Moody's downgrades three Mongolian banks following sovereign downgrade

Global Credit Research - 18 Jul 2014

Hong Kong, July 18, 2014 -- Moody's Investors Service has downgraded the local currency long-term deposit ratings for Khan Bank LLC, XacBank LLC, and Trade and Development Bank of Mongolia LLC (TDBM) to B2 from B1. At the same time, Moody's has downgraded the foreign currency long-term senior unsecured debt ratings for TDBM to B3 from B1.

The outlook for all the ratings is negative.

See below for a full list of the ratings, both downgraded and affirmed.

The rating action follows Moody's downgrade of Mongolia's sovereign ratings to B2 from B1 on 17 July 2014. Please see the related press release on www.moodys.com.

RATINGS RATIONALE

The rating action on the three banks' ratings is based on the consideration that the creditworthiness of the Mongolian banking system is highly correlated to the sovereign. The sovereign downgrade was driven by its strained external liquidity position, as reflected by a sharp loss in foreign-exchange reserves.

Furthermore, expansionary monetary and fiscal policies have added to demand pressures, fuelled inflation, and heightened spillover risks to the banking system and the balance of payments. Accompanied by a continued rise in the external debt burden, these factors increase the country's vulnerability to external and domestic shocks relative to rating peers.

Separately, Moody's rating action on the three banks also takes into account the risks to the banks stemming from the Mongolian government's pump-priming measures, some of which are heavily credit-driven.

Specifically, the Bank of Mongolia -- in addition to policy-rate reductions and fiscal spending -- provided MNT4.3 trillion ($2.6 billion) in loans to the banking system as of end-2013, representing about 40% of total credit for the banking system.

The banks on-lent these loans to targeted industries and their assets accordingly grew by 74% and loans by 54% during 2013.

These developments -- against the current backdrop of macro-economic and export deterioration -- have increased the risks to the banks' liquidity, profitability, asset quality and ultimately -- their capital adequacy.

Liquidity conditions for the banks continue to tighten as loan growth exceeds deposit growth. The system's loan-to-deposit ratio jumped to 97% at end-2013 from 85% a year ago.

Meanwhile, profitability is shrinking, as the banks lower lending rates to support the government's accommodative policies, while maintaining relatively high deposit rates to stem the deterioration in their funding profiles.

Moody's expects the banks' asset quality performance to deteriorate further during the rest of 2014 and into 2015, as the economy remains under pressure, and as loans booked during the continuing credit boom season.

For example, asset quality has deteriorated in the mining and manufacturing sectors, whose NPL ratios stood at 17.9% and 6.4% at end-March 2014, compared to 12.2% and 3.3% a year ago.

The construction sector has not shown a material deterioration and the NPL ratio for the sector stood at 2.9% at end-March 2014. However, loans to the sector grew by 123.7% year-on-year at end-March 2014, twice as fast as systemic loan growth at 54.5%. Once the loans season, we expect substantial asset quality deterioration.

Moreover, the mining sector remains vulnerable to continued slides in commodity prices and demand, while the manufacturing and construction sectors remain exposed to the subdued state of domestic economic growth.

Below we discuss each individual bank.

Trade and Development Bank of Mongolia

Moody's has lowered TDBM's baseline credit assessment (BCA) to b3 from b2. TDBM's BCA of b3 reflects its: (1) solid market position as a leading corporate lender in foreign exchange and trade-related businesses; and (2) diversified funding sources from both domestic depositors and foreign financial institutions.

However, the ratings are constrained by the bank's vulnerability to a deterioration in asset quality, given its high loan concentration and portfolio of corporate loans.

TDBM's top 20 group borrower exposures were equivalent to 366% of its Tier 1 capital, two times higher than those of Khan Bank and XacBank at end-March 2014. More than 50% of these borrowers are also in risky sectors, such as mining and construction. These sectors accounted for 19.4% and 18.1% of its total loans, respectively, at end-March 2014.

TDBM's BCA of b3 also reflects potential challenges related to corporate governance that could arise from its narrow shareholding structure.

Moody's has not incorporated any systemic support notching uplift to TDBM's B3 foreign currency unsecured debt rating, given its assessment of limited foreign currency support capacity of the Mongolia government. This is despite the systemic importance of TDBM -- as the second-largest lender in terms of loans -- in the Mongolian banking system.

