Rating Action Commentary
ֳ Affirms Odea at 'B'; Outlook Negative
Fri 12 Jun, 2020 - 10:20 AM ET
ֳ - London - 12 Jun 2020: ֳ has affirmed Odea Bank A.S.'s Long-Term Issuer Default Ratings (IDRs) at 'B' with a Negative Outlook and Viability Rating (VR) at 'b'. The bank's subordinated notes' rating has been downgraded by one notch to 'CCC+' from 'B-', and removed from Under Criteria Observation (UCO).
Key Rating Drivers
IDRS, VR AND NATIONAL RATING
Odea's IDRs are driven by its standalone strength, as reflected in its Viability Rating (VR). The VR reflects the bank's very weak asset quality and profitability, small absolute size, limited franchise (end-1Q20: less than 1% of sector assets) and concentration in the high-risk and volatile Turkish operating environment. These factors are balanced by a reasonable funding profile and limited reliance on wholesale funding.
Risks to Odea's Standalone Credit Profile, which were already significant after the Turkish lira depreciation in 2018 and economic slowdown in 2H18-2019, have been heightened by the coronavirus outbreak and lockdown measures, given pressure on its asset quality, capitalisation, performance, funding and liquidity. This drives the Negative Outlook on the bank's Long-Term IDRs, which could be downgraded if the recovery of the Turkish economy is slower and the impact of the pandemic is more severe than expected.
ֳ forecasts Turkey's GDP will contract 3% in 2020 followed by a subsequent sharp recovery (5.0% GDP growth) in 2021. Monetary policy measures and fiscal support for the private sector and financial markets - including the latest Central Bank of the Republic of Turkey interest-rate cuts and the expanded Credit Guarantee Fund (CGF) - should support borrowers' repayment capacity and banks' ability to grow to a degree, despite the challenging market conditions.
Odea provides banking services to corporate, commercial, SME and retail customers in Turkey, extending loans largely to the corporate and commercial segments. It has actively deleveraged lending since 2017 due to asset quality pressures and a focus on capital and liquidity. However, the introduction of the asset ratio requirement (April 2020; see Asset Ratio Requirement Credit-Negative for Turkish Banks at ) could force it to increase lending at a time when the operating environment has weakened, heightening credit risk at the bank.
Pre-existing risks to asset quality are significant as indicated by Odea's rising non-performing loans (NPL) ratio and exceptionally high Stage 2 loans compared with peers and the sector. However, the latter is in part attributable to its conservative loan classification approach, in our view.
NPLs decreased to a still high 12.5% of gross loans at end-1Q20 (end-2019: 14.5%) significantly above the sector average, although lending also contracted by 12% during this period (FX-adjusted basis)). Stage 2 loans, concentrated mainly in the real estate and shopping mall sectors, rose to 33% of gross loans (end-1Q20) and could migrate to the NPL category as loans season.
NPLs were 76%-covered by total reserves at end-1Q20, which is below the sector average of 103%. Specific reserves coverage of NPLs was 41%, which is partly a function of the bank's focus on commercial lending, where collateralisation is typically relatively high. Nevertheless, current market illiquidity means collateral is likely to be harder to realise.
Credit risks are heightened by single-name risk and exposure to the troubled construction sector (28% of loans), mainly comprising shopping malls. Foreign-currency lending is also material (55% of the loan book at end-1Q20; sector average: 38%), and heightens credit risk, given the impact of the Turkish lira depreciation on often weakly hedged borrowers' ability to service their debt.
In the short term, regulatory forbearance will support Odea's reported asset quality metrics. Nevertheless, we expect underlying asset quality to deteriorate and problematic exposures to rise from their current low level, given the severity and scale of the current downturn. However, the extent of asset quality weakening will ultimately depend on the pace of economic recovery.
At end-1Q20 Odea's reported CET1 ratio was 12%. Its total capital adequacy ratio was a stronger 19.5%, supported by USD282 million of subordinated Tier 2 capital, which provides a partial hedge against lira depreciation.
ֳ considers Odea's capital ratios to be only adequate for its risk profile, small size, significant asset-quality risks, concentration risk, limited capital generation and high unreserved NPLs. Underlying capitalisation is also sensitive to potential further lira depreciation (due to the inflation of foreign currency risk-weighted assets (RWA) and market volatility (due to revaluations of bond portfolios through equity).
In the short term, regulatory forbearance will provide uplift to Odea's reported capital metrics. We estimate its CET1 ratio would have been about 80bp lower net of forbearance measures at end-1Q20.
