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Fitch affirms ProCredit Holding, 5 SEE subsidiary banks

Fitch affirms ProCredit Holding, 5 SEE subsidiary banks Fitch (Author: fitchratings.com) License: all rights reserved.

TIRANA (Albania), April 11 (SeeNews) – Fitch Ratings said on Thursday it has affirmed the issuer default rating (IDR) of ProCredit Holding AG & Co KGaA's (PCH) at 'BBB' with a stable outlook and upgraded its viability rating (VR) to 'bb' from 'bb-'.

The agency has also affirmed the 'BBB' long-term IDR of ProCredit Bank’s subsidiary in Germany (PCBDE), as well as the long-term IDRs and VRs of ProCredit Bank’s subsidiaries in Bosnia (PCBiH), Kosovo (PCBK), North Macedonia (PCBM) and Serbia (PCBS), Fitch Ratings said in a statement.

The rating agency also affirmed ProCredit Bank’s Albanian subsidiary's (PCBA) long-term IDR at 'BB-' and downgraded its VR to 'b-' from 'b'.

“The outlooks are stable except for PCBM, which has a positive outlook.”

"The downgrade of PCBA's VR reflects the bank's pre-impairment operating losses in 2017 and 1H18 and the need for a capital injection in second half of 2018 to strengthen solvency," the agency said adding that ProCredit Bank has initiated restructuring measures at PCBA aimed at restoring its profitability, predominantly by exploiting cost savings through closer business ties with PCBK.

Fitch also said in the statement:

"KEY RATING DRIVERS

PCH'S IDRS AND SUPPORT RATINGS

PCH's IDRs and Support Rating are driven by Fitch's view of the potential support it can expect to receive from its core international financial institution (IFI) shareholders: KfW (AAA/Stable), IFC and DOEN Foundation (end-2018: combined stake of 35.7%). Apart from the three IFIs, Fitch views Zeitinger Invest (formerly IPC) and ProCredit Staff Invest as core shareholders in PCH. These entities have strategic control over the group, through their status as General Partners within the KGaA structure.

Fitch's view of support is based on the long-term and strategic commitment of the IFI shareholders, as highlighted by their role within PCH's structure, the alignment of their own missions of development finance with that of PCH, and a record of debt and capital support to PCH and its subsidiary banks.

PCH's VR
PCH's 'bb' VR reflects the group's exposure to difficult emerging market environments, the relatively narrow (except PCBK) franchises of the subsidiary banks in their respective jurisdictions and credit risks inherent in PCH's business model based on lending to SMEs.

PCH's VR also reflects strong corporate governance and risk management across the group, underpinned by supervision by BaFin of the consolidated PCH group, and by sound management. Prudent risk management and well controlled risk appetite have resulted in the group's record of asset quality that consistently exceeds the markets in which it operates. PCH's financial performance has been stable and resilient through the cycle, including during a period of significant change in the group's business model. 

PCH's VR is based on the consolidated group's financial profile, and does not incorporate any downward notching at the holding company level. This reflects the following factors: i) the group is subject to consolidated supervision and is required to meet regulatory requirements at the consolidated level; ii) there are no major legal restrictions in place on upstreaming capital or liquidity from subsidiaries to PCH; iii) moderate double leverage; iv) a simple group structure with full or large majority ownership of banking subsidiaries; and v) common branding across the group. 

The group has almost completed the implementation of its new strategy focused on lending to SMEs and reduction of the legacy portfolio of very small exposures (below EUR50,000). Its geographical focus is primarily on South Eastern Europe and Eastern Europe. The group operates through 13 banking subsidiaries in South Eastern Europe (70% of the loan book at end-2018), Eastern Europe (22%), South America (6%; operations in Colombia and Ecuador) and Germany (2%). 

The impaired loans ratio on a consolidated level further improved over 2018, reflecting the new strategic focus on larger, fully formalised SMEs. At end-2018, NPLs (defined as IFRS 9 Stage 3 loans) accounted for 3.1% of gross loans (2017: 4.5%). The coverage of NPLs with specific loan loss allowances was moderate at around 55%, partly reflecting the highly collateralised profile of the loan book. However, overall coverage was much stronger at around 91%, resulting in a very low 1.8% of uncovered NPLs relative to Fitch Core Capital (FCC). 

Operating profitability improved in 2018 with operating profit/risk-weighted assets (RWA) at 1.7% (2017: 1.5%), but the improvement was mostly due to some further cost efficiency improvements and net release of loan loss charges driven by recoveries of written-off loans. Net interest income suffered from further tightening of margins and was not fully compensated by growing fees and commissions. We believe that the group's revamped business model implemented in 2013 is likely to generate lower loan loss charges relative to gross loans, than under the previous focus on micro loans. However, we expect them to return to more normalised levels from what we believe was an unsustainably low level in 2018 and 2017.

