Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of JSC TBC Bank Group (TBC) and JSC Bank of Georgia (BOG) at 'BB-' and revised their Outlooks to Stable from Positive. Fitch has also affirmed the Long-Term IDRs of JSC Liberty Bank (LB) at 'B+' and Procredit Bank (Georgia) (PCBG) at 'BB+' with Stable Outlooks. A full list of rating actions is at the end of this commentary.
KEY RATING DRIVERS
IDRs, SUPPORT RATINGS, SUPPORT RATING FLOORS, SENIOR DEBT RATINGS
The IDRs of TBC, BOG and LB are driven by the banks' intrinsic strength, as reflected by their Viability Ratings (VRs). BOG's senior unsecured debt is rated in line with its Long-Term IDR.
The revision of the Outlooks on TBC and BOG to Stable from Positive reflects our view of still significant risks associated with continued rapid loan growth and sizable foreign currency (FC) lending.
The IDRs and VRs of TBC, BOG and LB, and the VR of PCBG, reflect their exposure to the still relatively high-risk Georgian operating environment. These ratings also reflect the four banks' generally sound financial metrics, reflected in reasonable asset quality metrics, strong performance, adequate capitalisation and stable funding profiles and comfortable liquidity.
LB's lower VR and Long-Term IDR factor in its moderate market shares compared with BOG and TBC, its large, albeit decreasing, exposure to unsecured retail lending and its as yet untested growth in the corporate segment following ownership and strategy changes.
PCBG's IDRs and Support Rating are driven by the potential support it may receive from its sole shareholder, ProCredit Holding AG & Co. KGaA (PCH, BBB/Stable), in case of need. In Fitch's view, PCH will continue to have a high propensity to provide support to its Georgian subsidiary given the importance of Georgia to the group, full ownership, common branding, strong operational and management integration between the parent and the subsidiary and a record of capital and liquidity support.
Fitch caps PCBG's ratings at one notch above the 'BB' sovereign rating to reflect the country risks that domestic banks are exposed to. In our view, in case of extreme macroeconomic and sovereign stress scenarios, these risks could limit PCBG's ability to service its obligations or the parent's propensity to continue providing support, or both.
The affirmation of BOG, TBC and LB's Support Ratings at '4' and Support Rating Floors (SRFs) at 'B' reflects Fitch's view of the limited probability of support being available from the Georgian authorities, in case of need. We believe that the authorities would likely have a high propensity to support BOG, TBC and LB, at least in the near term, in light of their high systemic importance (BOG/TBC) and extensive branch network and role in distributing pensions and benefits (LB).
However, the ability to provide support, especially in FC, may be constrained, given the banks' large FC liabilities (USD6.1 billion at end-2018) relative to sovereign FX reserves (USD3.3 billion at end-2018). Furthermore, Fitch understands that the National Bank of Georgia (NBG) plans to submit to parliament draft legislation on bank resolution. If legislation is ultimately adopted that provides a credible framework for the bail-in of senior creditors of failed banks, then Fitch would likely downgrade the Support Ratings of TBC, BOG and LB to '5' and revise their SRFs to 'No Floor'.
The VRs of all four banks reflect their exposure to the still relatively high-risk Georgian operating environment. The VRs of TBC, BOG and PCBG also consider their high FC lending and, in the cases of TBC and BOG, their rapid growth in what Fitch considers to be potentially high-risk FC mortgage lending in 2H18.
The four banks' VRs also reflect the relatively good near-term growth prospects for the Georgian economy, which should help support lenders' generally sound financial profiles. Regulatory constraints on retail lending from 2019, including more stringent affordability criteria and an increased minimum limit for FC lending (GEL200,000 vs. GEL100,000 in 2018) also somewhat reduce the potential for further high-risk credit growth.
The VRs of TBC and BOG further reflect their dominant positions in the local banking sector (38% and 35% of total sector assets at end-2018, respectively) and significant pricing power, which has underpinned their healthy profitability through the recent economic cycle.
LB's and PCBG's VRs reflect their only moderate market shares (5% and 4% of total sector assets, respectively) and focus on specific groups of customers (unsecured retail lending at LB and niche SME lending at PCBG). Recent changes in LB's strategy and its growing corporate franchise are yet to be tested and may pressure the bank's margins, as the share of good-quality borrowers is limited and competition is high.
Impaired loans (Stage 3 under IFRS 9) represented a moderate 3.4% of loans at end-2018, based on preliminary financial statements. Loan loss reserves covered a comfortable 94% of impaired loans and unreserved impaired loans represented a low 1% of Fitch Core Capital (FCC).
