June 15 (SeeNews) - Fitch Ratings said it has placed Turkey's Sekerbank T.A.S.'s 'B-' long-term issuer default ratings (IDRs) and 'b-' viability rating (VR) on rating watch negative (RWN).
The bank's subordinated notes' rating also has been downgraded by one notch to 'CCC' from 'CCC+', removed from under criteria observation (UCO), and placed on RWN, Fitch said in a statement on Friday.
The global rating agency also said in the statement:
"The RWN reflects the bank's weakened capital position amidst the coronavirus fallout, and uncertainty surrounding the sufficiency and timeliness of core capital strengthening measures.
Sekerbank's reported Tier 1 ratio fell slightly below its minimum regulatory requirement at end-1Q20 to 8.3% (including the impact of forbearance). A potential capital increase is due to be discussed at the bank's extraordinary shareholder meeting, which has been delayed until 18 June 2020 due to the pandemic, at which point a decision regarding the size and timing of any capital injection is expected to be made.
Fitch expects to resolve the RWN once it has greater clarity of the size and timing of any capital injection. We would not expect resolution of the RWN to extend beyond the usual six-month period for review given the bank's pressured capital position.
KEY RATING DRIVERS
IDRS, VR
Sekerbank's ratings are driven by its standalone creditworthiness, as reflected in its VR. This reflects the bank's weak capitalisation, performance and asset quality, weighed down by rising problematic loans in the challenging Turkish operating environment. The VR also reflects the bank's small absolute size, limited franchise (less than 1% share of sector assets at end-1Q20) and pricing power - although it has a widespread regional presence in Anatolia - and its concentration in the high-risk and volatile Turkish operating environment.
The RWN reflects the bank's pressured capital position and uncertainty about the sufficiency and timeliness of any potential capital injection.
Downside risks to Sekerbank's credit profile, which were already significant after the Turkish lira depreciation in 2018 and economic slowdown in 2H18-2019, have been heightened by the coronavirus outbreak and lockdown measures. Fitch forecasts Turkey's GDP will contract 3% in 2020 followed by a subsequent sharp recovery (5.0% GDP growth) in 2021. A larger than expected weakening in economic growth and an ensuing weaker recovery in 2021 would add to existing pressure on the bank's credit profile and could result in a downgrade even if capital is replenished in the near term.
Monetary policy measures and fiscal support for the private sector and financial markets, including the Central Bank of the Republic of Turkey interest-rate cuts, could support borrowers' repayment capacity. In addition, regulatory forbearance measures will provide uplift to its reported asset quality, capital and performance metrics over the short term.
Sekerbank's core capital ratios compare weakly with those of peers and we view capitalisation as a constraining factor for the VR. Prior to the 1Q20 breach, the bank had for some time reported thin capital buffers over regulatory minimum levels and this in turn constrained growth. Leverage is high and above the sector average, and the bank was loss making in 2019. Unreserved NPLs are also high relative to capital (end-1Q20: equal to 47% of CET1 capital).
At end-1Q20, Sekerbank reported a Tier 1 ratio of 8.3% (including the impact of regulatory forbearance), below its 8.57% regulatory minimum (the latter including a 2.5% capital conservation buffer and 0.07% countercyclical buffer). Its CET1 ratio of 7.31% was just above the minimum level (including buffer) of 7.07%, and its total capital adequacy ratio of 12.5% marginally exceeded the 12% recommended regulatory minimum. We regard capitalisation as tight given the bank's risk profile, small size, asset-quality pressures, concentration risk, weak internal capital generation and potential further lira depreciation (due to the inflation of foreign currency risk-weighted assets; RWA).
In the short term, regulatory forbearance will provide uplift to Sekerbank's reported capital metrics. We estimate its CET1 ratio would have been 25bp lower net of forbearance measures at end-1Q20. In addition, a potential core capital increase will be discussed at the bank's extraordinary shareholder meeting, while some form of AT1 debt issuance, as seen in 2019, is also possible. The bank is authorised to issue up to TRY400 million (equivalent to 1.6% of RWA at end-1Q20) of AT1 capital.
Asset quality risks at the bank are significant, given Sekerbank's exposure to the risky SME and micro-SME segments (end-2019: 54% of net loans), which are highly sensitive to the downturn from the pandemic. The bank also has exposure to high-risk sectors, including construction (18% of gross loans at end-1Q20, albeit mostly loans to contractors) and agriculture (11%) and single name risk is high.
Foreign-currency lending is also high (33% of the loan book at end-1Q20), but below the sector average, and heightens credit risk given the impact of the Turkish lira depreciation on often weakly hedged borrowers' ability to service their debt.
