - and funding profiles. The latter is due to reduced deposit volatility as the exchange rate stabilized somewhat since Q1, 2015," the report reads.

"At end-H1, 2016, Privat reported non-performing loans (NPLs, loans more than 90 days overdue) at 12% of total loans and individually impaired loans other than NPLs at a further 28% (end-2015: 12% and 29%, respectively). Reserve coverage of total impaired loans (including NPLs) was a low 37%, with unreserved impaired loans equal to 156% of Fitch Core Capital (FCC). Privat has been required by the National Bank of Ukraine (NBU) to obtain additional collateral for a significant portion of corporate loans, a process which started in 2016 and will likely be extended at least into 2017. Collateral structures and property valuations will be crucial in determining future reserve requirements," according to the statement.

"High related-party lending, large borrower and sector concentrations (the largest oil trading segment accounted for 20% of loans) and a still material share of FX-lending (49% of total), mostly to unhedged borrowers, remain sources of heightened credit risk. Related-party lending was reported in IFRS accounts at a high 19% of loans (equal to 109% of FCC) at end-H1, 2016 (end-2015: 18% and 119%, respectively), but in Fitch's view this may not fully capture all exposures to affiliated entities, given limitations on ownership transparency in Ukraine," Fitch said.

"The FCC ratio was 12% at end-H1, 2016, and Privat reported a total regulatory capital adequacy ratio (CAR) of around 10% at end-Q3, 2016. The latter was just in line with the usual regulatory minimum level, although the NBU has allowed banks to have CARs as low as 5% in 2016-2017, before raising the minimum requirement back to 10% by 2019. Regulatory forbearance in respect to only gradual strengthening of loan book quality and provisioning is important for Privat's reported solvency, in Fitch's view," the agency experts stated.

"Weak performance, driven by increased funding and credit risk costs, means that internal capital generation has been inadequate. Pre-impairment profit, adjusted for interest income accrued but not received in cash, was negative in the nine months of 2016. Sector deposit trends have stabilized in the nine months of 2016, and Privat has reported steady inflows. The bank's schedule of external debt repayments appears manageable following a restructuring in 2015. At end-9M16, the bank's FX-liquidity cushion of $670 million was sufficient to repay all wholesale external debt, although the stability of the bank's highly dollarized deposit funding is also key to maintaining FX liquidity. Net of scheduled external wholesale debt repayments in the next 12 months, FX liquidity covered around 11% of FX deposits at end-Q3, 2016," the document reads.

"Privat's UAH-liquidity is highly reliant on deposit trends and access to NBU funding. Fitch views Privat's financial flexibility as limited in light of scheduled repayments of NBU funding (equal to 9% of end-Q3, 2016 total liabilities) to August 2017. However, our base case expectation is that local currency liquidity support will be available for Privat from the NBU, as long as the regulator views the bank's solvency as adequate. Privat's systemic importance is underlined by the bank's 36% market share in retail deposits," the experts said.

"At end-H1, 2016, PB reported NPLs at 9% of total loans, and individually impaired loans (other than NPLs) contributed a further 20% of loans (end-2015: 11% and 23%, respectively). Reserve coverage of total impaired loans (including NPLs) was low at 45%, reflecting the bank's reliance on loan collateral. Recovery rates on these could be significantly constrained by a difficult operating environment, while additional downside risks to asset quality also stem from large borrower concentrations and FX lending (67% of the total), the latter mostly to weakly hedged borrowers," according to the posting.

"PB's loss absorption capacity is limited, with a regulatory CAR of around 10% at end-Q3, 2016. Fitch does not expect this to improve markedly given only moderate recapitalisation plans to end-2017 (equal to around 11% of end-Q3, 2016 regulatory capital). We expect pressure on PB's capital to remain significant as the bank's unreserved impaired loans were a high 92% of FCC at end-H1, 2016, and annualized pre-impairment profit (net of non-core revenues), at 0.3% of average gross loans in H1, 2016, offered only negligible capacity to absorb additional credit losses," the rating agency said.

"We expect pre-impairment performance to be constrained by still high, although gradually decreasing, funding and credit risk costs," the experts added.

"PB's deposit base remained generally stable in the nine months of 2016, reflecting broader sector trends. The bank has limited reliance on wholesale markets, while its liquidity management, in particular in FX, is highly reliant on access to FX liquidity through its Latvian subsidiary. Should this access become more constrained, PB's FX liquidity position would likely weaken significantly," the report says.

"Both banks' Support Rating Floors of 'No Floor' and Support Rating of '5' reflect Fitch's view that support cannot be relied on due to the Ukrainian authorities' limited financial flexibility to provide extraordinary support to banks, the two banks' private ownership and, in the case of PB, its limited systemic importance. Potential support from the shareholders, while possible, is also not factored into the ratings, as its probability cannot be reliably assessed," it states.

"The banks' VRs and IDRs could be downgraded if further deterioration in asset quality results in capital erosion, without sufficient support being provided by the shareholders, or if deposit outflows sharply erode banks' liquidity, in particular in foreign currency. Further stabilization of the country's economic prospects, combined with an improvement of banks' loss absorption capacity, would reduce downward pressure on ratings. However, an upgrade of either of the banks would probably require a significant strengthening of asset quality," the agency said.

The rating actions are as follows:

PrivatBank

Long-Term Foreign and Local Currency IDRs: affirmed at 'CCC'

Short-Term Foreign Currency IDR: affirmed at 'C'

Viability Rating: affirmed at 'ccc'

Senior unsecured debt of UK SPV Credit Finance plc: affirmed at 'CCC'/Recovery Rating 'RR4'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'

National Long-Term Rating: downgraded to 'BB(ukr) ' from 'A-(ukr)', Negative Outlook

Pivdennyi Bank:

Long-Term Foreign Currency IDR: affirmed at 'CCC'

Short-Term Foreign Currency IDR: affirmed at 'C'