Azerbaijan-Based Muganbank Affirmed At 'B-/B' On Adequate Liquidity Buffer; Outlook Stable | MuganBank

Azerbaijan-Based Muganbank Affirmed At 'B-/B' On Adequate Liquidity Buffer; Outlook Stable

2019-06-27

Overview
- Despite slight improvements in Muganbank's earnings in 2018, the bank's earnings capacity and asset quality remained weak, while capitalization deteriorated.
- Nevertheless, we expect that Muganbank will maintain an adequate liquidity buffer, supported by a stable deposit base and an inflow of government funds under a system-wide support program.
- Moreover, we expect that Muganbank will maintain adequate regulatory capital ratios, with appropriate buffers above the minimum threshold.
- We are therefore affirming our 'B-/B' long- and short-term ratings on Muganbank.
- The stable outlook reflects our view that Muganbank's credit profile is unlikely to change materially in the next 12 months.
Rating Action
On June XX, 2019, S&P Global Ratings affirmed its 'B-/B' long- and short-term issuer credit ratings on Azerbaijan-based Muganbank. The outlook is stable.
Rationale
The affirmation reflects our view that over the next 12 months, Muganbank will maintain an adequate liquidity buffer to meet its obligations when they become due, and will not be at risk of breaching regulatory ratios, including prudential capital ratios.
In 2018, and for the first five months of 2019, Muganbank's liquidity position remained broadly stable, with a buffer of liquid assets sufficient to meet the bank's obligations in both normal times and in times of stress. For example, the bank's broad liquid assets covered about 22% of its total customer deposits as of April 1, 2019, while its high liquid assets represented about 7.0% of total assets on the same date. We note that over the past year, Muganbank has managed to grow its customer deposits thanks to depositors' improving confidence and the relatively high interest rates that the bank pays for its customer funds.

We expect that Muganbank will maintain an adequate liquidity buffer thanks to stable customer deposits and additional liquidity that the bank is to receive under a system-wide government support program. The program aims to support individuals who suffered from the devaluation of Azerbaijani new manat (AZN) in 2015 and to facilitate the clean-up of a material volume of nonperforming assets at local banks. Muganbank has already received AZN21.6 million as part of this program as the government paid the bank some of the overdue individual loans denominated in foreign currency. The bank will also receive about AZN100 million ($60 million) to restructure loans to individuals overdue by more than 360 days. Aside from the positive impact on Muganbank's asset quality and business prospects, we believe that the program will further strengthen the bank's liquidity buffer and improve its flexibility in managing its liquidity position.

Over the past year, Muganbank has continued developing its corporate lending, mainly in the infrastructure and agriculture sectors, while simultaneously exiting unsecured retail business. Positively, the bank's customer base has become less volatile than in the previous three years thanks to improving customer confidence and a continuing economic recovery in Azerbaijan. Overall lending growth has remained modest, at 5.0% versus 11% for the system average. Meanwhile, the bank's earnings capacity has remained very weak, with the return on average equity remaining below 2.0% due to pressure on the net interest margin and weak operational efficiency. (Muganbank's cost-to-income ratio was 80% at year-end 2018, compared to an average of 50%-55% for its peers). We expect that in the next two years, Muganbank's profitability will remain weak and the bank will continue to depend on capital injections from the shareholder to support its business growth.

In 2018, Muganbank's capital position has deteriorated, and our risk-adjusted capital (RAC) ratio declined to 3.4% from 5.0%. We expect that the bank will continue generating losses in 2019-2020 due to pressure on its margins, subdued operational efficiency, and increased provisioning needs. We therefore expect that the bank's capital position will likely weaken further, with our RAC ratio declining to below 3.0%, taking into account a negative earnings buffer. 

Muganbank may receive an additional AZN5 million of capital support from the shareholder, but this is unlikely to substantially improve its capital position. We take into account modest business growth of 3%-5% over the next one-to-two years, balancing relatively high growth in corporate lending with rather flat dynamics in unsecured retail business.Nevertheless, we expect that the bank will continue operating with a buffer of at least 100 basis points above the minimum capital
regulatory ratio.

We think that despite a potential improvement, Muganbank's asset quality will continue weigh on its credit profile. At year-end 2018, the bank's stage 3 loans represented 37% of its loan portfolio (down from 40% a year ago), versus about 20%-22% for the system average. We expect that the bank's asset quality will improve thanks to the system-wide government program launched earlier this year, with stage 3 loans falling to about 26% by year-end 2019. Nevertheless, Muganbank's stock of problem assets will continue exceeding that of its peers. We expect that the bank's credit losses will be stable but elevated, with a cost of risk of 2.2%-2.3% in 2019-2020, as the bank will
continue to create provisions for its problem assets.
In our view, Muganbank is not dependent on favorable business, financial, and economic conditions to meet its financial obligations, and we do not foresee a default over the next 12 months. This reflects Muganbank's sufficient liquidity and regulatory capital buffer, stable credit losses, and improving economic conditions in Azerbaijan.

Outlook
The stable outlook on Muganbank reflects our view that Muganbank's credit profile will remain relatively unchanged over the next 12 months, supported by its acceptable liquidity buffer, curbed credit losses, and stabilizing economic risks in Azerbaijan's banking sector.

Downside scenario
We could lower ratings in the next 12 months if the volatility of customer funds increases, weighing on Muganbank's liquidity position, or if the bank's asset quality begins to deteriorate, with nonperforming assets and credit losses materially exceeding the system averages. A negative rating action may also follow aggressive growth that is not supported by capital injections from the shareholder, thereby putting pressure on the bank's capital regulatory ratios.

Upside scenario
A positive rating action is highly unlikely in the next 12 months.

Related Criteria
- Criteria | Financial Institutions | General: Risk-Adjusted Capital Framework Methodology, July
20, 2017
- General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
- General Criteria: Group Rating Methodology, Nov. 19, 2013
- Criteria | Financial Institutions | Banks: Quantitative Metrics For Rating Banks Globally:
Methodology And Assumptions, July 17, 2013
- General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
- Criteria | Financial Institutions | Banks: Banks: Rating Methodology And Assumptions, Nov. 9,
2011
- Criteria | Financial Institutions | Banks: Banking Industry Country Risk Assessment
Methodology And Assumptions, Nov. 9, 2011
- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009