13 Oct 2009 18:00

Moody's: negative outlook for Russian banking system despite resilience to global crisis

MOSCOW. Oct 13 (Interfax) - Russian banks will experience negative rating pressure in the near-to-medium-term, due to concerns over the credit fundamentals of domestic banks, Moody's Investors Service said in a press release.

"The first wave of the global financial crisis that struck Russian banks 12 months ago has been contained by timely and adequate actions by the government and the Central Bank of Russia (CBR). However, the risk of further instability in the banking system remains relatively high due to negative pressure on capitalization and profitability against a background of deteriorating asset quality and liquidity caused by weak depositor confidence and asset-liability mismatches," the press release says.

Moody's negative outlook for the Russian banking system expresses the rating agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades.

As in the past, the dynamics of the Russian banking sector will be largely driven by macroeconomic developments. Strong economic growth in the past eight years had supported banks' lending expansion at or above 40% per annum.

With Russia now in recession, the operating environment for banks has become hostile. GDP contracted more than 10% in the first half of 2009, and Moody's expects the economy to shrink by 8.5% for the whole year. The rating agency predicts only modest 1.7% economic growth in 2010 -- rebounding more strongly in 2011. For many banks, these growth expectations would require at least 12 months of reducing financial leverage, combined with working out problem loans, attracting new capital, repaying foreign debt and reassessing their funding strategies.

"Despite a hostile operating environment, the Russian banking system as a whole has shown adequate resilience to the crisis so far, largely due to state support", Eugene Tarzimanov, a Moscow-based Moody's Assistant Vice President-Analyst, the author of the report, is quoted in the press release as saying. Asset quality and capitalization therefore represent medium-term risks for Russian banks, and in Moody's opinion they are not likely to materially damage the banking system in the short term.

The state has put in place various anti-crisis mechanisms, ranging from liquidity to capital injections. Moody's notes that the state support package is one of the largest among emerging markets, exceeding 10% of GDP (ca. $170 billion, mostly through liquidity injections).

"The Russian government is committed to supporting the stability of the banking system, as highlighted by numerous bank bailouts and the government is likely to be more selective in channeling its support to banks, providing capital and liquidity to banks of systemic or regional importance. The beneficiaries of this support are state banks, which are taking market share from private sector banks," Tarzimanov said.

As regards asset quality, Moody's estimates that around 11% of loans ($70 billion) -- mostly granted pre-crisis to the corporate sector -- were problematic at mid-2009. Additionally, an equally high level of loans had been restructured. The stock of problem loans is likely to exceed $110 billion by year-end 2009, which would account for 20% of gross loans. This projected level of asset quality deterioration should be manageable for the banking sector, to be absorbed by available and upcoming capital, as well as reserves.

By year-end 2010, barring any economic shocks, Moody's would expect problem loans to grow to 25% of gross loans, largely driven by impairment in restructured loans and moderate new lending. Additional pressure on asset quality stems from foreign currency (FX) loans, which comprised around one-third of the total at mid-2009.

Moody's estimates that expected losses on FX loans are 70-100% higher compared to ruble-denominated loans. In this context, FX loans expose banks to high credit risk as the rating agency forecasts a 10% depreciation of the ruble against the dollar by year-end 2009. Of the ca. 20 Russian banks that collapsed as a result of the crisis, most had encountered severe liquidity problems when faced with significant retail and corporate deposit outflows.

On average, Moody's-rated Russian banks faced a 10-15% depletion of their deposits in the weeks following the crisis, and the rating agency believes that weak depositor confidence is one of the major threats to the Russian banking system. Moody's notes that liquidity support from the CBR and the Ministry of Finance helped to avert a more severe banking crisis. Currently, many Russian banks face the major medium-term risk of becoming materially dependent on CBR funding, which is relatively short term and will be withdrawn from the banking system at some point. While the CBR's "exit strategy" is unclear at this stage, Moody's believes that this process would be gradual in order to avoid destabilising the banking system. However, the weakest institutions could find it difficult to repay borrowings from the CBR.

Despite negative developments in the Russian banking system, the asset-weighted Bank Financial Strength Rating (BFSR) remained at D- over the past 12 months, mapping into a Baseline Credit Assessment (BCA) of Ba3. This is explained by the high concentration of system assets in a few large banks, mostly state-owned (top five exceed 50%). Moody's took negative rating actions on about one-quarter of rated Russian banks since the start of crisis in September 2008; these actions were driven by weaker stand-alone credit fundamentals, changes in systemic support assumptions, and defaults and banks being put into administration. The ratings of the other three-quarters of rated banks were not affected by the crisis due to their low rating levels that had already implied a high rating transition risk (B2 to B3 debt and deposit ratings).

Further negative rating actions are likely at selected banks, if their creditworthiness deteriorates beyond our base-case scenario for asset quality and liquidity, which already incorporates a relatively high level of stress. Banks' risk positioning remains a historical weakness in Russia. In particular, balance sheets are highly concentrated on selected clients, market risk appetite is high, and related-party deals are omnipresent. With a few exceptions, risk management, corporate governance, as well as transparency and disclosure all remain below international best practices. Moody's therefore notes that improvements in those areas would be key prerequisites for any positive rating actions.