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Fitch assigns BBB+ rating to Croatian unit of Erste Group Bank

Author Iskra Pavlova
Fitch assigns BBB+ rating to Croatian unit of Erste Group Bank Fitch (Author: License: all rights reserved.

ZAGREB (Croatia), March 17 (SeeNews) - Fitch Ratings said on Tuesday it has assigned to Croatia-based Erste&Steiermarkische Bank (ESB) a 'BBB+' long-term foreign-currency issuer default rating (IDR) with a stable outlook and viability rating (VR) of 'bb'.

The rating reflects Fitch's estimate for a high probability of support by ESB's parent - Erste Group Bank AG (A/Stable), since Erste owns a direct stake of 59% in the Croatian bank and an indirect stake of 41% via its unit Steiermarkische Bank und Sparkassen AG, the ratings agency said in a statement.

At the same time, ESB's rating is capped two notches above Croatia's 'BBB-' sovereign rating, reflecting transfer and convertibility risks, the statement reads.

Absent the country risk constraints, ESB would be rated one notch below the parent, Fitch said.

Here is what else the ratings agency said in the statement:

"We believe that the parent's propensity to support ESB is strong and underpinned by the strategic importance of Croatia and the wider CEE region for the Erste group. We have also considered ESB's close operational integration with Erste, a record of substantial funding provision by the parent and potential reputational damage for Erste from a subsidiary default, amplified by common branding. We view the parent's ability to provide support to ESB as very high, due to the group's strong and diversified credit profile, and the relative small size of the Croatian subsidiary. We do not interpret the group's intention to adopt a multiple point-of-entry resolution strategy as diminishing the ability or propensity to support ESB ahead of resolution, if needed.

In line with Fitch's applicable criteria, ESB's Short-Term IDR of 'F2' is at the lower of two options available for the Long-Term IDR of 'BBB+' as the latter is constrained by the Country Ceiling.


ESB's standalone credit risk profile, as expressed by its VR, reflects risk and challenges related to banking operations in Croatia and the bank's significant focus on SME and unsecured consumer lending. This has been reflected in ESB's volatile through-the-cycle performance and higher levels of problem loans when compared with regional peers. The VR is underpinned by ESB's strong domestic market franchise, prudent risk management, solid capitalisation and stable funding and liquidity.

We believe that the operating environment for Croatian banks will become more challenging due to the negative impact of the COVID-19 outbreak on the Croatian economy and in particular on tourism, which accounted for about 19% of Croatian GDP in 2019.

ESB follows a universal traditional banking model, but its business mix is skewed towards unsecured consumer (mostly cash) and SME lending, which could bring about higher credit losses in a downturn. Credit risks are partially mitigated by the bank's reasonable underwriting standards and good risk controls, which benefit from integration with the parent. At end-3Q19, consumer loans and SMEs (companies with turnover of EUR1 million-EUR50 million) each accounted for around a quarter of gross loan book.

We believe that ESB's asset quality could come under pressure if the operating environment weakens and the 2020 tourist season is strongly affected by COVID-19. Currently, ESB's Stage 3 loans/gross loans ratio is fairly high by regional standards. It decreased to about 7.1% at end-3Q19, from about 7.6% at end-2018 but remains elevated due to mostly legacy problems which were robustly provisioned for. Coverage of Stage 3 loans by total loan loss allowances was about 88% at end-3Q19, or about 71% including only specific loan-loss allowances for Stage 3 loans. There is moderate single-name concentration in the loan book, partly fuelled by state-guaranteed lending.

ESB's profitability could weaken in 2020 due to continuing margin pressure and a likely increase in loan impairment charges (LICs), which were unsustainably low in 9M19. The bank's profitability metrics compare well with its CEE peers rated by Fitch, but have been volatile through the economic cycle largely due to LICs. The operating profit to risk-weighted assets ratio was about 3.2% in 9M19. The bank's robust pre-impairment profitability is underpinned by its established market franchise, including in the higher-yielding market segments, healthy margins (net interest margin of about 3.3% in 9M19) and good operational efficiency (cost/income ratio of about 52%).

Our assessment of ESB's capitalisation balances its moderate capital buffers over regulatory minimums, reasonable internal capital generation and small unreserved Stage 3 loans against the risks of the Croatian operating environment. We have also factored in potential ordinary capital support from the parent. The common equity Tier 1 (CET1) and total capital adequacy ratios were 5.5pp and 2.6pp, respectively, above the regulatory minimums including buffers (reflecting both Pillar 1 and Pillar 2) at end-3Q19. The tangible common equity/tangible assets ratio (about 12.6%) compared well with similarly rated regional peers. Unreserved Stage 3 loans equalled a modest 5% of CET1.

ESB's refinancing risks are limited by its strong domestic deposit franchise, limited balance sheet currency mismatches, reasonable liquidity buffers and ordinary parent funding support. Customer deposits have been stable, accounting for about 82% of total funding (excluding derivatives) at end-3Q19. Deposit base stability was underpinned by a significant share of typically more sticky retail deposits (about 63%). The loans/deposits ratio (about 95%) was higher than the peer average, but it should be viewed against material on-balance sheet funding provided by the parent (about 12% of total funding). Third-party wholesale funding was small and mostly long-term. The liquidity coverage ratio and the net stable funding ratio were comfortable at about 168% and 155%, respectively, at end-3Q19.

ESB is the third largest bank in Croatia with around a 15% share of sector assets. It has a small foreign bank subsidiary based in Montenegro, Erste Bank AD Podgorica (about 6% of ESB's consolidated assets)."