Moody’s downgrades Latvia’s Privatbank with negative outlook

Moody's Investors Service has downgraded the long-term foreign and local currency deposit ratings of Privatbank AS to B2 from B1. The outlook on the long-term foreign and local currency deposit ratings and the bank financial strength rating (BFSR) is negative.
Moody's said the downgrade reflects the bank’s weakened profitability, asset quality and lower level of capital adequacy. As a result, in Moody's opinion the bank has become more dependent on its parent for financial support.
"For the first nine months of 2008, Privatbank's pre-tax, pre-provision income decreased by 40% year-on-year compared with 2007. The decrease was mainly due to a rise in operating expenses, which grew by 32% year-on-year. Positively, underlying core earnings increased, with net interest income growing by 22% and fee and commission income by 10% year-on-year. However, loan loss provisions accounted for a high 68% of pre-provision income compared with 28% in the respective period in 2007.
As a result, pre-tax profits decreased by 73% to LVL0.3 mln (EUR0.4 mln) from LVL1.1 mln (EUR1.6 mln) in 2007," explained Kimmo Rama, a Moody's Vice President-Senior Analyst.
Moody's believes that the bank is likely to experience further deterioration in asset quality in light of the weakening economic environment in Latvia as reflected by the negative outlook. "Weakening asset quality has already become visible in Privatbank's asset quality figures. Moody's understands that its problem loans (i.e. individually impaired and over 90 days past due, but not impaired loans) accounted for 12.1% of gross loans at the end of September 2008, significantly up from 4.1% at the end of 2007," said Rama.
Moody's added that Privatbank's exposure to the real estate sector (mainly residential mortgages) — which is likely to be adversely affected by the ongoing economic slowdown — accounts for a high 54% of total lending (or over 400% of Tier 1 capital).
The bank's total capital adequacy ratio stood at 10.7% at the end of September 2008 (Basel II), down from 14.3% at the end of 2007 (Basel I).
In Moody's view, the bank's capitalisation is low in light of the current economic slowdown, its high credit concentration risk and concerns over asset quality development.
Privatbank's funding is mainly based on customer deposits, which have continued to grow favourably in 2008. However, Moody's recognises that its deposit base exhibits a significant reliance on non-resident deposits which in the rating agency's view are more confidence-sensitive than domestic residential deposits. Moody's is concerned that, given the weakening economic environment in Latvia, non-resident deposits could now be more vulnerable to withdrawals. At end-June 2008, non-resident deposits accounted for 52% of its total customer deposits.
Privatbank is 95% owned by Ukraine's Privatbank (Ba1/NP/D-, stable). Moody's continues to assess the probability of parental support from its parent bank as moderate. However, given Privatbank's weakened financial fundamentals, the bank has, in Moody's opinion, become more dependent on its parent bank for funding and support.
The rating agency also notes that the parent bank's operating environment in Ukraine has become more challenging, which could potentially limit the parent's ability to provide capital support for Privatbank, should the need arise. As a consequence of the support assessment, there is a one-notch uplift for Privatbank's GLC deposit rating from its B3 Baseline Credit Assessment.