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  • 1. Global Credit Research Credit Opinion 22 OCT 2008 Credit Opinion: Alfa Bank Ukraine Alfa Bank Ukraine Kyiv, Ukraine Ratings Category Moody's Rating Outlook Stable Bank Deposits -Fgn Curr B2/NP Bank Deposits -Dom Curr Ba3/NP NSR Bank Deposits -Dom Curr Bank Financial Strength E+ Senior Unsecured Ba3 NSR Senior Unsecured -Dom Curr Other Short Term -Dom Curr NP Parent: Alfa-Bank Outlook Stable Bank Deposits Ba1/NP Bank Financial Strength D+ Subordinate Ba2 Contacts Analyst Phone Armen L. Dallakyan/London 44.20.7772.5454 Yaroslav Sovgyra/Moscow 7.495.641.1881 Reynold R. Leegerstee/London Yana Ruvinskaya/Moscow Key Indicators Alfa Bank Ukraine [1]2008 2007 2006 2005 2004 Avg. Total assets (US$ million) 3737.22 2598.31 1237.30 421.58 194.24 910.67 Shareholders' Equity (US$ million) 543.72 412.64 98.26 43.94 40.86 123.67 Return on average assets 0.44 0.62 0.19 -0.61 1.96 0.62 Recurring earnings power [2] 2.14 2.78 2.86 0.91 2.89 2.24 Net interest margin 8.66 6.31 5.72 3.06 4.48 4.99 Cost/income ratio (%) [3] 53.34 63.34 58.00 79.34 60.33 67.13 Problem loans % gross loans -- 0.52 0.35 0.04 0.64 0.35 Tier 1 Ratio (%) -- -- -- -- -- -- [1] As of June 30. [2] Preprovision income % average assets [3] Non-Interest Expense % Operating Income Opinion SUMMARY RATING RATIONALE Moody's assigns a bank financial strength rating (BFSR) of E+ to Alfa Bank Ukraine (ABU), which translates into a B2 Baseline Credit Assessment. The BFSR is underpinned by the bank's narrow, albeit rapidly evolving, independent franchise in the Ukrainian market steered by a team of experienced managers that is implementing a strategy of rapid expansion in retail and SME business lines whilst maintaining strong positions in corporate banking. However, the bank's BFSR is constrained by still high borrower concentration and weak, although improving financial fundamentals.
  • 2. ABU's immediate parent is a holding company - ABH Ukraine Limited, which is controlled by six individuals. Theses individuals together own the enlarged Alfa Group - parent of one of the largest private banks in Russia - Alfa Bank (Ba1/NP/D+/stable). Moody's assigns a global local currency (GLC) deposit rating of Ba3 to ABU. This rating factors in a moderate probability of support from the bank's affiliated companies, giving a two-notch uplift for ABU's ratings from its Baseline Credit Assessment of B2. Alfa Bank Russia's Ba1 Baseline Credit Assessment was used as a proxy for assessing the strength of the potential support provider. Credit Strengths - Wide-ranging support from affiliated companies, in particular from financially stronger Alfa Bank (Russia) - Good corporate franchise supported by a relatively sophisticated product offering (for a local market) - Ongoing expansion to SME and retail businesses and improving customer reach offers potential for strengthening market positions, as well as diversifying ABU's balance sheet and earnings - A team of experienced managers in place somewhat reduces implementation risks associated with the bank's strategy Credit Challenges - Increasing competition in the Ukrainian banking sector could limit the bank's ability to further strengthen its franchise, especially in retail and SME businesses - Hefty concentrations on both sides of the balance sheet make the bank's capitalisation and liquidity vulnerable to shocks - The high level of related-party business held on the bank's books leaves much room for improvement and undermines economic capitalisation - Rapidly growing retail loan book is unseasoned and untested - Weak, albeit improving, profitability and cost efficiency Rating Outlook All of the bank's ratings carry a stable outlook. What Could Change the Rating - Up The BFSR has limited upside potential at present. Future upgrades would be highly dependent on ABU's success in implementing the new strategy and strengthening its market positions without compromising key financial indicators, potentially leading to a material reduction in single-name and sector concentrations as well as related- party business on both sides of the balance sheet. The GLC deposit ratings of the bank may be upgraded as a result of (i) an upgrade of the bank's B2 Baseline Credit Assessment or (ii) an increased probability of support from affiliated companies. While we will continue using ABR's rating as a proxy for evaluating the level of parental support for ABU, the link between their ratings is not rigid and any impact on ABU's ratings as a result of future movements in ABR's deposit ratings will be examined on a case-by-case basis. What Could Change the Rating - Down Any material deterioration in asset quality or significant reduction in liquidity and capitalisation levels due to mismanaged growth could warrant a BFSR downgrade. The GLC deposit ratings of ABU could be downgraded in the event that (i) Moody's concludes that parental support would not be forthcoming in case of need or (ii) ownership is transferred to a shareholder whose credit quality was difficult to assess or an entity with a lower credit standing than Ba1. Recent Results and Developments With a head office in Kiev, ABU reported total assets of US$3.01 billion and net income of US$8.7 million at year- end 2007, according to the financial statements prepared under the local accounting standards. Under IFRS ABU
