The FINANCIAL — Fitch Ratings – Moscow – 10 Apr 2020: Fitch Ratings has revised the Outlooks on JSC TBC Bank (TBC, BB-), JSC Bank of Georgia (BOG, BB-), JSC Liberty Bank (LB, B+), JSC Terabank (Tera, B+) and Basisbank (Basis, B+) to Negative from Stable, while affirming their Long-Term Issuer Default Ratings (IDRs). Fitch has also affirmed ProCredit Bank Georgia (PCBG) at ‘BB+’ with a Stable Outlook.
The rating actions follow the revision of the Georgian banking sector outlook to negative from stable in light of the economic and financial -market fallout from the coronavirus outbreak (see ‘Fitch Ratings: Russian and CIS Banks Pressured by Coronavirus and Oil Price Slump’ dated 25 March 2020 on www.fitchratings.com). Fitch expects a sharp economic slowdown in Georgia in 2020 (GDP contraction of 3.2%, versus growth of 5.2% in 2019), before a recovery in 2021. However, there are significant downside risks to these forecasts.
We expect that weaker economic activity (especially in tourism-related sectors), exchange-rate pressures (the lari has depreciated 16% against the US dollar since the beginning of March, while 55% of sector loans were in foreign currency at end-2019) and weaker household real incomes (reflecting higher unemployment, salary reductions and decreasing remittances) will result in deterioration of Georgian banks’ asset quality, earnings and capitalisation.
The government has announced plans to allocate GEL2 billion (4% of GDP) to support the economy, in particular through suspension of taxes, VAT refunds and interest-rates subsidies for qualifying borrowers. The policy response should provide some support to households and to businesses operating in the most vulnerable sectors (mainly tourism-dependent). The National Bank of Georgia (NBG) has also introduced measures to support the stability of the banking sector, including postponing additional Pillar 2 capital buffers and allowing banks to utilise their capital conservation buffer (reduced to 0% from 2.5%) and two-thirds of the buffer covering foreign-currency risks. We believe these measures will reduce pressures on some borrowers and lower the potential for regulatory breaches by banks, but significant risks to lenders’ credit profiles remain.
KEY RATING DRIVERS
Key Rating Drivers – IDRs
The IDRs of TBC, BOG, LB, Basis and Tera are driven by the banks’ respective standalone profiles, as reflected by their Viability Ratings (VRs). The revisions of the Outlooks to Negative on these banks reflect the downside risks to their credit profiles resulting from the economic implications of the coronavirus pandemic.
PCBG’s IDRs and Support Rating are driven by the potential support the bank may receive from its sole shareholder, ProCredit Holding AG & Co. KGaA (PCH, BBB/Stable), in case of need. The Stable Outlook mirrors that on the Georgian sovereign.
Key Rating Drivers – VRs
The VRs of all six banks reflect their exposure to a high-risk operating environment, which we believe is likely to deteriorate materially in 2020 against the backdrop of economic recession, putting pressure on lenders’ financial metrics. We expect asset quality to weaken, albeit from rather moderate levels of impaired loans in most cases, and earnings challenges to increase due to growing loan loss allowances and subdued credit growth. However, we believe banks’ pre-impairment profits will remain sufficient to absorb moderate credit losses.
The banks’ regulatory capital ratios moderated after additional provisions booked at end-1Q20, and are exposed to further asset-quality pressures and a weaker lari, which could drive increases in risk- weighted assets (RWAs). Downside risks for funding and liquidity are low, in our view, as deposits have been stable to date, upcoming wholesale repayments are moderate, and liquidity cushions are sufficient to withstand significant stress.
BOG and TBC – VRs
Both banks’ ‘bb-‘ VRs are underpinned by strong local franchises (39% of sector loans for TBC and 35% for BOG at end-2019), significant pricing power and robust financial metrics. However, the ratings are constrained by exposure to the Georgian operating environment and high foreign-currency lending.
