Finance

Baku. Vahab Rzayev – APA-Economics. Fitch Ratings has maintained International Bank of Azerbaijan’s (IBAR) ’BBB-’ Long-term Issuer Default Rating (IDR) on Rating Watch Negative (RWN). At the same time, the agency has downgraded the bank’s Viability Rating (VR) to ’cc’ from ’b-’ and maintained the rating on RWN. A full list of rating actions is at the end of this commentary.

The RWN on IBAR’s Long-term IDR reflects continuing concerns over the willingness of the authorities to provide sufficient and timely support to the bank. Specifically, Fitch is concerned about the government’s prolonged failure to recapitalize the bank, and the possibility that the bank’s regulatory capital will be replenished by weaker quality subordinated debt, rather than better quality equity. In addition to these near-term issues, the expected partial privatization of the bank, which would result in the state’s stake falling below 50% from the current 50.2%, could also put downward pressure on the rating (for more details on the rationale for the RWN on IBAR’s IDRs, see, "Fitch Places International Bank of Azerbaijan on Rating Watch Negative", dated 7 March 2011on www.fitchratings.com).

IBAR has informed Fitch that the bank’s regulatory capital deficit will initially be addressed by a contribution of subordinated debt from the Central Bank of Azerbaijan (CBA), which management expects to take place by the end of October 2011. The amount of debt is currently under discussion. However, the transaction will likely be sufficient to bring IBAR back into compliance with regulatory capital requirements, given that subordinated debt contributed by the CBA is classified as Tier 1 capital for regulatory purposes. At the same time, Basel ratios will remain low (as the bank has currently almost fully utilized its Tier 2 capital limit), leaving IBAR still in breach of covenants in certain loan agreements with creditors. IBAR believes that the bank’s creditors will be unlikely to accelerate eligible funding (AZN465m, or 11% of total liabilities) in light of the expected contribution of subordinated debt.

IBAR’s long-discussed privatization appears to be now being pursued more actively. A share sale is currently earmarked to be finalized by end-June 2012, and the intention at present seems to be to attract an international, strategic shareholder, rather than to sell shares locally. However, there is currently little certainty about the size of the stake to be offered or how the eventual privatization may affect IBAR’s business model. Fitch also notes that improvements in the bank’s corporate governance, and in particular greater transparency in respect to minority shareholders, may be necessary to support the privatization.

In future, Fitch will likely cease to equalize the ratings of IBAR with those of the Azerbaijan sovereign (’BBB-’/Positive), reflecting the current delays with the bank’s recapitalization and the future possible privatization. At the same time, potential state support will still be factored into IBAR’s ratings in light of its dominant market shares and systemic importance, its part policy role, and its relatively small size compared to the sovereign’s available resources. Given these factors, any differential between IBAR’s ratings and those of the sovereign will likely be limited to one notch. If the sovereign’s rating is upgraded to ’BBB’, IBAR may therefore be affirmed at ’BBB-’, although if the sovereign’s rating is affirmed at its current level, IBAR may be downgraded to ’BB+’.

The downgrade of IBAR’s Viability Rating follows the confirmation of substantial AZN160m bottom-line losses incurred by the bank in H110 (according to the IFRS report published in August 2011). These losses, equal to 44% of end-2009 equity, have further depleted IBAR’s thin capital cushion and resulted in significant deterioration in its Basel capital ratios. According to IBAR estimates at end-2010 (the audited full year IFRS report has not yet been published), the total Basel capital ratio may have decreased to 8.1%, and the Tier 1 ratio to 4.9%. In Fitch’s view, these low safety margins indicate that recapitalization of the bank is likely to be needed in order for the bank to remain viable, which is commensurate with the ’cc’ Viability Rating. In addition, IBAR’s asset quality has continued to deteriorate, exerting further pressure on capital: the proportion of restructured/rolled-over loans rose to 14% at end-H111 (from 10% at end-2010 and 2% at end-2009), although the level of reported non-performing loans remained almost flat at 13%.

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