We note that Bank Obrazovanie has significantly decreased its single-name concentrations in its loan portfolio. The ratio of the top-20 largest borrowers to total adjusted capital dropped from 480% at June 30, 2011 to about 365% a year later, which is still higher than the domestic average. We believe this improvement was the result of both the expansion and diversification of lending and the capital injections of about Russian ruble (RUB) 633.8 million that the bank received at the end of 2011. We expect the bank to continue diversifying its customer base and reduce concentrations in its loan portfolio. We are therefore revising our assessment of the bank's risk position to "moderate" from "weak," as our criteria define these terms.
However, we consider the bank's expansion strategy to be risky. Bank Obrazovanie pursues a very aggressive asset growth strategy--of about 70% on average over for the last three years, which is significantly above the system average. Moreover, the bank's medium-term strategy assumes comparable growth rates. We understand that the bank is growing from a very low base, but its high reliance on shareholders' funds to increase its own capital to support further growth raises concerns for us over its capacity to continue expanding at such a high pace.
The bank's good franchise and recognition on the Moscow Interbank Currency Exchange (MICEX), where it ranks among the top three players in foreign exchange transactions by volume of operations, have historically boosted the bank's business position. Arbitrage opportunities in ruble/U.S. dollar high frequency trading have historically been an important source of revenues, despite their volatility. We believe this contribution could gradually diminish, however, as new participants enter the market, putting pressure on the bank's revenues from this income source. We also note that earnings from core banking operations continue to be weak and have not taken off despite high loan growth. This is because the bank's commercial franchise remains limited, in our view. We are therefore revising our assessment of the bank's business position to "weak" from "moderate".
Other factors that support our 'B-' long-term rating on Bank Obrazovanie, in addition to its "weak" business position and "moderate" risk position, are our 'bb' anchor for a commercial bank operating only in Russia, the bank's "weak" capital and earnings, "average" funding, and "adequate" liquidity, as our criteria define these terms.
The stable outlook balances our view of improvements in the diversification of the bank's loan portfolio against its aggressive growth strategy and weak core earnings profitability. We expect Bank Obrazovanie to continue growing its assets faster than the system as a whole.
An upgrade would most likely follow a significant capital injection from shareholders or reduced growth appetite, which would improve the bank's projected Standard & Poor's risk-adjusted capital (RAC) ratio sustainably above 5%. We could also take positive rating action if we saw material improvements in the bank's business position, such as attracting new, highly creditworthy clients and diversifying business lines. In our view, a sustainable improvement in the profitability of the bank's commercial banking business and less reliance on volatile trading revenues in the earnings mix are also crucial for any positive rating action.
We could consider a negative rating action if the bank's asset quality deteriorated, which could follow a rapid expansion in the bank's loan portfolio and relaxed underwriting practices. We could also lower the ratings on the bank if aggressive growth that is not supported by capital injections were to result in the projected RAC ratio before adjustments falling below 3%.
Ratings Score Snapshot
Issuer Credit Rating B-/Stable/C
Business Position Weak (-2)
Capital and Earnings Weak (-1)
Risk Position Moderate (-1)
Funding and Liquidity Average and Adequate (0)
GRE Support 0
Group Support 0
Sovereign Support 0
Additional Factors 0
Related Criteria And Research
-- Banks: Rating Methodology And Assumptions, Nov. 9, 2011
-- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
-- Bank Capital Methodology And Assumptions, Dec. 6, 2010
-- Banking Industry Country Risk Assessment: Russia, March 19, 2012
Commercial Bank OBRAZOVANIE
Counterparty Credit Rating B-/Stable/C
Russia National Scale ruBBB-/--/--