On September 5th, Russian Standard Bank (RUSB, Ba2 neg/BB- neg/BB- neg) released H1 2008 IFRS results. Profitability improved after a sharp fall in H2 2007, while asset quality shows signs of stabilisation. Low efficiency still weighs on bottom-line results, and funding constrains force the bank to shrink its balance sheet. In our view, the published results are neutral for the bank's credit standing and will not fundamentally impact spreads on Russian Standard's outstanding Eurobonds. We stick to our neutral recommendation on the name. From the relative value point of view, the bonds are cheap compared to their peers, and we recommend a marketweight position in senior RUSB 8.485% due 06/10 and in subordinated RUSB 8.875% due 12/15 (call 12/10) versus JP Morgan RUBI CORP Bank Index. We keep an underweight recommendation on other Russian Standard’s Eurobonds.

 

Russian Standard versus HCFB

Source: Bloomberg

 

Asset quality

 

It now seems that tighter underwriting standards, which the bank introduced in H2 2007 to reflect lower yields on its products and higher funding costs, start to positively impact the asset quality. In H1 2008, credit write-offs slowed down to 6.2% of gross loans from 10.3% in H1 2008, while non-performing loans (NPLs) dropped to 3.8% of gross loans (H2 2007: 5.5%). NPLs are to 153% covered by loan loss reserves. However, during 2007 and H1 2008 the bank recovered loans totalling RUB 3.5 bn previously written off as uncollectible. These amounts were added to the reserve stock. We therefore calculated an adjusted coverage ratio of 95%, which we regard only as adequate. On a separate note, Russian Standard changed the disclosure format for NPLs, which are currently classified as 120 days overdue (previously 90 days overdue). In our opinion, this slightly deflates NPLs ratio.

Profitability

 

In H1 2008 the bank turned back to profitability with bottom line result reaching RUB 5.1 bn. Despite falling interest income and rising funding costs, net interest margin stood at high 19.6%, which still gives Russian Standard some room for manoeuvre in case of further margin compression. We note that bottom line results were boosted by falling provision burden and insurance income earned through Russian Standard Insurance, which was acquired and fully consolidated in October 2007. At the same time, net fee and commission income was in a negative territory due to the cancellation of fees and commissions on certain product under pressure of Russian Antimonopoly Committee in H2 2007. Overall RoAA of 2.2% was depressed by negative net profit in H2 2007, and for 2008 we expect this indicator to stabilise at 4-5%.

 

Efficiency…

 

…is a weak point. Despite some improvement in cost / income ratio, cost basis still remains exceptionally high with operating expenses totalling as much as 11.2% of average earning assets. We especially want to highlight that such cost basis looks poor especially in the light of the recent changes in risk/return profile of the bank.

 

Funding, liquidity and capitalisation

 

Although Russian Standard was able to print several private and bilateral deals, access to capital markets still remains restricted. According to our expectations, share of customer funds increased only marginally to reach 14.2% of non-equity funding at end-H1 2008 (2007: 11.6%). We still believe that deposit collection capability is limited by the current format of the bank’s branch network. Despite constrained funding capability, we view positively liquidity profile as short-term amortising consumer loans provide Russian Standard with constant liquidity inflows. Despite the dividend payment of RUB 4 bn, equity cushion is sufficient to cover unexpected credit losses.

 

Outlook revision by Fitch

 

The rating agency noted that “the prolonged capital markets weakness and resulting difficulty in getting incremental funding makes RSB's business model increasingly vulnerable”. We believe that this comment does not provide market participants with new information. Seemingly we have not seen any reaction in the bonds yet. Currently all three rating agencies keep negative outlooks on Russian Standard’s ratings. In our opinion, a rating downgrade of even two notches is currently priced in.