Borrower concentrations are moderate compared with some regional peers, with the 25 largest borrowers accounting for 19% of gross loans, or 101% of FCC at end-2018. Dollarisation of the loan book remained high at 60% at end-2018, about 36% of which were FC mortgages issued mostly to unhedged borrowers (equal to 112% of TBC's FCC). Unsecured retail lending amounted to a further 93% of the bank's FCC.
Profitability is a rating strength. The operating profit to risk-weighted assets (RWA) ratio reached 4.9% in 2018 (2017: 4.6%) and the net interest margin is high at approximately 7%, supported by 21% loan growth. Declining operating expenses relative to gross revenues (37%) and moderate impairment charges (1.6% of average loans) supported a strong return on average equity (ROAE) of 22% in 2018.
TBC's FCC/RWA ratio was high at 19% at end-2018. This is higher than prudential regulatory capital ratios (Tier 1: 12.8% and total 17.9%) due to the more conservative regulatory risk-weighting of assets. Management's target is to maintain a minimum 1% buffer over the minimum requirements (11.8% and 16.7%, respectively, including buffers) which we view as reasonable.
Funding is mainly sourced from stable customer accounts (62% of total liabilities at end-2018, excluding government deposits). Concentrations are moderate, as the 20 largest depositors accounted for 22% of total customer accounts at end-2018. Funding from international financial institutions (IFIs) was a notable 16% of total liabilities, but the maturity schedule is comfortable, and TBC has a track record of refinancing maturing debt. A further 14% of liabilities were short-term repo funding from the NBG (5%) and government deposits (9%). Our estimate is that the buffer of liquid assets (cash, interbank assets and unpledged securities net of wholesale debt repayments and maturing government deposits in the upcoming 12 months) was sufficient to withstand an outflow of a moderate 7% of customer accounts at end-2018.
Impaired loans (Stage 3 under IFRS 9) stood at 6.6% of loans at end-2018, with only moderate coverage by total loan loss allowances of 50%. Unreserved impaired loans accounted for a notable 19% of FCC. Concentration of loans remained moderate compared with some regional peers, with the 25 largest borrowers accounting for 18% of gross loans at end-2018, or 104% of FCC.
Dollarisation of loans is stable at a high 57% at end-2018. FC mortgages contributed a notable 35% of total FC loans (117% of BOG's FCC) and are issued mostly to unhedged borrowers. Unsecured retail lending accounted for a further 116% of FCC.
Profitability was strong at BOG, driven by continued rapid lending growth (2018: 23%), with the ratio of operating profit to RWAs equal to 4% in 2018, supported by a relatively stable net interest margin (7%). Operating expenses were broadly stable at 38% of gross revenues and impairment charges were a moderate 1.7% of average loans, resulting in a strong ROAE of 22% in 2018 (25% in 2017).
The FCC/RWA ratio was moderate at 13.5% at end-2018. Regulatory capitalisation was weaker, with the Tier 1 and Total capital ratios equal to 12.2% and 16.6%, respectively (prudential minimums are 11.4% and 15.9%, respectively, including buffers). In March 2019, BOG issued perpetual Additional Tier 1 notes equal to about 2% of end-2018 RWAs, to boost regulatory capitalisation. BOG plans to maintain a buffer of 2% over its minimum prudential capital requirements.
Stable customer deposits represent BOG's core source of funding, accounting for 64% of total liabilities at end-2018. Concentrations are moderate, with the 20 largest depositors accounting for 16% of total customer accounts. Bonds accounted for a further 13% of total funding, including USD350 million Eurobonds maturing in 2023. Our assessment is that liquid assets were sufficient to withstand an outflow of a low 5% of total customer accounts.
LB's loan portfolio growth of 22% in 2018 was mainly driven by the corporate and SME segments. Retail loans continue to dominate the portfolio (81% of end-2018 loans) but growth is constrained by regulations on unsecured lending. The quality of the retail portfolio is stable and preliminary financial statements indicate that impaired loans (Stage 3 loans under IFRS 9) stood at a high 10% of gross retail loans, comfortably reserved at 115%.
Risks in unsecured lending (62% of total loans or 2.4x FCC) are partly mitigated because a large share of borrowers have regular inflows into their accounts held at the bank and these can be debited to meet loan repayments at the bank's discretion. The share of FC lending, at 22% of loans at end-2018, is significantly below the market average (57%), which we view positively.
Corporate and SME lending is an area for expansion under the bank's new ownership. These segments represented 19% of gross loans at end-2018, which brings moderate diversification to the loan portfolio. However, rapid growth in this segment may put pressure on asset quality as the portfolio seasons.
LB's profitability is strong, underpinned by still wide margins (15%). Profitability was supported by improved operating efficiency (cost-to-income ratio of 56% in 2018) and stable loan impairment charges on retail loans. As a result, operating profit remained a solid 5% of RWAs and ROAE was 23%.
