The credit rating of SME Bank JSC (hereinafter, SME Bank, or the Bank) has been affirmed at A+(RU) and the outlook has been changed from Stable to Developing on the announcement that the Bank is expected to merge with JSC "Bank DOM.RF" (A(RU), outlook Stable) (hereinafter, Bank DOM.RF). According to the base case expectations of ACRA, the merge may take place in the next 12–18 months. The absence of a clear step-by-step plan and timeline for the merge and further strategy and operations of the merged credit institution are factors that determine the Developing outlook on the credit rating of SME Bank.
Under the worst-case scenario, implying a significant delay in or cancellation of the merger, a deterioration in capitalization against the backdrop of potential risks in the loan portfolio and a challenging operating environment could lead to a negative rating action on the Bank. On the contrary, the implementation of the best-case scenario, which implies a successful merger, may, according to ACRA, drive up the market positions of the merged bank, optimize expenses, improve diversification or financial performance and, in general, lead to the emergence of a strategically more significant financial institution.
SME Bank is a medium-size Russian bank in terms of capital, ranking 42nd based on the results for the nine months of 2020, engaged in lending to small and medium-size enterprises (SMEs) as part of its participation in the government financial support programs. Today, the Bank is a 100% subsidiary of Federal SME Corporation (AAA(RU), outlook Stable), which is a government-owned entity.
Key rating assessment factors
The Banks’ business profile assessment is satisfactory (bbb) and takes into account its specifics and risks of current operations, which largely correspond to the mandate of a development institution. The Bank's primary focus is development of the SME segment, which, in ACRA’s view, exhibits high credit risks, especially in time of economic instability. The inherent risks, however, are partly mitigated by a substantial ongoing support from the government and its involvement in the Bank’s activities. In addition, the Bank’s operational stability is largely secured by a strong funding base primarily comprising government money.
As part of the expected merger, in the next 12–18 months, a drastic transformation of the strategy, risk management systems and management quality, as well as the niche and role of the new bank, is possible.
The capital adequacy assessment has been downgraded from strong to adequate. Since Q4 2019, SME Bank has almost doubled its loan portfolio (before provisions), which led to a significant decrease in the N1.2 ratio to 10.9% as of October 1, 2020 (17.8% as of October 1, 2019). The profitability remains weak, and further capital ratios will depend on the prospects for the merger and/or capital injections, which are still in their development phase.
The expected merger of SME Bank with Bank DOM.RF, which is better capitalized and has greater scale of operations, keeps the sub-factor score from a larger downgrade. ACRA expects that the N1.2 ratio of the merged bank will most likely remain at an adequately high level, consistently exceeding 12–15%.
The risk profile assessment is downgraded from weak to critical as the Bank continues aggressive expansion of its lending operations, in particular, in the construction and real estate sector, which, in ACRA's opinion, has structurally higher credit risks and sensitivity to economic downturns.
According to the Agency's estimates, the share of problem loans is 10–15% of the portfolio. In addition, the increased pressure on the asset quality is exerted by a significant volume of the loans with either long investment periods or borrowers who do not have a proven track record of stable returns. At the same time, the Agency understands that this feature, as well as the rapid growth of the loan portfolio, are a consequence of the specifics of the Bank's business model, similar to development institution.
ACRA also notes a substantial amount of problem exposure to banks. However, the Agency believes the respective impairment reserves are adequate and largely offset the related credit risks.
The funding and liquidity factor is assessed as adequate due to the sustainable resource base, including mostly government financing, as well as a comfort volume of liquid and high-liquid assets. These factors allow SME Bank to have a short-term liquidity surplus in both ACRA’s base case and stress scenarios.
Positive individual adjustment due to operational transformation. ACRA expects that, based on the results of the announced merger, the new financial institution may have a higher standalone creditworthiness assessment (SCA). This will primarily be facilitated by higher risk management standards, which can be introduced as part of the integration with Bank DOM.RF and have a positive impact on the risk profile assessment. Strengthening the mandate and role of the consolidated bank can also boost the business profile.
High probability of extraordinary support from the parent entity. ACRA takes into account the expected merger of SME Bank and Bank DOM.RF in the next 12–18 months, which, in the Agency's opinion, implies greater strategic importance and, accordingly, a higher likelihood of extraordinary external support to SME Bank. In this regard, the Agency adds four notches to the rating profile of SME Bank for the external support potential.
ACRA also notes the long relationship history, strong integration, and the key role of the Bank for Federal SME Corporation, which will persist until the merger of the Bank with Bank DOM.RF.
Thus, ACRA believes that in the event of an urgent need, Federal SME Corporation will be able to redirect both short-term and long-term financing to the Bank from the state, as well as to inject capital. Additionally, the Agency takes into account the following factors:
- Significant legal, reputational, and operational relationships between the Bank and Federal SME Corporation;
- The Bank is regarded as an important part of Federal SME Corporation performing unique SME lending operations (due to availability of a bank license) for Federal SME Corporation;
- The Bank’s size is material for Federal SME Corporation totaling around 30% of Federal SME Corporation’s consolidated equity and 60% of its total assets.
Key assumptions
- Merger of SME Bank and Bank DOM.RF within the 12 to 18-month horizon.
Potential outlook or rating change factors
The Developing outlook assumes with equal probability either an upgrade or a downgrade of the rating within the 12 to 18-month horizon.
A positive rating action may be prompted by:
- A substantial strengthening of the presence, role and importance of the merged bank, which may result in a stronger assessment of the external support potential or the business profile;
- An improvement in the creditworthiness of Bank DOM.RF in the next 12–18 months.
A negative rating action may be prompted by:
- A significant delay in or cancellation of the merger of Bank DOM.RF and SME Bank, which will result in maintenance of the current weak capitalization ratios and critical risk profile;
- A substantial weakening of the presence, role and importance of the merged bank against the base case scenario of ACRA, which may result in a weaker assessment of the external support potential or the business profile;
- A decline in the creditworthiness of Bank DOM.RF in the next 12–18 months.
Rating components
SCA: bbb-.
Adjustments: +1 notch to SCA.
Support: +4 notches to SCA.
Issue ratings
No outstanding issues have been rated.
Regulatory disclosure
The credit rating has been assigned under the national scale for the Russian Federation and is based on Methodology for Credit Ratings Assignment to Banks and Bank Groups Under the National Scale for the Russian Federation, the Methodology for Analyzing Member Company Relationships Within Corporate Groups as well as the Key Concepts Used by The Analytical Credit Rating Agency Within the Scope of Its Rating Activities.
Disclosure of deviations from the approved methodologies: the capitalization of SME Bank JSC was estimated with a deviation from the methodology due to the announced plans of merger of the rated entity with other financial institution as part of the reform of development institutions. The assessment reflects ACRA's expectations on the future capitalization of the new bank.
The credit rating assigned to SME Bank JSC was first published on December 29, 2017. The credit rating and its outlook are expected to be within one year following the publication date of this press release.
The credit rating is based on the data provided by SME Bank JSC, information from publicly available sources, and ACRA’s own databases. The rating analysis is based on the IFRS consolidated statements of SME Bank JSC and financial statements of SME Bank JSC composed in compliance with the Bank of Russia Ordinance No. 4927-U dated October 8, 2018. The credit rating is solicited, and SME Bank JSC participated in its assignment.
No material discrepancies between the data provided and the data officially disclosed by SME Bank JSC in its financial statements have been discovered.
ACRA provided additional services to SME Bank JSC. No conflicts of interest were discovered in the course of credit rating assignment.
