The bank's viability rating (VR) at 'b+' balances the rating agency's view of a solid domestic franchise, expertise in SME lending, below- average risk appetite as reflected in better-than-sector asset quality, and solid performance, against risks stemming from its operations in the developing economy of Kosovo, Fitch said in a statement on Tuesday.
Fitch also said in the statement:
PCBK's IDRs and Shareholder Support Rating (SSR) reflect Fitch's view of potential support from its sole shareholder, ProCredit Holding AG & Co. KGaA (PCH; BBB/Stable).
Country Risks Constrain Support: PCBK is strategically important to PCH and remains an important part of the group's long-standing and well-established presence in south eastern Europe (SEE). Nonetheless, the extent to which potential support can be factored into PCBK's ratings is constrained by Fitch's view of Kosovo's country risks, in particular transfer and convertibility. Without these constraints, the bank's Long-Term IDR would have been notched down once from the parent's 'BBB' Long-Term IDR.
Challenging Operating Environment: Kosovo's business environment is characterised by high risk due to an underdeveloped legal and regulatory framework relative to other European emerging markets, even though the banking system's financial metrics remain sound and the sector has delivered solid growth. We expect high inflation and economic uncertainties to decrease loan demand, putting moderate pressure on the banking sector's profitability and asset quality at least in the short term.
Asset Quality at Moderate Risk: The bank's impaired loan ratio improved to nearly 2% at end-1H22 from 3.4% at end-2020, which is lower than the sector average. We believe that asset-quality risks have increased given heightened macroeconomic uncertainty, but expect the core metric to deteriorate only moderately, with impaired loans remaining below 3% of gross loans, given the bank's generally prudent underwriting criteria. Furthermore, the bank's ongoing write-offs and recovery activity will likely partially compensate the inflow of impaired loans.
Improved Operating Profitability: Operating profitability improved to 4% of risk-weighted assets (RWAs) in 1H22 from 3.2% in 2021, largely driven by a reversal of loan impairment charges. We expect profitability to moderately weaken over 2022-2023, because of increased operating costs and loan impairment charges due to macro-economic risks, while interest margins are expected to remain largely stable.
Reduced Capital Buffers: PCBK's common equity Tier 1 (CET1) ratio weakened to 13.4% at end-1H22 from 17.6% at end-2020 following EUR35 million dividend distribution from previous years' profits, but also due to a 10% growth in RWAs since 2021. We believe this buffer provides an adequate cushion given the bank's reasonable asset quality and access to capital from the parent, in case of need.
Largely Retail Deposit Base: PCBK's funding mix is dominated by typically more stable retail customer deposits and underpinned by the bank's strong domestic franchise. The bank generally keeps it loans-to-deposits ratio close to 80%, although at end-1H22 it increased to 92% due to temporary deposit outflows reflecting increased trade-capital flows. The bank's liquidity buffers comprised cash, central- and-regional government securities and central bank reserves, and resulted in a reasonable liquidity coverage ratio (LCR) of 118% at end-1H22.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The Long-Term IDR and SSR of PCBK would be downgraded on adverse changes to Fitch's perception of country risks in Kosovo. The ratings may also be downgraded on a substantial decrease in the bank's strategic importance for the group, which is primarily based on the group's commitment to the country and the region.
The VR of PCBK may be downgraded on a marked weakening in asset-quality metrics, in particular if its Stage 3 ratio increases above 5%, accompanied by sustained weakening of core profitability.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
PCBK's Long-Term IDR and SSR could be upgraded as a result of diminished country risks, which we view as unlikely in the medium term.
Fitch does not foresee a VR upgrade in the medium term, given its current high level relative to the operating environment. An upgrade would probably require an improvement of the operating- environment score, accompanied by an extended record of solid asset-quality and profitability metrics, supported by larger capital buffers.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
PCBK's IDRs and SSR are driven by support from PCH.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
