Fitch Places Crystal on Watch Negative on FINCA's Acquisition
Ritch Ratings has placed JSC MFO Crystal's (Crystal) 'B' Long-Term Issuer Default Rating (IDR) on Rating Watch Negative (RWN).
The rating actions follow Crystal's announcement that it has agreed with FINCA Impact Finance to acquire FINCA Bank Georgia (FBG). The transaction is pending regulatory approval. Management expects to finalize the acquisition in April 2020, with full integration of Crystal and FBG in a single legal entity, branded as Bank Crystal, by the end of 2020.
KEY RATING DRIVERS
The RWN on Crystal's Long-Term IDR reflects a potential downgrade upon completion of the transaction, due to tight capitalization versus requirements and execution risk. The outcome would depend on the post-merger capital structure, capital adequacy levels and buffers above regulatory requirements, ability to enhance efficiency and maintain asset quality for the combined entity.
In Fitch's view, the projected core equity Tier 1 (CET1) ratio for the combined entity will likely be weaker than Georgian peers' and may no longer be commensurate with a 'B' Long-Term IDR. It also deems the planned headroom by Crystal above its reported CET1 requirement for end-2020 as very tight, particularly in view of integration risks and of its business model, which lends to higher-risk microfinance borrowers in Georgia's volatile operating environment. Crystal is still exploring different options with the local regulator in relation to its capital level and structure after the acquisition, which Fitch will re-assess once the process is finalized.
Fitch says it also sees elevated execution risk in the acquisition given the relative size, shifting regulation, as well as management-and-operational complexity of the merger.
Fitch notes it does not expect a change in the business model following the acquisition of FBG. Bank Crystal will continue lending to mainly rural microfinance borrowers, but will also increase its exposure to loans to smaller SMEs (above GEL100,000 of original loan size) to about 20% of loans. The acquisition will expand Crystal's client base and regional presence, which should be beneficial in the long term. However, the pricing power of the combined entity would remain limited relative to larger Georgian financial institutions'. Fitch also sees a positive impact from Crystal becoming subject to Georgia's prudent banking regulation.
RATING SENSITIVITIES
Fitch announced it will review the rating upon completion of the transaction. In resolving the Rating Watch, the IDR and senior debt rating are particularly sensitive to the level of capitalization of the merged entity and the extent of capital buffer above the regulatory minimum. This will be assessed in the context of risks relating to execution as well as future strategy, asset quality, profitability trends. A tight capital adequacy buffer compared with that of peers focused on retail lending or a deterioration of asset quality (Stage 3 plus annualized write-offs above 10%), pointing to looser underwriting, would also trigger a downgrade.
Conversely, the IDR could be affirmed at 'B' if the quality and capital cushion above regulations are comparable to pre-merger levels, while asset quality and profitability are expected to be in line with the pre-merger trends.
Upside is limited for Crystal's Long-Term IDR unless we see a more material strengthening of lending franchise and sustained improvements in both capitalization and funding franchise.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance for Crystal 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 to the way in which they are being managed by the entity.
Crystal has an ESG Relevance Score of 4 for governance structure, which reflects weaknesses in governance and high key-man risk. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.