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Rating Action:

Moody's assigns Counterparty Risk Assessments to six Azerbaijani banks; affirms ratings and changes outlooks for three banks' long-term ratings to stable from positive

04 Jun 2015

London, 04 June 2015 -- Moody's Investors Service has today assigned Counterparty Risk Assessments (CR Assessments) to six Azerbaijani banks, following the publication of the rating agency's new bank rating methodology (see "Banks" published on 16 March 2015):

-- Ba2(cr) to International Bank of Azerbaijan

-- Ba3(cr) to OJSC Bank of Baku and VTB Bank (Azerbaijan)

-- B1(cr) to UniBank Commercial Bank, Joint Stock Commercal Bank Respublika and OJSC Xalq Bank

Concurrently, Not-Prime(cr) short-term CR Assessments have been assigned to all the above-mentioned banks.

Moody's has also affirmed the ratings and assessments of International Bank of Azerbaijan, UniBank Commercial Bank and Joint Stock Commercal Bank Respublika and changed the outlooks on their long-term debt ratings to stable from positive, given the challenging operating environment in Azerbaijan (Baa3 stable), that pressures the banks' financial fundamentals. Other bank-specific reasons for the affirmations that partly offset the weak operating environment can be found below, under "Bank Specific Factors".

At the same time Moody's has withdrawn, for its own business reasons, the outlook on the International Bank of Azerbaijan subordinated debt ratings. Please refer to Moody's Investors Service's Policy for Withdrawal of Credit Ratings available on its website, www.moodys.com.

RATINGS RATIONALE

--- OPERATING ENVIRONMENT

The recent slump in oil prices has put downward pressure on the country's GDP growth, creating an operating environment that exerts pressure on the banks' fundamentals. Azerbaijan's economy is heavily dependent on the hydrocarbon sector, which accounts for 40% of nominal GDP and more than 70% to total consolidated government revenues. As such, Moody's forecasts that GDP growth will slow down to 1% in 2015, based on its current assumption of oil prices at roughly 55 $/bbl this year. This has a negative spillover effect on the non-oil sector, including the banking system, through a slowdown of economic activity. However, Moody's acknowledges that government spending initiatives and the sizable pool of accumulated foreign assets (at 70% of GDP) -- which serve as a buffer against external shocks -- partly mitigate the pressure. The devaluation of the local currency by 25% on 21 February 2015 replenished the state budget as it reduced fiscal pressure from lower oil revenues. However, it had negative effect on the Azeri banking sector.

Moody's forecasts flat lending growth in 2015 at around 0% (excluding the devaluation effect) on the back of the slowdown in economic activity and the lack of local currency (manat) liquidity. Azeri banks appear unwilling to extend more local-currency loans in this environment, which will result in a widening of banks' short open foreign-currency positions; furthermore, customers are unwilling to take on foreign-currency risks. Moody's anticipates a negative trend in asset quality following the manat devaluation, as most Azeri banks' foreign-currency loans (40% of gross loans as of 1 March 2015) were granted to borrowers that do not have foreign-currency revenues, as well as the seasoning of the banks' loan book amidst the slowdown in lending and higher inflation expectations that will worsen the population's purchasing power.

Furthermore, Moody's projects higher provisioning needs in the next 12 months with average credit costs of around 3% of gross loans, putting pressure on banks' profitability and capitalisation. The immediate negative effect on system-wide capitalisation from the revaluation of FX assets is estimated at around 2 percentage points. However, despite the negative trend in capitalisation, most banks' loss-absorption cushion is sufficient to absorb expected losses under Moody's central stress-test assumptions. On the funding side, the devaluation weakened depositors confidence with significant shifts into FX, which widened the mismatch between banks' FX assets and FX liabilities. At the same time, Azeri banks have moderate refinancing risk, given their relatively moderate dependence on market funding and sufficient FX liquidity.

--- BANK SPECIFIC FACTORS

-- International Bank of Azerbaijan

The affirmation of International Bank's of Azerbaijan (IBA) b3 BCA and adjusted BCA, Ba3 long-term deposit and senior unsecured debt ratings with a stable outlook, as well as B1 subordinated debt and Not-Prime short-term deposit ratings reflects the bank's announced recapitalisation measures, which support its loss-absorption capacity following the negative effects from the manat devaluation and expected higher provisioning needs.