ֳ expects the bank's profitability to remain under pressure due to high impairment charges and low growth. Its operating profit/RWA ratio was a very low 0.6% in 1Q20, as loan impairment charges absorbed a high 52% of pre-impairment profit. We expect impairments to remain high, as banks provision for increased risks despite the easing of regulatory loan classifications. We also expect increased loan restructurings to weaken revenue quality across the banking sector. However, the bank's margins will continue to benefit in the short term from the latest lira rate cuts, driven by the short-term repricing gap between its assets and liabilities, before loan yields start to reprice in 2H20.
The bank is largely funded by customer deposits, which represented 83% of non-equity funding at end-1Q20. The ֳ-calculated gross loans-to-deposits ratio was a solid 82% at end-1Q20. The share of foreign-currency deposits is very high (66%, versus the sector average of 52%). As a result, the bank has lower wholesale funding reliance than larger bank peers. Foreign-currency wholesale funding amounted to a moderate 17% of non-equity finding at end-1Q20 (about 30% was short-term).
Foreign-currency liquidity is adequate and broadly sufficient to cover the bank's maturing foreign-currency non-deposit liabilities over the next 12 months. It comprises mainly interbank assets, mandatory reserves held against local-currency liabilities in the reserve option mechanism and cash. However, foreign-currency liquidity could come under pressure in case of prolonged market closure and deposit instability.
Odea is owned by Bank Audi S.A.L. The latter was affirmed at 'RD', due to restrictions imposed by the Banque du Liban on banks' operations in foreign currency (including for payments on customer deposits in Lebanon), before its ratings were subsequently withdrawn in January 2020.
ֳ sees limited contagion risk for Odea from its parent, based on i) its zero exposure to Lebanon; ii) the fact that Odea has not paid any dividends to date; and (iii) the relatively strong Turkish regulator, which ֳ believes would seek to limit transfers of capital and liquidity to the parent in case of stress at the latter.
NATIONAL RATING
The affirmation of the National Rating reflects our view that Odea's creditworthiness in local currency relative to other Turkish issuers has not changed.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating of '5' and Support Rating Floor of 'No Floor' reflect ֳ's view that support cannot be relied upon from the Turkish authorities, due to the bank's small size and limited systemic importance, nor from the bank's shareholder.
SUBORDINATED DEBT
Odea's subordinated notes' rating is notched down from the VR anchor rating. ֳ has downgraded the subordinated notes' ratings by one notch, to 'CCC+' from 'B-', and removed them from Under Criteria Observation (UCO). This is in line with the change in ֳ's baseline notching from the anchor rating for loss-severity to two notches from one notch for such instruments, reflecting our expectation of poor recoveries in case of default.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The bank's IDRs and National Rating are primarily sensitive to the bank's VR. The most immediate downside rating sensitivity for the VR is the economic and financial market fallout of the pandemic, given the negative implications for asset quality, earnings, capitalisation and funding and liquidity.
The VR could be downgraded due to i) a marked deterioration in the operating environment, as reflected in adverse changes to the lira exchange rate, economic growth prospects, and external funding market access; ii) a weakening of the bank's foreign currency liquidity position due to foreign currency deposit instability or a loss of market access; or iii) a greater than expected deterioration in underlying asset quality that materially weakened the bank's capital position or was indicative of a further increase in risk appetite.
A material increase in exposure to Lebanese assets could also lead to a downgrade (although this is not our base case).
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Upside for the bank's ratings is limited in the near term given the Negative Outlook. The Outlook could be revised to Stable if economic conditions stabilise, supporting Odea's earnings, asset quality, and funding stability.
SUBORDINATED DEBT
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The subordinated debt rating is primarily sensitive to a change in Odea's VR, from which it is notched. Therefore, a downgrade of the VR would lead to a downgrade of the subordinated debt rating. The debt rating could also be downgraded should ֳ change its assessment of non-performance risk.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade of Odea's VR would lead to an upgrade of the subordinated debt rating.
SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF are sensitive to ֳ's view on the likelihood of Odea receiving extraordinary support from the Turkish authorities, in case of need. A positive reassessment of these ratings, although not impossible, is very unlikely in our view given Odea's limited systemic importance and the limited ability of the sovereign to provide support in FC.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit /site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on ֳ's ESG Relevance Scores, visit .
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
Applicable Criteria
Additional Disclosures
Endorsement Status
| Odea Bank A.S. | EU Issued |