ACRA has retained the “Rating under revision: developing” status with regard to the credit ratings of SME Bank JSC (hereinafter, SME Bank, or the Bank) and its subordinated debt issue (RU000A102HA5) as this continues to reflect the lack of a final version of the new development strategy, coupled with continuing uncertainty surrounding the timing, scope and form of external support. ACRA may affirm, upgrade or downgrade the credit ratings of SME Bank and its subordinated debt issue, as well as remove the “Rating under revision: developing” status as the situation develops and additional information becomes available over the next 90 days.
The positive scenario involves a robust new business model that the Bank will adhere to and demonstrate fundamentally more effective risk management and greater self-sufficiency in issues of capitalization and profitability than before. At the same, ACRA notes a certain stabilization of capital adequacy ratios at regulatory safer levels compared to Q2 and Q3 2021, when prudential ratios were close to the minimum required. A negative rating action may be supported by signs of ineffectiveness of the new business model or signals that there is no support from Federal SME Corporation (hereinafter, the Supporting Entity, SE, or the Group; holds a 100% stake in the Bank; ACRA rating AAA(RU), outlook Stable) and/or other ultimate owners of the Bank who are related to the state, which creates prerequisites for regulatory intervention.
SME Bank’s current credit rating — BBB(RU) — stems from the satisfactory business profile assessment (bbb), critical risk profile as well as capitalization and profit assessments, and the adequate funding and liquidity position coupled with strong extraordinary support.
key assessment factors
The continuing process of forming a new development strategy is one of the factors in retaining the “Rating under revision: developing” status. In addition, it takes into account the fact that the recovery of business and SME Bank’s performance of functions to develop the SME segment still depend on the prospects of a further increase in the capital adequacy metrics.
Increasing Tier 1 capital, which would allow the Bank to build up its loss absorption buffer, is an important precondition for maintaining the current credit rating. ACRA believes that such an increase could occur both due to external capital injections and/or due to changes in the existing equity structure.
Assessing the intermediate dynamics of SME Bank’s financial indicators, ACRA recorded an increase in the N1.2 capital adequacy ratio from 7.7% as of the middle of the year (the regulatory minimum is 6%) to 10.7% at the beginning of November, which is due to the Bank’s transition to a finalized approach in calculating risk-weighted assets, as well as optimizing and adjusting collateral accounting. Despite the technical nature of these improvements, they have somewhat reduced the pressure on capital adequacy ratios.
The potential impact of other factors on the credit rating have not changed. In particular, SME Bank’s ability to generate profits over the next 12–18 months under the strategy that has not yet been finalized continues to be uncertain. ACRA takes into account losses incurred in previous years, especially credit expenses of 2021, which were the result of aggressive loan portfolio growth in 2020 — the cost of risk exceeded 7% year-on-year in the first nine months of 2021.
The volume of potential problem lending, according to ACRA, stands at about 25–30% of the loan portfolio, which is considerably higher than the average for the sector. Additional credit risks stem from a significant amount of loans with either long investment periods or borrowers who do not have a proven track record of stable returns.
Risks associated with funding and liquidity are still manageable mainly thanks to the stable funds from State Development Corporation "VEB.RF" (ACRA rating AAA(RU), outlook Stable; part of the ownership structure of SME Bank), which made up approximately 63% of the funding base at the beginning of October 2021, including 10% of subordinated debt. This fact, coupled with a comfortable liquidity cushion, allowed SME Bank to overcome the period of instability in depositors’ behavior, which was observed in the second and third quarters of this year. Significant volumes of tied funding will remain a positive rating factor, mitigating risks over the next 12 to 18 months.
KEY ASSUMPTIONS
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Increased capitalization;
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Continuing uncertainty with regard to the aggressive use of capital, lack of a final version of the strategy and its realization over the next 12 to 18 months, and the sustainability of the new business model.
POTENTIAL OUTLOOK OR RATING CHANGE FACTORS
The “Rating under revision: developing” status assumes with equal probability either an upgrade or a downgrade of the rating within the next 90 days.
Removal of the “Rating under revision: developing” status and affirmation of the credit rating may be prompted by:
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Obtaining capital support sufficient for further stable performance of the Bank’s functions;
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Adoption of a strategy that, in ACRA’s opinion, makes it possible to maintain stable creditworthiness.
Removal of the “Rating under revision: developing” status and upgrade of the credit rating may be prompted by:
- Considerable improvement of asset quality.
Removal of the “Rating under revision: developing” status and downgrade of the credit rating may be prompted by:
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Lack of sufficient support from the Group and its ultimate owners;
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Continued decline in capitalization that increases regulatory risks;
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Signs of potential unprofitability of the upd ated business model, as well as its dependence on external capital injections, which would call into question the Bank’s ability to sustainably develop.
RATING COMPONENTS
Standalone creditworthiness assessment (SCA): bb-.
Adjustments: none.
Support: SCA + 4 notches.
ISSUE RATINGS
Rationale. The bond listed below is a senior unsecured debt instrument of SME Bank JSC. According to ACRA’s methodology, the credit rating of this issue type is se t at three notches below the final rating of the Bank, which is BBB(RU).
SME Bank JSC, series C01 (RU000A102HA5), maturity date: December 3, 2030, issue volume: RUB 720 mln — BB(RU), status “Rating under revision: developing”.
REGULATORY DISCLOSURE
The credit ratings have been assigned under the national scale for the Russian Federation based on the Methodology for Credit Ratings Assignment to Banks and Bank Groups Under the National Scale for the Russian Federation, Methodology for Analyzing Rated Entities Associated with a State or a Group, and the Key Concepts Used by the Analytical Credit Rating Agency within the Scope of Its Rating Activities. The Methodology for Assigning Credit Ratings to Individual Issues of Financial Instruments on the National Scale for the Russian Federation was also applied to assign the credit rating to the above issue.
The credit ratings of SME Bank JSC and the bond (ISIN RU000A102HA5) issued by SME Bank JSC were published by ACRA for the first time on December 29, 2017 and March 25, 2021, respectively. The credit rating of SME Bank JSC and its outlook and the credit rating of the bond issue are expected to be revised within 90 days following the publication date of this press release.
The credit ratings were assigned based on data provided by SME Bank JSC, information from publicly available sources, and ACRA’s own databases. The rating analysis was performed using the IFRS consolidated statements of SME Bank JSC and the financial statements of SME Bank JSC drawn up in compliance with Bank of Russia Ordinance No. 4927-U dated October 8, 2018. The credit ratings are solicited, and SME Bank JSC participated in their assignment.
In assigning the credit ratings, ACRA used only information, the quality and reliability of which was, in ACRA’s opinion, appropriate and sufficient to apply the methodologies.
ACRA provided additional services to SME Bank JSC. No conflicts of interest were discovered in the course of credit rating assignment.
