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TEXT-S&P lifts SME Bank ST FC rtg to 'A-2',afrms others;otlk stbl
September 13, 2012 / 10:40 AM / 5 years ago

TEXT-S&P lifts SME Bank ST FC rtg to 'A-2',afrms others;otlk stbl

(The following statement was released by the rating agency)

Sept 13 -

Overview

-- Russia-based SME Bank is a core subsidiary of the Vnesheconombank (VEB) group, a government-related entity (GRE).

-- SME Bank has strong capitalization and access to VEB group financial resources and enjoys a high likelihood of extraordinary government support from the Russian Federation.

-- We are raising the short-term foreign-currency rating on SME Bank to ‘A-2’, in line with the short-term rating on VEB, and affirming all the other ratings on SME Bank.

-- The stable outlook on SME Bank mirrors that on VEB and Russia, as well as the likelihood that, if the link between SME Bank and VEB remains unchanged, the outlook on SME Bank will likely continue to reflect the outlook on VEB.

Rating Action

On Sept. 13, 2012, Standard & Poor’s Ratings Services raised its short-term foreign-currency rating on Russia-based SME Bank to ‘A-2’. At the same time, the long-term foreign-currency rating was affirmed at ‘BBB’ and the long- and short-term local-currency ratings were affirmed at ‘BBB+/A-2’. The outlook is stable.

Rationale

The ratings on SME Bank reflect our view that the bank is a “core” subsidiary of its 100% owner, Vnesheconombank (VEB; foreign currency BBB/Stable/A-2; local currency BBB+/Stable/A-2), which is a government-related entity (GRE) with an “almost certain” likelihood of support from the Russian Federation (foreign currency BBB/Stable/A-2; local currency BBB+/Stable/A-2; Russia national scale ‘ruAAA’).

We classify SME Bank as a GRE with a “high” likelihood of timely and sufficient extraordinary support from Russia, its ultimate owner. Accordingly, we equalize the ratings on SME Bank with those on VEB.

SME bank also enjoys strong capitalization. However, exposure of the bank’s medium-term strategy to changes in government economic development policy, credit risks related to lending to small and midsize enterprises (SMEs), and limited earnings under the applied business model are credit weaknesses.

SME Bank’s stand-alone credit profile (SACP) is ‘bb-'. This is based on the bank’s ‘bb’ anchor and our assessment of the bank’s “moderate” business position, “strong” capital and earnings, “moderate” risk position, “above average” funding, and “adequate” liquidity, as our criteria define these terms.

In our view, SME Bank is a “core” subsidiary of VEB because it is an integral development-finance institution operating within the VEB group. SME Bank bears almost sole responsibility for the state’s program for the development of the SME sector. This is one of the key priorities for the federal government, which SME Bank undertakes directly as an integral component of VEB’s larger mandate. The core status also reflects strong financial links between VEB and SME Bank, notably with respect to funding.

In accordance with our criteria for GREs, our view of a “high” likelihood of extraordinary government support is based on our assessment of SME Bank’s “important” role in implementing the state’s public policy in the development of the SME sector and “integral” link with the Russian Federation. The state’s full ownership and strong oversight of the bank’s business and financial plans will, in our view, continue in the medium term.

Under our bank criteria, we use our Banking Industry Country Risk Assessment’s economic and industry risk scores to determine a bank’s anchor, the starting point in assigning an issuer credit rating. The anchor for a commercial bank operating only in Russia is ‘bb’, based on an economic risk score of ‘7’ and an industry risk score of ‘7’.

We consider Russia to have moderate growth prospects, credit expansion, and debt levels. Credit risk in the economy is very high, due to significant proportion of lending in foreign currency, the poor credit standing of the nonexport economy, and what we regard as Russia’s weak and arbitrary legal system.

With regard to industry risk, we see deficiencies in Russia’s bank supervision and believe that the dominance of state-owned banks unfavorably distorts competition for private-sector banks. Bank funding markets are risky, owing to a lack of long-term financing in rubles and the prevalent use of foreign currency. Nonetheless, this area has improved since 2008, due to a significant increase in retail deposits and the Russian Central Bank’s regular and effective liquidity support operations.

