Rough times 'a comin...

Standard & Poor's Banking Industry Country Risk Assessment places Azerbaijan in Group 9
February 24, 2009

Russia & CIS Business and Financial Newswire

Standard & Poor's Ratings Services has categorized the banking industry of the Republic of Azerbaijan in Group 9, following its Banking Industry Country Risk Assessment (BICRA), the ratings agency said in a statement.

The agency's BICRA rankings reflect the strengths and weaknesses of a country's banking system, compared with those of other countries, on a scale ranging from Group 1 (the strongest) to Group 10 (the weakest).

Other countries in Group 9 include Belarus, Nigeria, Costa Rica, Guatemala, Lebanon, and Vietnam. Azerbaijan ranks ahead of Ukraine (Group 10), but behind Russia and Kazakhstan (Group 8).

The placement of Azerbaijan in Group 9 reflects the high industry and economic risks facing the young and fragmented banking system, which is vulnerable to potential credit quality and liquidity deterioration after several years of very rapid growth, the statement says. The system is characterized by high dollarization, the economy's oil dependence, banks' single-name and industry concentrations, and weak risk-management practices. These vulnerabilities are partly mitigated by decent medium- term prospects for macroeconomic growth, banks' limited dependence on international borrowings, and their adequate capitalization and financial performance. For these reasons, the Azerbaijani banking system has so far been less affected by the global economic turbulence, compared with many other countries in the Commonwealth of Independent States, it says.

The banking sector is dominated by a state-owned bank, International Bank of Azerbaijan, which has a market share of 40%, followed by very dynamic private-sector banks--about 45 of them at year- end 2008--with the market share of the largest at less then 8%.

Economic growth is expected to decelerate to a still decent 4.0% in 2009 against 8.5% in 2008, following a sharp decrease in oil prices.

Azerbaijan's economy is highly dependent on oil, which contributed 60% of GDP in 2008.
The rapid lending growth of the past few years is now slowing, owing to sluggish macroeconomic growth and reduced access to international funding. Total system loans increased by only 6% in the fourth quarter of 2008 compared with more than 40% in the first nine months of the year and more than 80% in 2007. As of Dec. 31, 2008, 49% of total system loans were denominated in foreign currencies, highlighting local banks' asset-quality vulnerability to an unlikely, but still not impossible, devaluation of the local currency.

S&P expects deteriorating credit conditions and a slowdown in growth to lead to a significant rise in banks' credit costs and problem loans, at least over the next two to three years. Although loans overdue by more than 30 days were at 2.2% of total loans on Dec. 31, 2008, this ratio does not reflect potential problem loans because portfolios are unseasoned. The expected deterioration was only partly offset by the sector's adequate capitalization (an average capital ratio of 17%) and satisfactory profitability, reflected in a return on assets of 2.2% at year-end 2008. However, banks' provisioning, which covered 6.2% of total loans at year-end 2008, provide an adequate cushion to absorb potential credit losses.

The agency's key analytical measure, which reflects the contingent liability of a banking system relative to sovereign risk, is an estimate of the incidence of gross problematic assets (GPAs) in a reasonable worst-case scenario of economic recession, expressed as a percentage of domestic credit to the private sector and nonfinancial public enterprises. S&P has estimated the GPAs for Azerbaijan's financial system to be in the 35%-50% range (on par with Belarus, Russia, and Kazakhstan).

Although customer deposits have continued to increase rapidly, rising 37% in 2008 after 55% in 2007, the banking system's ratio of loans to deposits reached a fairly high 162% on Dec. 31, 2008, reflecting the strong growth in lending in recent years. At the same time, foreign funding represented 23% of the system's liabilities, largely comprising more sustainable financing from multilateral institutions.

Under the agency's criteria, it considers Azerbaijan to be "supportive" of its banking system. In line with this approach, S&P gives no rating uplift to private-sector banks for potential government support. During times of financial stress, the authorities are likely to increase supervision and regulation of troubled entities, but, in the agency's opinion, would provide only limited extraordinary financial support to privately owned banks.