The FCC ratio increased by around 70bp to 15.4% at end-2018 despite around 8.5% growth of RWA over 2018. The FCC improvement predominantly resulted from a capital increase completed in 1Q18 and reasonable profits generated in 2018. The group's regulatory capitalisation improved further with a reported CET1 ratio of 14.4% at end-2018, comfortably above regulatory requirements. However, at these levels it remains moderate relative to the credit risks the group faces. Common equity double leverage at PCH was a moderate 113% at end-2018 (2017: 121%).

Granular customer deposits are the group's main source of funding. At end-2018 they accounted for around 75% of total funding. Senior and subordinated debt issued by PCH as well as bank funding at PCH and IFI funding extended directly to subsidiaries complement the funding structure. Liquidity is well-managed across the group, and adequate reserves are held at PCH to cover potential liquidity needs from subsidiary banks in case of stress. The maturity structure of PCH's debt is well spread, with a large proportion of medium/longer-term funding and only around 3% of the total maturing over 2019.

SUBSIDIARY BANKS - IDRs AND SUPPORT RATINGS
The IDRs and Support Ratings of the five South Eastern European (SEE) banks - PCBA, PCBiH, PCBK, PCBM and PCBS - reflect the likelihood of potential support from their sole shareholder PCH.

This view takes into account the strategic importance of the South Eastern European region to PCH, shown by the long standing presence on these markets, strong integration of the subsidiary banks into the group and a record of liquidity and funding support provided to these entities. Our assessment of support also factors in the full ownership of subsidiaries, common branding and the potential negative implications of a subsidiary default for the group.

However, the extent to which potential support can be factored into the subsidiaries' ratings is constrained by the agency's assessment of risks relating to their respective jurisdictions. Absent of country risk constraints, the subsidiaries' Long-Term IDRs would typically be notched down once from the parent's IDR.

PCBM and PCBS's Long-Term Foreign-Currency IDRs are constrained by the respective Country Ceilings (North Macedonia: BB+, Serbia: BB+). PCBA, PCBiH and PCBK's Long-Term Foreign-Currency IDRs reflect Fitch's assessment of transfer and convertibility risks in jurisdictions in which these banks operate. The Positive Outlook on PCBM's IDRs reflects the Outlook on the sovereign.

PCBDE's Support Rating and the equalisation of the bank's IDRs with those of PCH reflect Fitch's view of a high likelihood of parental support. This view is based primarily on the bank's treasury role within the group and a strong legal commitment in the form of a profit and loss transfer agreement, which obliges PCH to replenish PCBDE's equity should the latter suffer a loss. The Stable Outlook reflects that on the parent.

SUBSIDIARY BANKS - VRs
The VRs of PCH's South-Eastern European subsidiaries reflect, to varying degrees, the risks related to the challenging operating environments making the banks performance prone to potential market shocks, which cannot be fully mitigated by the benefits of the prudent risk management framework, unique corporate culture and strong corporate governance implemented across the PCH group. For PCBA and PCBiH, the VRs also consider the banks' constrained revenue and internal capital generation capacity due to limited franchises and small scale. 

All five banks' business models are focused on financing larger and more established medium-sized businesses and development in green lending. The banks are undergoing the implementation of new group-wide strategy and over the last two years they have significantly reduced their branch network, which as expected, resulted in the loss of some market share, especially among depositors considered non-core.

All five banks' asset quality has continued to improve, driven by healthy new loan origination, problem loans off-loading, tight group control and a supportive economic conditions. At end-1H18, NPLs (Stage 3 loans) at PCBA accounted for 8.8% of gross loans, 6.3% at PCBiH (excluding fully-provisioned written-off loans as per group definition) and 4.1% at PCBK. PCBM and PCBS's indicators were below 2.5%. Coverage of NPLs by loan loss allowances was solid - at over 90% for PCBA, PCBK and PCBM - or moderate at about 60%-70% at the remaining banks. We expect the banks' moderate risk appetites will support stable asset quality in 2019 and beyond. 

PCBK's strong position in its small domestic market (20% market share in total banking sector assets at end-1H18) supports stable and recurring profitability that allows a steady flow of dividends to the parent. PCBM and PCBS managed to maintain a reasonable level of profitability despite a further contraction in margins and continued change in the client structure towards larger, more formalised SMEs. The Kosovar subsidiary reported the strongest operating profit/ risk-weighted assets ratios at 2.8% at end-1H18. PCBM and PCBS's ratios stood at 1.8% and 1.5%, respectively. 

Weak pre-impairment operating profitability makes PCBA and PCBiH reliant on capital injections from shareholder. PCBiH reported a small profit in 2018 (BAM48,500) supported by the reversal of impairment charges. With parental support both banks maintained capital ratios over regulatory requirements and realised growth of business in 2018. PCBiH holds an adequate capital buffer with a FCC ratio of 15.3% at end-1H18. We view PCBA's FCC ratio of 12.7% (3Q18) as providing only a modest buffer against unforeseen shocks given bank's focus on SME lending, ongoing restructuring announced by the group and difficult operating environment.