Sekerbank's impaired loans ratio increased to 13.3% of loans at end-1Q20 (end-2018: 5.6%), although lending contracted during this period, falling by 6% and 4% (FX-adjusted basis) in 2019 and 1Q20, respectively. Stage 2 loans, concentrated mainly in the construction and wholesale and retail trade sectors, were also high at 12.3% of gross loans (end-1Q20) and could migrate to the non-performing loan (NPL) category as loans season. NPLs were 72%-covered by total reserves (including Stage 1, Stage 2 and Stage 3 reserves) at end-1Q20.
In the short term, regulatory forbearance will support the bank's reported asset quality metrics. Nevertheless, we expect underlying asset quality to deteriorate and impairments to rise, given the severity and scale of the current downturn, although to what extent will ultimately depend on the pace of recovery.
Fitch expects profitability to remain under pressure due to high impairment charges and low growth costs. The bank made a TRY782 million loss in 2019 (equal to 32% of end-2018 equity), as impairment charges exceeded pre-impairment profit. It subsequently recorded a TRY39 million net profit in 1Q20 (8% return on equity, annualised), but this was largely driven by the short-term repricing gap between its assets and liabilities as lira deposit costs fell in the declining interest rate environment.
The bank is mainly deposit-funded (end-1Q20: 81% of total funding) and benefits from a stable regional deposit franchise underpinned by its large branch network. A high 49% of deposits were in foreign currency at end-1Q20, following increased sector-wide dollarisation.
The bank has reduced foreign-currency wholesale funding exposure and new foreign-currency borrowings are likely to be limited given its low growth appetite and focus on local-currency lending. Foreign-currency wholesale funding was equal to a moderate 9% of total funding at end-1Q20, below sector average, while funding maturities were largely over one year.
The bank's foreign-currency liquidity - comprising largely cash and interbank balances (including those placed with the Central Bank of Turkey), maturing FX swaps and government securities - is reasonable and Sekerbank should be able to cope with a short-lived market closure given its limited short-term refinancing needs. However, foreign-currency liquidity could come under pressure from a prolonged loss of market access or foreign-currency deposit outflows.
NATIONAL RATING
The RWN on the National Long-Term Rating reflects the RWN on the bank's Long-Term Local-Currency IDR.
SUBORDINATED DEBT
Sekerbank's subordinated notes' rating is notched from the VR anchor rating. It has been downgraded to 'CCC' from 'CCC+' and removed from Under Criteria Observation (UCO). This is in line with the change in Fitch's baseline notching from the anchor rating for loss-severity to two notches from one notch for such instruments in the agency's revised Bank Rating Criteria, reflecting our expectation of poor recoveries in case of default. The RWN on the subordinated notes mirrors the RWN on the VR.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating (SR) of '5' and Support Rating Floor (SRF) of 'No Floor' reflect Fitch's view that support cannot be relied upon from the Turkish authorities, due to the bank's small size and limited systemic importance, nor from the bank's shareholders.
RATING SENSITIVITIES
IDRS VR AND NATIONAL RATING
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The RWN on the bank could result in a downgrade of the bank's ratings if new core capital fails to be forthcoming, is not forthcoming on a timely basis or is insufficient to support capitalisation at a level commensurate with the bank's rating level and risk profile.
The bank's ratings could also be downgraded in case of a greater than expected deterioration in the operating environment that puts further pressure on its asset quality, profitability and capitalisation. A weakening in foreign-currency liquidity, due to deposit outflows or an inability to refinance maturing external obligations, could also result in a downgrade.
The National Rating could be downgraded if Sekerbank's creditworthiness relative to other rated Turkish issuers weakens.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The bank's ratings could be affirmed and removed from RWN if capital injections were sufficient to significantly strengthen the bank's solvency. A Stable Outlook could be assigned if both (i) economic conditions stabilise; and (ii) the bank's asset quality, earnings, capital and liquidity positions prove to be resilient to the current downturn.
An upgrade of the bank's ratings is unlikely in the near term given the RWN.
SUBORDINATED DEBT RATING
The subordinated debt rating is primarily sensitive to a change in Sekerbank's VR, from which it is notched. Therefore, a downgrade of Sekerbank's VR would lead to a downgrade of the subordinated debt rating.
SR AND SRF
The SR and SRF are sensitive to Fitch's view on the likelihood of Sekerbank receiving extraordinary support from the Turkish authorities, in case of need. A positive reassessment of these ratings, although not impossible, is very unlikely in our view given Sekerbank's limited systemic importance and the limited ability of the sovereign to provide support in foreign currency.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions 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. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [...].
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.
ESG CONSIDERATIONS
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit [...]."