Fitch Ratings has affirmed Slovenia-based Gorenjska Banka d.d., Kranj's (Gorenjska Banka) Long-Term Issuer Default Rating (IDR) at 'BB-' and Viability Rating (VR) at 'bb-'.

The ratings have been removed from Rating Watch Evolving (RWE). The Outlook on the IDR is Stable.

Fitch has removed the RWE as planned acquisition of selected CEE subsidiaries (including Slovenia-based Sberbank banka d.d) from Sberbank Europe AG has not materialised. Fitch placed Gorenjska Banka on RWE following the announcement on 3 November 2021 that together with parent Serbia-based AIK Banka a.d. and Agri Cyprus Europe Ltd, it had agreed the acquisition with Sberbank Europe AG. As a result of resolution action Sberbank banka d.d was taken over by the Slovenian central bank and subsequently sold to Nova Ljubljanska Banka d.d. on 1 March 2022.

The affirmation reflects no significant changes to the bank's credit profile since the last full review in March 2021.

Fitch has withdrawn Gorenjska Banka's 's Support Rating as it is no longer relevant to the agency's coverage following the publication of its updated Bank Rating Criteria on 12 November 2021. In line with the updated criteria, we have assigned Gorenjska Banka a Shareholder Support Rating (SSR) of 'no support' (ns).

Key Rating Drivers

Gorenjska Banka's IDRs are driven by its standalone financial strength, as expressed by its VR. Gorenjska Banka's ratings do not factor in any potential support from AIK due to is large size relative to its parent, which could make it difficult for the latter to provide support in case of need. In addition, it reflects limitations to AIK's own credit profile, given its exposure to its home market of Serbia (BB+/Stable), whose operating environment we assess at 'bb-'.

At the same time, we do not expect significant near-term contagion risks from AIK for Gorenjska Banka. This is based on AIK's reasonable reported financial metrics, no reliance on funding from AIK and our view that direct supervision by ECB prevents upstreaming of capital or liquidity from Gorenjska Banka to AIK to the extent it could put significant pressure on Gorenjska Banka's credit profile.

VR

Fitch assessment of Gorenjska Banka's standalone profile reflects the bank's small size and modest franchise, modest capital buffers, sizeable loan-book concentrations and volatile profitability. The bank's funding profile and liquidity are rating strengths.

Gorenjska Banka's business model is simple, relatively stable and profitable and focused on Slovenia, which we consider relatively low risk. Lending is predominantly to corporates and SMEs, with only 32% exposure to retail clients. Customer deposits provide the bulk of funding. Despite franchise weaknesses, these features of the bank's business model allow Gorenjska Banka's business profile to be scored at 'bb-', which is above the implied 'b' category score.

In our view, the bank's risk appetite is higher than rated Slovenian peers. This is demonstrated by reducing, but still sizeable related-party exposures, and higher-than-average loan growth and industry concentrations, including to real estate and construction (around 30% of corporate gross exposure at end-2021).

The impaired loan ratio (Stage 3 loans) of 2.2% was broadly stable in 2021 (2020: 2.0%) as loan performance has benefited from Slovenia's post-2020 economic recovery, despite the expiration of loan repayment moratoria and other extraordinary state support measures. According to management, the bank's direct credit exposure to Russia and Ukraine is small and largely covered by guarantees or insurance, but we believe that second-order economic effects of the conflict in Ukraine (such as rising energy prices, higher inflation, weaker growth) will gradually put pressure on retail and corporate borrowers. Nevertheless, considering current asset quality metrics and expectation that deterioration is likely to be contained, we have upgraded the asset quality score to 'bb-' from 'b+'.

In this context, we also expect Stage 2 loans (about 16% of total gross loans) to stay elevated given the bank's cautious approach to restaging.

Coverage of Stage 3 loans with specific loan loss allowances was low at around 32% at and-2021, but reflects the highly collateralised nature of the bank's loan book. The coverage of Stage 3 loans by all loan loss allowances was solid at close to 72%.

Sizeable industry and single-obligor concentrations continue to weigh on our assessment of Gorenjska Banka's asset quality.