Impaired loans (Stage 3 and purchased or originated credit-impaired loans under IFRS 9, including leasing) ratios declined to 4.8% and 3% at BOG and TBC, respectively, at end-2019, from 6.6% and 3.5% at end-2018, helped by lending growth and write-offs. Asset quality has been supported by the stricter regulatory affordability criteria and restrictions on new foreign-currency lending in the retail segment. Coverage of impaired loans by specific loan loss allowances (LLAs) was a low 35% at TBC and 29% at BOG, reflecting high reliance on collateral.
Significant loan dollarisation (56% and 59% at BOG and TBC, respectively) heightens credit risks as the lari depreciates, as the share of naturally hedged borrowers is low. Stage 3 loans are likely to rise in 2020, in particular in the most vulnerable sectors of the economy (tourism, trade, transportation, construction and real estate), which accounted for 27% of loans at BOG and 26% at TBC, as well as in consumer loans (17% of loans at BOG and 15% at TBC).
Profitability remained healthy in 2019 with operating profit/RWAs ratios of 3.8% and 4.6% at BOG and TBC, respectively (the difference mainly due to RWA calculations). Net interest margins contracted to 6% from 7% in 2019 due to seasoning of high-yielding portfolios. This decline was partly compensated by reduced risk costs (below 1% for both banks), which we however expect to rise in 2020 as loans season in the difficult operating environment. Margins are also likely to come under further pressure from limited new lending.
The banks’ regulatory capital ratios declined by about 3pp at end-1Q20 following the NBG requirement to increase LLAs against potential asset-quality deterioration, with CET1 ratios falling to a moderate 9.1% at TBC (bank’s estimate) and about 8.5% at BOG (Fitch estimate). However, headroom above the minimum requirements remained broadly unchanged as the regulator reduced capital buffers at the same time. BOG’s IFRS-based Fitch Core Capital ratio (FCC) was moderately above the regulatory CET1 ratio, while TBC’s was significantly higher, mainly due to the difference in RWA calculation. Both banks postponed dividend payments for 2019 to preserve capital, but solvency could come under further pressure in case of additional provisioning requirements or continued lari depreciation.
BOG and TBC are predominantly funded by deposits (62% and 64% of end-2019 liabilities, respectively), which have been broadly stable to date. Wholesale debt maturities in 2020 are moderate at both banks. Highly-liquid assets (cash, short-term placements with NBG and banks, net of sizable obligatory reserves, and unpledged securities eligible for repo) amounted to a reasonable 24% of deposits at BOG and 17% at TBC at end-2019.
BOG and TBC – DEBT RATINGS
TBC’s and BOG’s senior unsecured debt is rated in line with the banks’ respective Long-Term IDRs of ‘BB-‘.
The two banks’ perpetual additional Tier 1 (AT1) notes are rated at ‘B-‘, three notches below the VRs. The notching reflects (i) the high loss severity of the notes due to their deep subordination, and (ii) additional non-performance risk relative to the VR, given fully discretionary coupon omission.
The trigger for mandatory coupon omission for each bank is a decline in any of its regulatory capital ratios (CET1, tier 1 or total) below the minimum level plus the combined pillar 1 buffers of capital conservation (now 0%), countercyclical (0%) and systemic importance (1.5%), i.e. the trigger levels are now 6% CET1, 7.5% tier 1 and 9.5% total. Based on the banks’ estimated capital ratios at end-1Q20, their headroom above these trigger levels was lowest for the CET1 ratio, but still a significant 310bp for TBC and about 250bp for BOG (Fitch estimate).
The NBG could also impose restrictions on coupon payments if banks breach minimum capital ratios including all (pillar 1 and pillar 2) buffers. At end-1Q20 the minimum required ratios including all applicable buffers were 6.9% CET1, 8.8% Tier 1 (8.7% for BOG) and 13.3% total for both banks. The headroom above those levels was lowest for the CET1 ratios, and stood at 220pb for TBC and about 150bp for BOG at end-1Q20. In Fitch’s view, there is some uncertainty as to whether the NBG would prevent coupon payments if banks breach minimum requirements including all buffers while still meeting minimum requirements plus pillar 1 buffers.