  • 3. reported total assets of US$1.24 billion and net income of US$1.6 million at year-end 2006 (6m 2007: total assets US$1.9 billion and net income of US$1.7 million). DETAILED RATING CONSIDERATIONS Detailed considerations for ABU's currently assigned ratings are as follows: Bank Financial Strength Rating Moody's assigns an E+ BFSR to ABU, which Moody's believes is an appropriate measure of the bank's financial strength given its very short track record of operating under its new strategy, the still high level of related-party lending and a potentially volatile performance that is susceptible to a limited number of key customers (although of a better-than-average credit quality) that still dominate both sides of the balance sheet. As a point of reference, the assigned rating is one notch lower than the D- outcome of Moody's bank financial strength scorecard. We think that the scorecard outcome does not fully capture the risk of high borrower concentration and still weak, although improving financial fundamentals of the bank. Qualitative Factors (70%) Factor 1: Franchise Value Trend: Improving ABU is the 10th largest bank in Ukraine in terms of total assets (excluding loans funded by Alfa Bank Russia) with a market share of 2.5% as at year-end 2007 and an increasingly wide but also well thought-out regional coverage. As of December 31, 2007 the bank had 233 branches (of which 41 standard branches, the rest are mini-offices or information & consulting centers) and 1033 POS (points of sale) across Ukraine. ABU was initially focused on large corporate clients - a business segment in which it has been reasonably successful - but, by leveraging Alfa Group's franchise, the bank has more recently managed to attract several of Ukraine's leading companies and is now penetrating this market deeper by providing more sophisticated products (in the context of the local markets) and competitive pricing. So far corporate business has been the major contributor to the bank's bottom-line performance. Since 2005 the bank has embarked on a strategy through which it hopes to become one of the top five players in the local market by 2010 - an ambitious plan given the present gap between ABU and the market leaders - by supplementing its business with rapid penetration in the Ukrainian retail and SME financing markets. Following this strategic move, the bank's team has been supplemented by a number of local and foreign professionals in the areas of risk management, IT, retail and SMEs. As a result at year-end 2007 ABU had 2.9% market share (#8 in ranking) in loans to legal entities and 2.3% market share (#9 in ranking) in loans to individuals - a significant increase from the beginning of the year. The bank scores D- for franchise value. Factor 2: Risk Positioning Trend: Neutral Until August 2006, ABU was majority-owned by one of the largest private banks in Russia - Alfa Bank (Ba1/NP/D+/stable). However, ownership was subsequently transferred to a company controlled by six individuals that together own the enlarged Alfa Group, which - in addition to investment and commercial banking activities (carried out by Alfa Bank Russia, Amsterdam Trade Bank, Alfa Bank Kazakhstan and some other smaller entities consolidated into a single Alfa Banking Group) - also has investments in the oil industry, retail (supermarket chains in Russia and Ukraine), telecommunications, insurance and other areas. ABU's Supervisory Board has seven members, only one of which is independent, while the level of related-party lending remains quite high (accounting for almost half of the bank's Tier 1 equity as at end-1H2007), and we therefore see considerable room for further improvement in the bank's corporate governance. ABU's risk management standards are very much in line with those of Alfa Bank Russia and are superior to those of many of its local privately owned peers. Although the bank lacks risk-adjusted performance measures, which limits the Supervisory Board's ability to establish the bank's risk appetite, we consider the presence of the Group's Chief Risk Manager on the Board as a mitigating factor. We also note that the bank's systems remain untested in the Ukrainian environment and a longer track record of the bank operating without major unexpected losses will be required to attain a higher score for this factor.
