Bancherul - BANCI / ENGLISH / Moody's set to downgrade Erste Group Bank's ratings

Moody's Investors Service said in a press release it has placed on review for downgrade Erste Group Bank AG's standalone bank financial strength rating of C- and the A1 long-term debt and deposit ratings.

The P-1 short-term rating was affirmed.

"The review for downgrade on the BFSR follows the bank's report of a major loss that partly stems from previously undisclosed credit default swap (CDS) exposures", said Moody's.

Accordingly, the review will focus on Erste's risk management, internal controls and financial transparency as well as the risk-adjusted profit generating capacity of its business model. The review for downgrade of the A1 long-term ratings follows the review on the BFSR.

As part of the re-assessment of the C- BFSR, a lower mapping of the standalone credit strength to Baa2 from Baa1 is likely, while a move of the BFSR below the C- range cannot be ruled out entirely.

Consequently, the rating agency notes that a one-notch downgrade of the long-term debt and deposit ratings is the most likely outcome of the rating review.

The decision to review Erste's C- BFSR for downgrade was prompted by Moody's concerns about the bank's risk appetite as well as its related risk-management policies, internal controls and financial transparency following an announcement on 10 October 2011 of extraordinary charges leading to a net loss of EUR1.5 billion in Q3 2011.

Particularly relevant is the disclosure of a EUR 5.2 billion net CDS portfolio (protection sold), which appears to be unrelated to Erste's core business operations and had previously been recognised at cost, rather than at fair value. Erste also announced the harmonisation of IT tools requiring the restatement of certain income-recognition accounting, raising questions about the uniform application of appropriate risk-management tools as well as financial transparency on a group-wide basis.

Both changes may mean that earlier qualitative assumptions that Moody's had assumed are no longer consistent with the C- BFSR and the Baa1 standalone credit assessment.

At the same time, Moody's acknowledges the bank's announcement -- during its Q3 2011 earnings call -- that it has reduced its net CDS exposure to EUR300 million as of 27 October 2011 through various measures such as novation, close-outs and -- to a much lesser extent -- hedges.

It is Moody's understanding that these actions have effectively reduced the contingent liability relating to these derivatives contracts and related earnings volatility. However, the restatement of the CDS exposures had a negative impact of approximately EUR460 million after tax.

This, combined with the other extraordinary charges (predominantly goodwill write-offs for its Hungarian and Romanian businesses), required the bank to postpone the planned repayment of EUR1.2 billion in government-provided participation capital.

This could limit the bank's strategic and financial flexibility for a longer period than Moody's previously expected. In the absence of previously anticipated meaningful profit generation for the full-year 2011, Erste's 7.4% core Tier 1 capital ratio (excluding government participation capital) as per 30 September 2011 is weak compared with other banks' capital ratios rated at the C- BFSR level.

In Moody's view, the comparative weakness increases the pressure on Erste to make a rapid return to its earlier earnings-generation capacity to bolster its regulatory capital levels.

Erste's A1 long-term ratings currently benefit from the very high support assumptions as a systemically relevant bank in Austria which results in three notches of uplift from the bank's Baa1 standalone credit strength. Accordingly, the long-term rating is expected to move in tandem with Erste's standalone risk assessment.