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December 20 (SeeNews) - Fitch Ratings said on Wednesday it affirmed Zagrebacka Banka's (ZABA) long-term issuer default rating (IDR) at 'BBB-', with a stable outlook.
The ratings agency has also affirmed ZABA's short-term IDR at 'F3', support rating (SR) at '2' and viability rating (VR) at 'bb', it said in a statement.
"The affirmation of ZABA's IDRs and SR reflects Fitch's view of a high probability that it would be supported, if required, by its parent, UniCredit S.p.A. (BBB/Stable/bbb). The Stable Outlook on ZABA's IDR reflects that on the parent", Fitch said.
The ratings agency also added:
"Fitch believes that UniCredit has a strong propensity to support ZABA as the Croatian subsidiary is based in the CEE region, which is strategically important for UniCredit. This is further underpinned by ZABA's close operational integration with the parent group and potential reputational damage for UniCredit from a subsidiary default. ZABA's relatively small size (about 2% of UniCredit's consolidated assets) means that potential support should be manageable for the parent.
VR ZABA's VR is effectively constrained by the Croatian sovereign rating (BB/Stable) and reflects the difficult domestic operating environment and Fitch's view of a high correlation between the sovereign and the bank's credit profile. The VR also reflects the bank's high (albeit declining) impaired loans and volatile through-the-cycle performance. The VR is underpinned by ZABA's sizeable capital buffers and potential capital support from the parent, its comfortable funding and liquidity position and leading domestic market franchise.
ZABA is the largest bank in Croatia, holding high market shares in sector customer loans and deposits (about 25%). Its strong and diversified franchise and prudent risk management framework underpin the business model stability, but the bank's asset quality and profitability have suffered from the challenging operating environment. The domestic economy is recovering, although credit demand remains fairly muted (especially in the corporate segment). Fitch expects Croatia's GDP to increase by 3.0% in 2017 and 2.8% in 2018.
The high correlation of ZABA's credit profile with the sovereign rating stems from the bank's high direct exposure to the sovereign and to other parts of the public sector as well as to the broader domestic operating environment, and its limited geographical diversification. At end-3Q17, ZABA's (gross) credit exposure to the Croatian sovereign (comprising government debt securities, state-guaranteed loans and accounts with the Croatian central bank) was equal to about 31% of total assets and about 227% of the bank's Fitch Core Capital (FCC).
We believe that the bank's asset quality could further improve in 2018 unless potential spill-over risks from Agrokor materialise (this is not our base case). This view is based on healthy new loan origination, decent economic growth and the planned bad debt sales.
ZABA's impaired loans ratio dropped to about 12.8% at end-3Q17 (from 14.5% at end-3Q16), although this is still high by international standards. The improvement was largely driven by loan write-offs and sales (equal to about 4.7% of average gross loans in 9M17) which mitigated the negative impact of Agrokor's default (fully reflected in the impaired loans ratio). The domestic regulator requires banks to have a minimum 50% reserve coverage of exposures to Agrokor (excluding a super senior facility). The coverage of total impaired loans by reserves was adequate (about 68% at end-3Q17).
We expect a recovery in profits in 2018 assuming Agrokor's problems do not escalate. Margins could narrow due to limited room for further deposit rate cuts and price competition. However, this could be mitigated by increasing lending volumes in higher-yielding market segments (consumer, SMEs).
ZABA's profitability has been weaker than that of its large regional peers, mostly due to high loan impairment charges (LICs). Pre-impairment profitability is supported by high cost efficiency (46% cost/income ratio at end-3Q17) and still healthy margins (3.4% average net interest margin). At end-3Q17, the ratio of operating profit/risk-weighted assets had fallen to about 1.7%, from 2.9% at end-2016, due to inflated LICs driven by Agrokor.
The bank's solid capital position is underpinned by its high FCC ratio, sizeable capital surplus over regulatory minimums, muted growth and potential capital support from the parent. However, ZABA's capitalisation must be viewed against the challenging domestic operating environment, the high credit exposure to the sovereign and legacy bad debts. At end-3Q17, the FCC ratio was about 24%, while unreserved impaired loans absorbed about 20% of FCC.
The common equity Tier 1 and total capital adequacy ratios were 11.9pp and 8.4pp, respectively, above the regulatory minimums (under Pillar 1) at end-1H17. High capital ratios benefit from ZABA's substantial domestic sovereign exposure being risk-weighted at zero. The tangible common equity/tangible assets ratio was 13.9% at end-3Q17, which compares well with peers.
The bank's comfortable funding and liquidity position is underpinned by its strong domestic deposit franchise, limited balance sheet currency mismatch, access to parent funding and substantial liquid assets. The loans/deposits ratio is likely to stay materially below 100% (89% at end-3Q17). However, the bank's liquidity is sensitive to sovereign stress since a significant part of the liquidity buffer is held in Croatian government debt.
RATING SENSITIVITIES IDRS, SR ZABA's IDRs and SR are sensitive to our view of the ability and propensity of its parent to support it. The bank would be downgraded in case of a parent downgrade, while an upgrade of the bank's IDR would require both a parent upgrade and an upward revision of Croatia's Country Ceiling (BBB-). We do not expect the parent's support propensity to weaken.
VR The bank's VR is sensitive to Fitch's broader assessment of Croatia's operating environment and in particular Croatia's sovereign rating. A potential sovereign rating upgrade could lead to an upgrade of the bank's VR, while a sovereign downgrade would be likely to result in a lowering of the VR. A further reduction of legacy bad debts and a sustainable improvement in the bank's profitability would be also positive for the bank's standalone profile."
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