Operating profitability was solid in 2021. The headline ratio of operating profit-to- risk weighted assets (RWAs) improved to around 2.4% from 2.0% in 2020, underpinned by low loan impairment charges (LICs). Revenue was up by around 17% yoy, which allowed for pre-impairment profit improvement, despite s strong increase in operating expenses. In our view, Gorenjska Banka's LICs are likely to be much higher in 2022 and 2023, but overall-profitability metrics should remain reasonable, supported by expected loan growth and stable margins. For this reason, we have upgraded the earnings and profitability score to 'bb' from 'bb-'.

Our assessment of capital and leverage considers the small absolute size of the bank's capital base and elevated risk appetite manifesting itself in sizeable loan book concentrations. The bank's common equity Tier 1 (CET1) ratio declined to 14.3% at end-2021 from 14.9% a year before, driven by RWA growth and only a small part of 2020 profit and none of 2021 profit is included in CET1 capital. We expect that at current level of CET 1 profit retention is likely to balance Gorenjska Banka's loan growth and help stabilise capitalisation metrics.

Customer deposits are stable and diversified, although the share of term deposits is higher than at peers, indicating somewhat weaker customer relationships. Refinancing risks are low and the liquidity position is solid. Our outlook for the bank's funding and liquidity profile is stable. Wholesale funding is limited and primarily sourced from the Slovenian development bank and AIK (through a subordinated loan). Liquidity remains sound with regulatory liquidity ratios materially above minimum requirements.

SSR

The SSR Support Rating of 'ns' reflects Fitch's opinion that support from AIK, while possible, cannot be relied on. This reflects that the large size of Gorenjska Banka relative to AIK limits the parent's ability to provide support.

Gorenjska Banka's gross direct exposure to AIK (money market placement) was broadly unchanged over the last year and equivalent to about 40% of Gorenjska Banka's CET1 capital at end-2021. On a net basis it reduced to around 20% of CET1 (2020: 30%). Some related-party loans have been repaid, reducing this part of exposure to around 10% of CET1. In our view, despite a modest reduction over 2021, this indicates increased risk appetite and weaknesses in Gorenjska Banka's governance structure relative to peers. Although not a key rating driver, combined with other factors, governance risk has a moderate influence on Gorenjska Banka's VR. This is reflected in a score of '4' for Governance Structure under our Environmental Social and Governance (ESG) Relevance Scores.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

IDRs and VR

Our base case is that Gorenjska Banka's VR and hence Long-Term IDR have moderate headroom to withstand pressures stemming from the deteriorating economic outlook. They would be downgraded if the bank experiences a sharp deterioration in asset quality, capitalisation and operating profitability metrics without clear prospects for recovery. The bank's ratings would likely be downgraded if:

the bank's capitalisation weakens beyond our baseline expectations, in particular if the buffers above the minimum regulatory requirements for CET1 ratio decrease substantially, providing only small headroom above the minimum capital requirements, and if loan book concentrations are not reduced.

there is a substantial increase in risk appetite, especially if combined with asset quality and profitability deterioration, or evidence of material governance weakness.

SSR

A downgrade of Gorenjska Banka's SSR is not possible, given it is currently the lowest SSR on our scale.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

IDRs and VR

An upgrade would require a significant strengthening of the bank's franchise, and a record of sound performance under AIK's ownership.

SSR

An upgrade is unlikely, as it would require a material change of Gorenjska Banka's size relative to AIK.

VR ADJUSTMENTS

The business profile score of 'bb-' has been assigned above the implied score, due to the following adjustment: Business Model (positive).

The earnings and profitability score of 'bb' has been assigned below the implied score due to the following adjustment: Earnings Stability (negative).

The capitalisation and leverage score of 'bb-' has been assigned below the implied score due to the following adjustments: Size of Capital Base (negative) and Risk Profile and Business Model (Negative)

Funding and Liquidity score of 'bb+' has been assigned below the implied score due to the following adjustments: Deposit Structure (negative)

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond 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 https://www.fitchratings.com/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

Gorenjska Banka d.d., Kranj has an ESG Relevance Score of '4' for Governance Structure reflecting board independence issues given sizeable direct and indirect related-party exposures with parent AIK, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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