The FCC/RWA ratio remained strong (17%) and stable. Capitalisation and leverage is a relative rating strength for LB. Regulatory capital ratios are lower (Tier 1 and Total capital ratios at 14.1% and 17.7%, respectively, at end-2018). LB does not operate with ratios significantly above minimum capital requirements (including buffers) but the bank plans to attract subordinated debt in 1H19 to support its regulatory capitalisation.
The bank's funding and liquidity profile is a rating strength, in our view. Customer deposits represented 94% of LB's liabilities at end-2018. Concentrations are rising with the 20 largest depositors representing 20% of total liabilities at end-2018 (end-2017: 12%). The bank's liquidity was sufficient to cover a high 38% of customer deposits.
PCBG's asset quality benefits from a well-controlled risk appetite supervised by the parent group. According to preliminary end-2018 financial statements, impaired loans (IFRS 9 Stage 3 loans) represented 2.7% of gross loans, reserved at 92%. Loans in FC constitute a high 77% of total loans and the share of naturally hedged borrowers is limited. The loan book was moderately concentrated: exposure to the 25 largest clients was equal to 101% of the bank's FCC at end-2018.
Net interest margins are declining (4.9% in 2018, down from 5.5% in 2017) reflecting a shift towards larger SMEs and intensified competition on the market. Pre-impairment profitability remained stable at 3% of gross loans in 2018, supported by improved operating efficiency (cost/income ratio of 53% in 2018 compared to 58% in 2017). Profitability benefited from (unsustainable) zero loan impairment charges, resulting in operating profit equal to 3% of RWAs in 2018 (2017: 2%) and a ROAE of 14%.
The FCC/RWA ratio declined to 17% at end-2018 from 19% at end-2017 due to the transition to IFRS 9, which consumed a moderate 4% of end-2017 equity, and dividend payouts. The bank maintains a 2% buffer above minimum prudential capital ratios and its Tier 1 and total capital ratios reached 13.4% and 17.8%, respectively, at end-2018. The bank's capitalisation benefits from ordinary support from PCH, as possible capital pressures, if any, would likely be offset by equity injections from the parent.
Compared to peers, PCBG's funding profile is more reliant on wholesale markets. Customer deposits represented 53% of total liabilities at end-2018. Loans from IFIs stood at 20% of liabilities, while funds from PCH and sister banks added 24%. PCBG's liquidity cushion (cash, unpledged securities eligible for repo and short-term bank placements) was sufficient to cover all expected outflows of wholesale debt in 2019.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES (BOG)
The affirmation of BOG's perpetual additional Tier 1 notes at 'B-' reflects their higher loss severity in light of their deep subordination, and additional non-performance risk relative to the VR. Non-performance risk reflects the write-down trigger (core equity Tier 1 ratio falling below 5.125% or intervention by the NBG) and fully discretionary coupon omission. The rating is three notches below BOG's VR. According to our criteria, this is the highest possible rating that can be assigned to deeply subordinated notes issued by banks with a VR anchor of 'bb-'.
IDRs, VRs, SUPPORT RATINGS, SUPPORT RATING FLOORS, SENIOR DEBT RATINGS
We do not anticipate changes to TBC's, BOG's and LB's VRs in the near term and consequently the Outlooks on the banks' IDRs are Stable. Upside potential could arise from improvements in the operating environment, for example driven by further diversification and growth of Georgia's economy. A notable decrease in loan dollarisation rates at the banks could be positive for TBC and BOG, while LB's ratings are also sensitive to a positive track record of the bank's performance under the new strategy.
Downgrades of the IDRs and VRs of BOG, TBC and LB, and of PCBG's VR, could result from a material increase in risk appetite or a marked deterioration in asset quality, leading to a substantial weakening of capitalisation.
Upside for PCBG's VR is currently limited, given its moderate franchise and profitability and higher share of FC lending. PCBG's support-driven IDRs are sensitive to Fitch's assessment of support from PCH and country risk considerations associated with Georgia.
The Support Ratings and SRFs of TBC, BOG and LB are sensitive to changes in the overall probability of sovereign support. A change in the sovereign rating could affect this, although this is considered unlikely in the foreseeable future given the Stable Outlook on Georgia's sovereign rating. If legislation is adopted which provides a credible framework for the bail-in of senior creditors of failed banks, then Fitch would likely downgrade the Support Ratings of TBC, BOG and LB to '5' and revise their SRFs to 'No Floor'.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES (BOG)
Fitch may widen the rating notching between the notes and BOG's VR if non-performance risk increases. The rating of the notes would also be downgraded if the instrument becomes non-performing, i.e. if the bank cancels any coupon payment or at least partially writes off the principal. Upside for the notes is limited, as per Fitch's criteria the minimum notching of deeply subordinated instruments would increase to four notches, should BOG's VR be upgraded to 'bb'.
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