PCBK capitalisation (FCC ratio of 17.8% at end-1H18) is a rating strength considering decent profitability, improved asset quality and high provision coverage of NPLs. Capitalisation at PCBM and PCBS was solid (FCC ratios of 13.0% and 18.8%, respectively, at end-1H18) supported by reasonable profitability and strong loan portfolio quality. Net NPLs were low (not exceeding 5% of FCC) at both banks.

The funding mix at all five banks is dominated by customer deposits and supported by long-term sources from IFIs earmarked for various SMEs development projects as well as by loan facilities from the group. PCBA and PCBK rely on retail deposits, which account for about 80% of customer funding, while three other banks customer deposit bases are balanced between private individuals and SMEs. The funding gap, driven by outflow of some retail deposits recorded in 1H18 due to branch network optimisation and solid (PCBiH, PCBM and PCBS) or moderate (PCBA and PCBK) lending growth, was closed with wholesale funding. Consequently, all five banks reported higher gross loans/deposits ratios compared to end-2017.

The banks' adequate liquidity is underpinned by their large pools of liquid assets containing cash, mandatory reserves in central banks and, at selected banks, government or highly rated debt securities. The liquidity coverage and net stable funding ratios were above 100% at end-2018.

Fitch does not assign a VR to PCBDE because the bank does not have a meaningful standalone franchise, and its operations rely strongly on integration within the broader group.

PCBDE's role in the group is focused on providing treasury, clearing and liquidity management services to sister banks. Placements from sister companies and PCH tend to be short term and are therefore reinvested in highly liquid assets. Funding provided to sister banks is sourced from deposits attracted on the German market. PCBDE maintains a net short position in operations with its sister banks.

At end-3Q18, about 56% of PCBDE's assets were cash and other liquid assets, mainly central bank deposits and interbank placements with highly rated German banks. Funding provided to PCH group sister banks and co-financing of some of their large credit exposures accounted for 30% and 8% of assets at end-3Q18, respectively. The group's international payments clearing has been centralised at PCBDE. 

PCBDE's other operations still have a narrow focus with a medium-term goal of widening the business with German firms active in south-east and eastern Europe. PCBDE acts as a central treasury for the Group and sister banks place surplus liquidity there. Placements from sister banks and other group companies (including the holding company) accounted for about 54% of the bank's liabilities at end-3Q18. PCBDE is also attracting deposits from German customers, both retail and institutional. At end-3Q18 they accounted for around 40% of PCBDE's liabilities.

The bank is a regulatory anchor for the group's consolidated supervision by BaFin and Bundesbank. Fitch believes the regulator would be supportive of any measures by PCH to protect German deposits and ensure the bank's viability. A profit and loss transfer agreement between the parent and the bank includes a provision requiring a capital injection by the parent if PCBDE's regulatory total capital ratio falls below 13%.

The rating actions are as follows: 

ProCredit Holding AG & Co. KGaA (PCH)
Long-Term IDR affirmed at 'BBB'; Outlook Stable
Short-Term IDR affirmed at 'F2'
Viability Rating upgraded to 'bb' from 'bb-'
Support Rating affirmed at '2'
Senior unsecured expected rating of 'BBB(EXP)' withdrawn

PCBDE
Long-Term IDR affirmed at 'BBB'; Outlook Stable
Short-Term IDR affirmed at 'F2'
Support Rating affirmed at '2'
Long-Term Deposit Rating affirmed at 'BBB'
Short-Term Deposit Rating affirmed at 'F2'

PCBA
Long-Term Foreign-Currency IDR affirmed at 'BB-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'B'
Long-Term Local-Currency IDR affirmed at 'BB-'; Outlook Stable
Short-Term Local-Currency IDR affirmed at 'B'
Viability Rating downgraded to 'b-' from 'b'
Support Rating affirmed at '3'

PCBiH
Long-Term Foreign-Currency IDR: affirmed at 'B+'; Outlook Stable
Short-Term Foreign-Currency IDR: affirmed at 'B' 
Long-Term Local-Currency IDR: affirmed at 'BB-' Outlook Stable
Short-Term Local-Currency IDR: affirmed at 'B'
Viability Rating: affirmed at 'b-'
Support Rating: affirmed at '4'

PCBK
Long-Term Foreign-Currency IDR: affirmed at 'BB'; Outlook Stable
Short-Term Foreign-Currency IDR: affirmed at 'B'
Viability Rating: affirmed at 'b+'
Support Rating: affirmed at '3' 

PCBM
Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Positive
Short-Term Foreign-Currency IDR affirmed at 'B'
Long-Term Local-Currency IDR affirmed at 'BB+'; Outlook Positive
Short-Term Local-Currency IDR affirmed at 'B'
Viability Rating affirmed at 'b+'
Support Rating affirmed at '3'

PCBS
Long-Term Foreign-Currency IDR: affirmed at 'BB+'; Outlook Stable
Short-Term Foreign-Currency IDR: affirmed at 'B' 
Long-Term Local-Currency IDR: affirmed at 'BB+' Outlook Stable
Short-Term Local-Currency IDR: affirmed at 'B'
Viability Rating: affirmed at 'bb-' 
Support Rating: affirmed at '3'

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