  • 4. The bank's loan portfolio is quite heavily concentrated, with the top 20 exposures exceeding the bank's Tier 1 equity by more than 4 times. However, at the same time we note the above-average quality of the bank's largest borrowers (in the Ukrainian context), together with its reasonable approach to collateralisation and the fact that the largest exposure of US$140 million (at end-1H2007) is fully covered by a cash deposit and thus decreasing the actual risk carried by ABU. Sector concentrations are moderately blended, with the largest sector exposure standing in excess of 100% of Tier 1 capital (although we note that this is partly attributable to a significant capital injection effected by the shareholders in late 2006, and sector concentrations may slightly deteriorate going forward as the bank continues to grow its loan book). The bank's liquidity has been historically well managed, but its high, although declining reliance on its parent for funding makes it difficult to assess ABU's standalone capacity to manage its liquidity gaps, and only a greater independence in terms of funding would enable us to raise our assessment of this group of factors. The bank's market risk appetite, as measured by the potential loss of its trading and non-trading books due to major market movements, is relatively modest. ABU releases financial statements in accordance with IFRS and reviewed by auditors on a semi-annual basis and full audited reports on an annual basis, but we are of the opinion that, although the level of public disclosures is adequate, it could still be improved to include more relevant information in the areas of risk management and asset quality. Moody's assigns an E score for risk positioning with a neutral view going forward. Only a solid track record of considerably lower exposures to the bank's related parties and a much greater granularity of the loan portfolio could warrant a higher score for this group of factors. Factor 3: Regulatory Environment For a discussion of the regulatory environment, see Moody's latest Banking System Outlook on Ukraine, published in November 2007. Factor 4: Operating Environment Trend: Neutral This factor is also common to all Ukrainian banks. Moody's assigns an E+ score for the overall operating environment. For a discussion of the operating environment, see Moody's latest Banking System Outlook on Ukraine, published in November 2007. Quantitative Factors (30%) Factor 5: Profitability Trend: Improving ABU's profitability remains quite modest, although improving significantly over the past two years as the bank's investments in branch network development, IT infrastructure start to make returns. At year-end 2007 the bank reported ROA of 0.29%, according to reports under local accounting standards. The main constraints to ABU's profitability are high operating expenses and loan loss provisioning expenses. We assign a C score for the bank's profitability and see an improving trend as the bank's earning generation capacity could improve as the retail and SME loan portfolios should bring much higher returns. Factor 6: Liquidity Trend: Weakening With a ratio of net loans to customer deposits of 267% at end-1H2007, ABU is heavily reliant on market sources for funding. The bank intends to significantly increase the share of retail deposits in its funding structure, however we think that in the medium term ABU would be resorting to corporate deposits and, to some extent, market borrowings to support its aggressive growth plans. Although we consider the funds provided by the bank's related parties as a relatively sticky source of funding, we understand that going forward its share will be gradually decreasing. Having said this, we also note that the bank's liquidity position is also vulnerable to chunky deposit withdrawals (the 20 largest term deposits accounted for about 90% of the total category as of 31 June 2007). Given the above, we consider a D- score as a good reflection of the bank's liquidity position and assign a weakening trend as the bank's access to retail deposit market is limited, whereas the ongoing credit crunch makes market borrowings more difficult to obtain. Factor 7: Capital Adequacy