On 3 April 2020, TBC paid the latest coupon on its AT1 notes, following the end-1Q20 reduction in capital ratios; the next coupon on BOG’s notes is due on 28 June. The AT1 notes will be written down if the CET1 ratio falls below 5.125% or if the bank is subject to intervention by NBG.
LB – VR
LB’s ‘b+’ VR reflects exposure to the Georgian operating environment, moderate market shares and less-diversified business model compared with BOG’s and TBC’s, but at the same time also the bank’s reasonable financial metrics.
LB’s asset quality improved in 2019, helped by the cessation of high-yield consumer lending, almost completely banned by regulatory restrictions. Based on preliminary financial statements, Stage 3 loans decreased to 5.2% at end-2019 from 9% at end-2018 due to write-offs and strong corporate growth. The cost of risk (loan impairment charges/average gross loans ratio) moderated to 1.4% in 2019 from 3.7% in 2018, while corporate and SME loans increased to about 30% of gross loans providing reasonable diversification to the bank’s lending activities.
At the same time we expect a spike in impaired consumer loans in 2020 (the segment accounted for 36% of total loans, excluding lower-risk pension advances) as the crisis negatively impacts household incomes and employment levels. The bank’s exposure to vulnerable industries in the corporate loan book accounted for a further 18% of total loans.
Profitability was under pressure from tighter margins on the back of a portfolio mix change and declining loan yields in core retail products. Operational expenses remained elevated due to the bank’s large branch network. As a result, the operating profit/RWAs ratio contracted to 2.5% in 2019 from 4.2% in 2018. We expect that the bank’s profitability will remain under pressure in 2020 from higher risk costs and weaker lending growth.
Regulatory capital ratios declined about 1pp in 1Q20 following the NBG requirement to increase LLAs, albeit the impact was lower than the sector average. LB’s regulatory CET1 ratio fell to an estimated 10.9% at end-1Q20, which was moderately above larger peers’.
We do not expect significant pressures on the bank’s funding and liquidity profile. LB is predominantly funded by customer accounts (85% of total liabilities at end-2019), of which 54% are sourced from households. Customer funding has been generally stable to date. Liquidity buffers are strong, covering 35% of customer accounts at end-2019.
PCBG – VR
PCBG’s ‘bb-‘ VR captures the bank’s modest franchise, high risk appetite given significant dollarisation, but also robust risk management policies and generally sound financial metrics to date.
Impaired loans remained a sound 2.9% at end-2019, supported by the bank’s the prudent risk- management framework and group supervision. Impaired exposures were almost fully covered by total LLAs. However, PCBG’s focus on the vulnerable SME segment skews asset-quality risks to the downside. Lending dollarisation is highest among Fitch-rated banks (75% at end-2019), exposing the bank to potential further depreciation of the local currency. These risks are only partly mitigated by PCBG’s sound underwriting policies and borrowers’ mostly reasonable financial performance to date.
PCBG’s profitability has been adequate with a 3% operating profit/RWAs ratio in 2019. Margins continued to contract as a result of its exit from the high-yielding micro business, intensified competition and low credit growth. Capital pressures resulting from potential inflation of RWAs and additional provisioning of problem loans are moderated by significant capital buffers above the minimum regulatory requirements (about 650bp for CET1 at end-1Q20). The FCC ratio at end-2019 was a healthy 19.4%, helped by dividend postponement and modest credit growth.
The bank is mainly reliant on customer funding (60% of end-2019 liabilities). Wholesale debt (35% of liabilities) refinancing risks are mitigated by moderate upcoming repayments and the predominance of IFIs and related parties in the funding structure. Liquidity is underpinned by potential support from the parent and sister banks. At end-2019, highly-liquid assets (excluding sizeable obligatory reserves) covered 22% of customer deposits.