IBA received timely capital support in the form of an AZN250 million subordinated loan from the Central Bank of Azerbaijan (CBAR) on 27 February 2015, which enabled it to maintain regulatory total Capital Adequacy Ratio (CAR) at 12.02% as of 1 April 2015. According to the initial capital raising plan, AZN 100 million Tier 1 injection was approved by shareholders in January 2015, out of which AZN 51 million has been already paid by the Ministry of Finance in March 2015. Furthermore, on 2 April 2015, shareholders approved an additional AZN 200 million capital injection to be provided by end-2015. Subject to the completion of the targeted capital injections, Moody's assumes that IBA's capital buffer will be sufficient to absorb expected losses under its central stress-scenario. At the same time, the bank's ratings remain constrained by worsening asset quality, high single-name loan concentrations, and modest core profitability.

Moody's believes that there is very high likelihood of government support for IBA, resulting in three notches of uplift from the bank's BCA of b3. This is based on the controlling ownership by the government, strong market position as the largest bank in Azerbaijan (with the market share of 35% in system-wide assets) and nationwide domestic franchise, and track record of support.

-- UniBank Commercial Bank

The affirmation of UniBank's b2 BCA and adjusted BCA, B2 long-term deposit ratings with a stable outlook, and Not-Prime short-term deposit rating reflects sound core profitability and capitalisation, providing an ample loss-absorption cushion against the expected increase in credit costs. At the same time, UniBank's ratings are constrained by pressure on asset quality given the recent growth in the consumer lending segment and foreign-currency exposure to unhedged borrowers (35% of loans denominated in FX as of year-end 2014) that are vulnerable to the recent manat devaluation.

Unibank's non-performing loans (NPLs, overdue more than 90 days) increased to 6.8% as of year-end 2014 from 3.1% in 2013 given the loan book seasoning amidst the challenging operating environment and the slowdown in retail lending growth. Moody's expects that the worsening of households' purchasing power amid higher inflation expectations, the recent manat devaluation and potential increase in unemployment imply that the negative trend in lending will continue. Credit costs amounted to 3% of gross loans in 2014, and Moody's expects them to increase to around 7% in 2015 (which is still below those of the Russian consumer players, with an average cost of risk of 20%).

At the same time, Unibank has robust recurring earnings generation with pre-provision income (PPI) to average assets of 8.75% owing to a high net interest margin (NIM) of 15.4% as of year-end 2014. Although PPI is likely to decrease given the narrowing NIM on the back of slowdown in lending and higher funding costs, as well as the reduction in commissions related to loan issuance, Moody's still believes that PPI will provide an adequate buffer against expected increase in credit losses. Unibank's total CAR of 17% and Tier 1 of 15% under Basel as of year-end 2014 was under pressure from the manat devaluation. However, following the deleveraging and reduction in off-balance sheet exposures, the bank was able to keep regulatory total CAR at 16.3% and Tier 1 at 13.2% as of 1 April 2015. The bank intends to maintain a total CAR not lower than 15% in the future.

-- Joint Stock Commercal Bank Respublika

The affirmation of Respublika's b2 BCA and adjusted BCA, B2 long-term deposit ratings with a stable outlook and Not-Prime short-term deposit rating reflects its currently satisfactory loss-absorption buffer and sufficient liquidity cushion. At the same time, Respublika's ratings are constrained by the expected worsening of asset quality given the high share of FX exposures that put pressure on profitability and capitalisation, and high deposit concentrations.

Bank Respublika reported historically low NPLs (overdue more than 90 days) of 1.2% as of year-end 2014 (0.5% as of year-end 2013), which are below that of sector average. Its credit quality metrics have been supported by the diversified loan book structure with adequate single-name concentrations and relatively low-risk appetite with moderate growth rates in the past. However, the high share of foreign-currency loans at 44% of loan book at year-end 2014 exposes the bank to risk of asset-quality deterioration following the recent local-currency devaluation. Moody's anticipates an increase in the bank's credit costs to around 4.5% as of year-end 2015 on the back of the revaluation of existing reserves for FX loans; and the initiated loan restructuring process owing to weakening borrowers' creditworthiness, as most of them do not have foreign-currency revenues. Given that PPI/total assets amounted to 3.3% as of year-end 2014 according to management's data, Moody's expects that the bank's bottom-line profitability will be around zero in 2015. Bank Respublika's capitalisation remains adequate, despite pressure from the local-currency devaluation: total CAR was 18.5% and Tier 1 12.3% as of Q1 2015 (19.2% and 10.9% respectively as of year-end 2014). The bank's capital buffer is adequate to withstand potential stress under Moody's central scenario.