  • 5. Trend: Neutral ABU's regulatory capital adequacy remains ample, despite the bank's recent business growth as a result of the bank's shareholders making timely and sufficient capital injections. In Moody's view, the bank's regulatory capitalisation levels are comfortable, but this does not indicate any immediate positive rating implications, as economic capitalisation is expected to decline in the medium term given the bank's rapid expansion. ABU remains reliant on its shareholders for capital injections, as its internal capital generation ability remains weak and is lagging behind its rapid pace of growth. The scorecard output of A has been adjusted to a lower score to reflect the bank's weak internal capital generation and constant need of capital injections to sustain its high pace of growth. Factor 8: Efficiency Trend: Neutral The bank's cost-efficiency decreased significantly in 2005 and showed some signs of improvement in 2006. We believe that the bank is well positioned within a D score for cost efficiency and assign a neutral trend as its plans for further regional expansion are unlikely to allow the cost-to-income ratio to improve considerably in the medium term. Factor 9: Asset Quality Trend: Weakening The quality of ABU's loan portfolio has been strong to date, but we note that the bank's fast growth in the new business lines (i.e. retail and SME), together with the high, albeit declining level of borrower concentration may distort its asset quality numbers going forward. Although these concerns are partly mitigated by the bank's good underwriting techniques and adequate collateral requirements, we will be using a lower score than the A scorecard outcome to reflect the untested nature of the bank's retail and SME loans. For the same reason we assign a weakening trend to this group of factors. Global Local Currency Deposit Rating (Joint Default Analysis) ABU's Ba3/Not-Prime global local currency deposit ratings incorporate a moderate probability of support from the bank's affiliated companies, giving a three-notch uplift for ABU's ratings from its Baseline Credit Assessment of B2. (Alfa Bank Russia's Ba1 deposit rating was used as a proxy for assessing the strength of the potential support provider, although it may not necessarily be the actual provide of support.) We believe that, if ABU were to face financial difficulties, its beneficial owners might opt to (i) provide direct support, and/or (ii) use one of Alfa Banking Holding's entities to support ABU. Incentives for Alfa Bank Russia (ABR) to support its sister bank include the common brand name and the fact that ABR is strongly represented on ABU's supervisory board; hence its default would have negative repercussions for ABR. We do not factor any probability of systemic support into ABU's ratings given the bank's relatively low systemic importance. National Scale Rating Moody's assigns a National Scale Rating to ABU. National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. Foreign Currency Deposit Rating ABU's foreign currency deposit rating of B2 is constrained by Ukraine's ceiling for such instruments. Foreign Currency Debt Rating ABU's foreign currency long-term debt rating of Ba3 is at the same level as the bank's GLC rating. ABOUT MOODY'S BANK RATINGS Bank Financial Strength Rating Moody's Bank Financial Strength Ratings (BFSRs) represent Moody's opinion of a bank's intrinsic safety and
  • 6. soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by Moody's Bank Deposit Ratings. BFSRs do not take into account the probability that the bank will receive such external support, nor do they address risks arising from sovereign actions that may interfere with a bank's ability to honor its domestic or foreign currency obligations. Factors considered in the assignment of BFSRs include bank- specific elements such as financial fundamentals, franchise value, and business and asset diversification. Although BFSRs exclude the external factors specified above, they do take into account other risk factors in the bank's operating environment, including the strength and prospective performance of the economy, as well as the structure and relative fragility of the financial system, and the quality of banking regulation and supervision. Global Local Currency Deposit Rating A deposit rating, as an opinion of relative credit risk, incorporates the BFSR as well as Moody's opinion of any external support. Specifically, Moody's Bank Deposit Ratings are opinions of a bank's ability to repay punctually its deposit obligations. As such, they are intended to incorporate those aspects of credit risk relevant to the prospective payment performance of rated banks with respect to deposit obligations, which includes: intrinsic financial strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and explicit external support elements. Moody's Bank Deposit Ratings do not take into account the benefit of deposit insurance schemes which make payments to depositors, but they do recognize the potential support from schemes that may provide assistance to banks directly. According to Moody's