Fitch Affirms 2 Georgian Microfinance Organisations

Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of JSC MFO Crystal at 'B' and JSC Microfinance Organisation Swiss Capital at 'B-'. The Outlooks are Stable. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS AND SENIOR DEBT

Crystal and Swiss Capital focus on consumer and micro lending in the high-risk Georgian operating environment.

The ratings are constrained by the companies' monoline business models, limited franchises, recent rapid growth, the unsettled operating and regulatory environment, as well as reliance on wholesale funding. Strong financial metrics, particularly profitability, asset quality (for Crystal) and capitalisation (for Swiss Capital) support the ratings.

The companies have notable market shares in the Georgian microfinance sector (Crystal - 25%, Swiss Capital - 6%), but a low 1.0% and 0.2%, respectively, of the broader financial sector. Crystal focuses on loans for both consumer and business purposes (67% of end-2018 gross loans) and agricultural loans (28%). Swiss Capital focuses on consumer loans collateralised by car (74% of end-2018 gross loans) and by real estate (16%), while the uncollateralised portfolio (10%) is in run-off mode.

The microfinance sector in Georgia is undergoing regulatory changes, with increasing scrutiny from National Bank of Georgia. The companies, particularly Swiss Capital, have to adjust their strategy to adapt to frequent regulatory changes including a ban on lending in foreign currency (FC), tightening of interest rate cap (to 50%) and underwriting standards, prudential limits on liquidity and capital, reporting standards and restrictions on funding.

Crystal aims at less risky microfinance lending, as reflected by the low share of Stage 3 loans (3.2% at end-2018) and modest NPL generation (3.1% in 2018). Swiss Capital has higher tolerance for credit risk with Stage 3 loans amounting to 17% of gross loans and NPL generation at 9.7%. Crystal reported strong reserve coverage of Stage 3 loans at 475% while Swiss Capital had low 57% reserve coverage with net Stage 3 loans amounting to 12% of equity. Collateralised nature of lending partially mitigates risk for Swiss Capital but 2018 Stage 3 recoveries represented a modest 16% of newly recognised problems.

Both companies have a limited legacy FC portfolio (Crystal - 4% of end-2018 loans, Swiss Capital - 8%) in run-off mode since new origination is banned by the regulator. Fitch expects gradual deterioration of asset quality for Crystal upon seasoning of its loan book (36% growth of gross loans in 2018) and stabilisation, albeit at a quite weak level, for Swiss Capital.

Profitability is a credit strength for both companies as a function of high net interest margins (19% for Crystal, 46% for Swiss Capital) coupled with adequate efficiency (cost-to-income 80% and 51%, respectively). Provisioning cost consumed low 12% of Crystal's pre-impairment profit but higher 31% for Swiss Capital resulting in a robust return on average assets of 4.7% and 13.8%, respectively. Fitch expects an improvement in Crystal's profitability subject to its ability to control costs and a moderation of Swiss Capital's performance as the interest yield (50% on average in 2018) will be constrained by the recently introduced cap (at maximum 50%).

With 3.6x debt-to-tangible equity and 21% equity to assets in March 2019 Crystal had only a limited cushion above the regulatory capital adequacy requirement. The requirement will step-up to 18% since June-2019 (from 16% at end-2018) as regulation tightens. Crystal attracted a GEL10 million (19% of end-2018 equity) injection from its shareholders in March 2019. The company also plans to renew its subordinated debt maturing in June 2019. If successful, this would underpin medium-term growth plans that would otherwise be constrained by internal capital generation (26% average in 2016-2018).

Swiss Capital operates with low leverage, which mitigates its riskier business model. End-2018 debt-to-tangible equity was 0.8x and management plans to maintain it below 1.0x in the medium term, supported by strong earnings and profit retention (76% in 2018). Swiss Capital's end-2018 equity-to-assets amounted to 57%, providing a comfortable cushion above the forthcoming regulatory requirement of 18%, sufficient to create additional provisions at 46% of gross loans.

Crystal has historically relied on wholesale funding and enjoys established relationships with a wide range of providers as well as reasonable diversification with the five largest sources amounting for 42% of total funding.

Swiss Capital funding needs are lower due to a high proportion of equity. The company relied on funding from individuals but had to shift to wholesale funding after the regulator imposed regulatory limitations on quasi-retail funding. Two local banks amounted to 47% of Swiss Capital's funding at end-2018, representing high concentration. Another 19% of funding came from related parties. Management plans to diversify its wholesale funding and finalise the shift to wholesale sources in 2019.

Both companies aim to shift towards local currency funding. This represented 48% of Crystal's end-2018 funding and 59% for Swiss Capital. The companies tapped the local capital market with debut bonds (GEL10 million each) in 2H18 (Crystal) and 1H19 (Swiss Capital). Local bonds accounted for 9% of funding at Crystal and 27% at Swiss Capital in March 2019. Both companies plan further modest issuance.

RATING SENSITIVITIES

IDRS AND SENIOR DEBT

The ratings for both companies are sensitive to changes in the operating environment (stronger driver for Crystal's ratings) and regulatory framework (Swiss Capital).

Crystal

The ratings could be upgraded in case of strengthening of Crystal's franchise, diversification towards local currency funding and an extended record of good control of credit risk.

A depletion of the cushion over regulatory capitalisation requirement that would constrain the business, weakening of capital quality or significant deterioration of asset quality (Stage 3 above 10%) pointing to looser underwriting and leading to capital erosion would trigger a downgrade.

Swiss Capital

Upgrade potential is limited and would require a notable strengthening of franchise and a record of stable performance upon completing the business repositioning after the recent regulatory changes.

The company's inability to successfully complete the shift towards wholesale funding that triggers refinancing risk would result in a downgrade, as would a sharp increase in leverage (debt-to-tangible equity above 3x).

The rating actions are as follows:

JSC MFO Crystal

Long-Term Foreign- and Local-Currency IDRs: affirmed at 'B'; Outlook Stable;

Short-Term Foreign- and Local-Currency IDRs: affirmed at 'B';

Senior unsecured issue rating: affirmed at 'B' with a Recovery Rating of 'RR4'

JSC MFO Swiss Capital

Long-Term Foreign- and Local-Currency IDRs affirmed at 'B-'; Outlook Stable

Short-Term Foreign- and Local-Currency IDRs affirmed at 'B'

Senior unsecured issue rating assigned at 'B-' with a Recovery Rating of 'RR4'