WHAT COULD CHANGE THE RATINGS UP/DOWN

Upward rating momentum on the ratings of International Bank of Azerbaijan, UniBank and Joint Stock Respublika is currently limited, constrained by challenging operating environment in Azerbaijan.

Downward rating pressure could occur if (1) the macroeconomic environment deteriorates such that banks are required to create additional loan loss reserves beyond the level currently anticipated by Moody's; or (2) there is significant deterioration in the banks' asset quality and consequently profitability, leading to a material erosion of capitalisation levels.

---CR ASSESSMENTS

CR Assessments are opinions of how counterparty obligations are likely to be treated if a bank fails and are distinct from debt and deposit ratings in that they (1) consider only the risk of default rather expected loss and (2) apply to counterparty obligations and contractual commitments rather than debt or deposit instruments. The CR Assessment is an opinion of the counterparty risk related to a bank's covered bonds, contractual performance obligations (servicing), derivatives (e.g., swaps), letters of credit, guarantees and liquidity facilities.

In most cases, the starting point for the CR Assessment -- which is an assessment of the ability to avoid defaulting on its operating obligations -- is one notch above the bank's adjusted baseline credit assessment (BCA), which represents the rating agency's view of the probability of a bank failing on its obligations without considering government support. Moody's then adds the same support assumptions as applied to deposit ratings. As a result, the CR Assessment of all six banks are one notch higher than their deposit ratings.

This announcement follows the publication of Moody's new bank rating methodology published on 16 March 2015 (see "Banks," http://www.moodys.com/viewresearchdoc.aspx?docid=PR_320662).

Assignments:

..Issuer: International Bank of Azerbaijan

.... Counterparty Risk Assessment, Assigned Ba2(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

..Issuer: Joint Stock Commercal Bank Respublika

.... Counterparty Risk Assessment, Assigned B1(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

..Issuer: OJSC Bank of Baku

.... Counterparty Risk Assessment, Assigned Ba3(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

..Issuer: OJSC XALQ BANK

.... Counterparty Risk Assessment, Assigned B1(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

..Issuer: UniBank Commercial Bank

.... Counterparty Risk Assessment, Assigned B1(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

..Issuer: VTB Bank (Azerbaijan)

.... Counterparty Risk Assessment, Assigned Ba3(cr)

.... Counterparty Risk Assessment, Assigned NP(cr)

Affirmations:

..Issuer: International Bank of Azerbaijan

.... Adjusted Baseline Credit Assessment, Affirmed b3

.... Baseline Credit Assessment, Affirmed b3

.... ST Deposit Rating , Affirmed NP

....Subordinate Regular Bond/Debenture, Affirmed B1

....Senior Unsecured Regular Bond/Debenture, Affirmed Ba3 STA

....LT Deposit Rating, Affirmed Ba3 STA

..Issuer: Joint Stock Commercal Bank Respublika

.... Adjusted Baseline Credit Assessment, Affirmed b2

.... Baseline Credit Assessment, Affirmed b2

.... ST Deposit Rating, Affirmed NP

....LT Deposit Rating, Affirmed B2 STA

..Issuer: UniBank Commercial Bank

.... Adjusted Baseline Credit Assessment, Affirmed b2

.... Baseline Credit Assessment, Affirmed b2

.... ST Deposit Rating, Affirmed NP

....LT Deposit Rating, Affirmed B2 STA

Outlook Actions:

..Issuer: International Bank of Azerbaijan

....Outlook, Changed To Stable From Positive

..Issuer: Joint Stock Commercal Bank Respublika

....Outlook, Changed To Stable From Positive

..Issuer: UniBank Commercial Bank

....Outlook, Changed To Stable From Positive

The principal methodology used in these ratings was Banks published in March 2015. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

The below contact information is provided for information purposes only. Please see the ratings tab of the issuer page at www.moodys.com, for each of the ratings covered, Moody's disclosures on the lead analyst and the Moody's legal entity that has issued the ratings.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Maria Malyukova
Analyst
Financial Institutions Group
Moody's Investors Service Limited, Russian Branch
7th floor, Four Winds Plaza
21 1st Tverskaya-Yamskaya St.
Moscow 125047
Russia
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves Lemay
MD-Banking & Sovereign
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
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United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's assigns Counterparty Risk Assessments to six Azerbaijani banks; affirms ratings and changes outlooks for three banks' long-term ratings to stable from positive
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