Fitch Ratings has affirmed Sekerbank T.A.S.'s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B-' with Negative Outlooks and Viability Rating (VR) at 'b-'.

Fitch has also upgraded Sekerbank's National Rating to 'BBB-(tur)' from 'BB+(tur)', reflecting an improvement in its creditworthiness relative to other Turkish issuers, given the improvement in its reported asset quality and profitability metrics resulting from the clean-up of its loan book and transformation plan. The Negative Outlook on the National Rating reflects that on the bank's Long-Term Local-Currency (LTLC) IDR.

Fitch has withdrawn the bank's '5' Support Rating and 'No Floor' Support Rating Floor, as they are no longer relevant to its coverage following the publication of the updated Bank Rating Criteria on 12 November 2021. Fitch has assigned Sekerbank a Government Support Rating (GSR) of 'no support'.

Key Rating Drivers

Sekerbank's 'B-' IDRs are driven by its standalone creditworthiness, as reflected in its VR. The Negative Outlooks reflect operating environment pressures, which heighten risks to the bank's credit profile.

The VR reflects the concentration of the bank's operations in the volatile Turkish operating environment, in light of which we assess the core capitalisation as weak and FX liquidity only adequate. The VR also considers Sekerbank's limited franchise and small market shares, although it has a more meaningful regional presence in Anatolia, lack of pricing power and exposure to cyclical sectors. The bank's operations are focused mainly on the SME and commercial segments, and to a lesser extent, corporate and retail customers.

Risks to the bank's credit profile remain skewed to the downside, given macro and policy uncertainty in the run-up to the 2023 elections and Turkey's large external financing need amid tighter global financing conditions. Turkish banks are vulnerable to exchange-rate volatility due to refinancing risks, high sector foreign-currency (FC) lending, given that not all exposures will be fully hedged against lira depreciation, and risks to FC liquidity, due to banks' exposure to external FC wholesale funding amid exposure to investor sentiment and high deposit dollarisation.

The bank's 'B' Short-Term IDRs are the only possible option in the 'B-' Long-Term IDR category.

High Exposure to Vulnerable Sectors: Sekerbank has tightened underwriting standards and has focused on the clean-up of its loan book in recent years, as reflected in the deleveraging of FC corporate loans and subdued growth in LC SME lending. The loan book grew by 1% in 1Q22, following a 3% contraction (FX-adjusted basis) in 2021, and its 2022 loan growth target of 10% is well below inflation expectations and peer banks' targets.

Nevertheless, the bank is exposed to the high-risk SME and micro-SME segments (end-2021: 45% of gross loans, including commercial loans), which are highly sensitive to economic cycles, and vulnerable sectors, including construction (end-2021: 17% of gross loans), tourism (16%) and agriculture (9%). FC lending also remains high (end-1Q22: 44%), given that in our view, not all borrowers are fully hedged against lira depreciation. Single-name risk is also high. The bank's top 25 loans comprised 3.4x of common equity Tier 1 (CET1) capital at end-2021.

Loan Book Clean-Up: Sekerbank's non-performing loan (NPL) ratio (end-1Q22: 6.4%) underperforms the sector's, reflecting weaker underwriting standards and loan monitoring historically, but also the clean-up of the bank's loan book since 2018, with NPLs decreasing from 13.4% at end-2019, despite pandemic-related and Turkish operating environment pressures. Stage 2 loans are moderate (6.9% of loans, significantly below the sector average), and 50% of these were restructured. The quality of new loan origination since 2019 significantly outperforms the sector average headline NPL ratio, suggesting an improvement in underlying asset quality, underpinned by the bank's risk management framework and credit underwriting standards under its transformation programme.

Coverage of NPLs by specific reserves was moderate 78% at end-1Q22, reflecting reliance on collateral given the bank's SME focus. However, total reserves coverage of NPLs was a reasonable 98% at end-1Q22 (up from 90% at end-2021) and Stage 2 reserves coverage was 10%. The bank aims to further increase provisioning levels in 2022.

Improving Profitability: Profitability has improved in 2021 and 1Q22, driven by lower loan impairment charges but also margin widening in the lower lira rate environment. The bank reported return on equity (ROE) of 45% (annualised) in 1Q22 as lira funding costs declined to 5.4%, from 7.2% in 2021 and loan impairment charges (LICs) moderated to 24% of pre-impairment profit from 52%. We expect profitability to be solid in 2022 boosted by gains on CPI linkers in the high inflation environment, notwithstanding pressure on costs.

Weak Core Capitalisation: Core capitalisation is weak for Sekerbank's risk profile, given limited buffers over the regulatory minimum Tier 1 ratio, the small size of the equity base, asset-quality risks and sensitivity to lira depreciation (given the high share of FC risk-weighted assets; RWAs). Net of regulatory forbearance, Sekerbank's CET1 and Tier 1 ratios stood at 9.4% and 9.5%, respectively, at end-1Q22, while its total regulatory capital ratio was 14.8%, supported by FC subordinated debt (which provides a partial hedge against lira depreciation), moderately above the 12% regulatory minimum. Pre-impairment profit (3.2% of average loans at end-2021) provides a moderate buffer to absorb unexpected losses through the income statement.

Granular Deposit Base, Adequate FX Liquidity: Sekerbank is mainly funded by granular deposits (end-1Q22: 79% of non-equity funding), reflecting its widespread presence in Anatolia. Nonetheless, a high 64% of deposits were in FC (sector 58%). FC wholesale funding (11% of total funding), largely comprising funding from international financial institutions and subordinated debt (maturity in 2032) is moderate with generally medium- to long-term tenors, mitigating refinancing risks.

FC liquidity, largely comprising cash and interbank balances and government securities, is sufficient to cover short-term refinancing needs. Nevertheless, FC liquid assets are small in absolute size and insufficient to cover a material share of FC deposits in case of sector-wide deposit instability.

The bank's 'no support' GSR reflects Fitch's view that support from the Turkish authorities cannot be relied upon, given the bank's small size and limited systemic importance. In addition, support from Sekerbank's shareholders, while possible, cannot be relied upon.

SUBORDINATED DEBT RATING

Sekerbank's subordinated notes' rating has been affirmed at 'CCC' and is notched down twice from the VR anchor rating for loss severity, 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 ratings could be downgraded in case of further deterioration of the operating environment or if core capital metrics weaken below their respective minimum regulatory requirements, particularly in the absence of remedial actions. A notable deterioration of Sekerbank's FC liquidity, in case of FC deposit instability could also lead to negative rating action.

The Short-Term IDRs are sensitive to changes in the Long-Term IDRs.

Sekerbank's National Rating is sensitive to a change in the entity's creditworthiness relative to other rated Turkish issuers. Negative rating action on the LTLC IDR could lead to negative action on the National Rating.

SUBORDINATED DEBT RATING

The subordinated debt rating is primarily sensitive to a change in Sekerbank's VR anchor rating. Therefore, a downgrade of Sekerbank's VR would lead to a downgrade of the subordinated debt rating. The debt rating could also be downgraded should Fitch adversely change its assessment of non-performance risk.

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

An upgrade of the bank's ratings is unlikely in the near-term given the Negative Outlooks.

VR ADJUSTMENTS

The operating environment score of 'b' for Turkish banks is lower than the category implied score of 'bb', due to the following adjustment reasons: Sovereign rating (negative) and macroeconomic stability (negative). The latter adjustment reflects heightened market volatility, high dollarisation and high risk of FX movements in Turkey.

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

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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