joint default analysis (JDA) methodology, the global local currency deposit rating of a bank is determined by the incorporation of external elements of support into the bank's Baseline Credit Assessment. In calculating the Global Local Currency Deposit rating for a bank, the JDA methodology also factors in the rating of the support provider, in the form of the local currency deposit ceiling for a country, Moody's assessment of the probability of systemic support for the bank in the event of a stress situation and the degree of dependence between the issuer rating and the Local Currency Deposit Ceiling. National Scale Rating National scale ratings are intended primarily for use by domestic investors and are not comparable to Moody's globally applicable ratings; rather they address relative credit risk within a given country. An Aaa rating on Moody's National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss expectation associated with systemic events that could affect all issuers, even those that receive the highest ratings on the National Scale. Foreign Currency Deposit Rating Moody's ratings on foreign currency bank obligations derive from the bank's local currency rating for the same class of obligation. The implementation of JDA for banks can lead to high local currency ratings for certain banks, which could also produce high foreign currency ratings. Nevertheless, it should be noted that foreign currency deposit ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may result in the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the bank's rating for local currency obligations. Foreign Currency Debt Rating Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign currency deposit ratings, foreign currency debt ratings may also be constrained by the country ceiling for foreign currency bonds and notes; however, in some cases the ratings on foreign currency debt obligations may be allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility to pierce that ceiling. About Moody's Bank Financial Strength Scorecard Moody's bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial strength of a bank, used as a key tool by Moody's analysts to ensure consistency of approach across banks and regions. The model output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Alfa Bank Ukraine
  • 7. Rating Factors [1] A B C D E Total Score Trend Qualitative Factors (70%) E Factor: Franchise Value D- Improving Market Share and Sustainability x Geographical Diversification x Earnings Stability x Earnings Diversification [2] Factor: Risk Positioning E Neutral Corporate Governance [2] x - Ownership and Organizational Complexity -- -- -- -- -- - Key Man Risk -- -- -- -- -- - Insider and Related-Party Risks -- -- -- -- -- Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration -- -- -- -- -- - Borrower Concentration -- -- -- -- -- - Industry Concentration -- -- -- -- -- Liquidity Management x Market Risk Appetite x Factor: Operating Environment E+ Neutral Economic Stability x Integrity and Corruption x Legal System x Financial Factors (30%) C Factor: Profitability C Improving PPP % Avg RWA 2.52% Net Income % Avg RWA 0.55% Factor: Liquidity D- Weakening (Mkt funds-Liquid Assets) % Total Assets 23.63% Liquidity Management x Factor: Capital Adequacy A Neutral Tier 1 ratio (%) 14.50% Tangible Common Equity % RWA 14.50% Factor: Efficiency D Neutral Cost/income ratio 67.43% Factor: Asset Quality A Weakening Problem Loans % Gross Loans 0.61% Problem Loans % (Equity + LLR) 3.91% Lowest Combined Score (9%) D- Economic Insolvency Override Neutral Aggregate Score D- Assigned BFSR E+ [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non public information [2] - A blank score under Earnings diversification or Corporate Governance indicates the risk is neutral
  • 8. © Copyright 2008, Moody's Investors Service, Inc. and/or its licensors including Moody's Assurance Company, Inc. (together, "MOODY'S"). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided "as is" without warranty of any kind and MOODY'S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY'S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY'S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY'S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY'S have, prior to assignment of any rating, agreed to pay to MOODY'S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody's Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody's Investors Service (MIS), also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody's website at under the heading "Shareholder Relations - Corporate Governance - Director and Shareholder Affiliation Policy."