We assess SME Bank’s business position as “moderate”. It acts as a specialized development institution providing finance for Russian SMEs, which implies risk concentrations. Although owned by VEB, SME Bank interacts separately with the Ministry of Economic Development, which manages a public policy program aimed at SME development. Moreover, SME Bank continues to operate with a banking license under the supervision of the Russian Central Bank. On Dec. 31, 2011, total assets amounted to about Russian rubles (RUB) 90.7 billion (about $3 billion). Of this, 88% comprised loans and advances. SME Bank does not lend the money directly to SMEs, but channels the funding through small and midsize financial institutions, including commercial banks and leasing and factoring companies. As a development institution, SME Bank’s operations are more focused on its assigned task than profit maximization. Consequently, the bank is more tolerant of risk in its portfolio than other banks. In addition, the bank does not plan to increase its market share dramatically, but rather to fill the infrastructure gaps in the SME lending market.

SME Bank’s capitalization is “strong” reflecting our expectation that the risk-adjusted capital (RAC) ratio before diversifications will stay above 15% over the next three years, with earnings capacity remaining adequate. In line with our base-case scenario, the bank’s fast asset growth over the next three years will be supported by regular capital injections, as it experienced in 2007 and 2009. At the same time, SME Bank does not seek to maximize profitability. Instead, it prefers to maintain long-term sustainability, while fulfilling government policy objectives.

We assess SME Bank’s risk position as “moderate”. The bank’s loan portfolio carries relatively high counterparty and sector concentration risk, as the bank provides loans mostly to other Russian financial institutions focusing on SME lending. Moreover, due to the gradually shifting focus to nonbank institutions, SME Bank takes higher credit risks, in our opinion, by lending to niche players that can be more sensitive to adverse market trends.

Additional risk is related to the potential weakening of ultimate borrowers’ asset quality during a period of rapid loan portfolio growth. As of Dec. 31, 2011, the bank’s loans overdue by more than 90 days stood at a low 1.2% of the total loan book. However, we believe the loan portfolio is relatively unseasoned and credit losses could materialize in the future.

The bank’s funding is “above average” and its liquidity position is “adequate”, in our opinion. We consider that SME Bank has better-than-average funding and is more resilient to loss of confidence in the market due to the large proportion of long-term funding provided by VEB. About 63% of liabilities come from the parent company as of Dec. 31, 2011. Moreover, in the event of a liquidity squeeze, SME Bank could access the full range of central bank funding available to licensed financial institutions in Russia. This includes direct repurchase agreement transactions and uncollateralized and collateralized loans, as well as sources of liquidity through VEB and Russia’s National Welfare Fund. Liquidity ratios and market indicators for SME Bank are stronger than for other Russian banks.

Outlook

The outlook on SME Bank mirrors that on VEB and the Russian Federation, and reflects our expectation of an “almost certain” likelihood of extraordinary support from VEB.

If the link between SME Bank and VEB remains unchanged, the ratings and outlook on SME Bank will likely continue to reflect the ratings and outlook on VEB.

We could lower the ratings if SME Bank’s status within the VEB group weakens, unless it receives additional direct government support. Given its mandate, we do not expect to see government support or the bank’s SACP strengthen significantly in the medium term.

Ratings Score Snapshot

Issuer Credit Rating BBB/Stable/A-2 (foreign currency)

BBB+/Stable/A-2 (local currency)

SACP bb-

Anchor bb

Business Position Moderate (-1)

Capital and Earnings Strong (+1)

Risk Position Moderate (-1)

Funding and Liquidity Above average and Adequate (0)

Support +4

GRE Support 0

Group Support +4

Sovereign Support 0

Additional Factors 0

Related Criteria And Research

-- Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010

-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011

-- Group Rating Methodology And Assumptions, Nov. 9, 2011

-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

Ratings List

Ratings Affirmed; Upgraded

To From

SME Bank

Issuer Credit Rating

Foreign Currency BBB/Stable/A-2 BBB/Stable/A-3

Ratings Affirmed

SME Bank

Issuer Credit Rating

Local Currency BBB+/Stable/A-2

Senior Unsecured BBB+

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