However, Moody's has incorporated one notch of systemic support to its local currency deposit rating of B2, given the proven track record of the Mongolian government of providing support to depositors of failed banks such as Anod Bank (unrated), Zoos Bank (unrated) and Savings Bank (unrated). Moody's expects the government to support deposits at banks that are considered to be of high systemic importance to the economy.

Khan Bank

Moody's has lowered Khan Bank's BCA to b2 from b1. Its BCA of b2 reflects its (1) strong franchise in Mongolia as the largest bank in terms of loans, as well as its extensive nationwide branch network, the largest among all domestic banks; and (2) relatively granular loan book given that retail borrowers accounted for over 60% of its total loan portfolio at end-March 2014.

The ratings do not incorporate any uplift for systemic support because Mongolia's sovereign rating is also B2.

XacBank

Moody's has lowered XacBank's BCA to b2 from b1. The bank's b2 BCA reflects its (1) growing franchise and well-established expertise in micro-finance; and (2) relatively low credit concentration risk.

The bank's local currency deposit rating does not incorporate any uplift for systemic support because the sovereign rating for the Mongolian government is the same as the bank's standalone rating of B2.

What Could Change the Rating - Up

Given that the B2 issuer ratings assigned to Khan Bank and XacBank are the same as the sovereign rating, an upgrade of the banks' ratings is unlikely. A return to a stable outlook would require a return to a stable outlook on the sovereign rating, as well as evidence that asset quality pressures can be contained as loan books season.

Upward pressure on the B3 issuer rating of TDBM could occur if it substantially reduces its borrower concentration and exposure to risky sectors.

What Could Change the Rating - Down

The following factors could exert negative pressure on the three banks' ratings: (1) corporate governance-related problems that cause a loss of depositor confidence, therefore increasing the threat of a deposit flight; (2) a significant deterioration in asset quality; for example new NPLs to gross loans exceeding 4.0%; (3) a rise in concentrations, or a rise in exposures to risky sectors, in particular construction; (4) the Tier 1 ratio falling below 9%; or (5) a significant deterioration in profitability, such that net income is less than 1.4% of average risk weighted assets.

The resultant ratings and actions are listed below:

Trade Development Bank of Mongolia --

• baseline credit assessment of b2 lowered to b3;

• local currency bank deposits rating of B1 downgraded to B2;

• foreign currency bank deposits rating of B2 downgraded to B3;

• issuer rating of B1 downgraded to B3;

• local currency long-term senior unsecured of B1 downgraded to B3;

• foreign currency long-term senior unsecured debt/subordinated debt of B1/B2 downgraded to B3/Caa1; and

• foreign currency long-term senior unsecured MTN/subordinated MTN of (P)B1/(P)B2 downgraded to (P)B3/(P)Caa1.

The revised ratings all carry negative outlooks.

All other ratings were affirmed: Bank Financial Strength of E+; local currency/foreign currency short-term deposits rating of NP; local currency/foreign currency short-term issuer rating of NP; and ST MTN program rating of (P)NP.

Khan Bank --

• baseline credit assessment of b1 lowered to b2;

• local currency bank deposits rating of B1 downgraded to B2;

• foreign currency bank deposits rating of B2 downgraded to B3;

• issuer rating of B1 downgraded to B2; and

• local currency/foreign currency long-term senior unsecured

MTN/subordinated MTN of (P)B1/(P)B2 downgraded to (P)B2/(P)B3.

The revised ratings all carry negative outlooks.

All other ratings were affirmed: Bank Financial Strength of E+; and local currency/foreign currency short-term deposits rating of NP.

XacBank --

• baseline credit assessment of b1 lowered to b2;

• local currency bank deposits rating of B1 downgraded to B2;

• foreign currency bank deposits rating of B2 downgraded to B3;

• issuer rating of B1 downgraded to B2; and

• foreign currency long-term senior unsecured MTN of (P)B1 downgraded to (P)B2.

The revised ratings all carry negative outlooks.

All other ratings were affirmed: Bank Financial Strength of E+; local currency/foreign currency short-term deposit rating of NP; local currency/foreign currency short-term issuer rating of NP; and ST MTN program rating of (P)NP.

The principal methodology used in these ratings was Global Banks published in May 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Trade and Development Bank of Mongolia LLC, based in Ulaanbaatar, reported total assets of MNT5.1 trillion (US$3.1 billion) as of end-2013.

Khan Bank LLC, based in Ulaanbaatar, reported total assets of MNT4.8 trillion (US$2.9 billion) as of end-2013

XacBank LLC, headquartered in Ulaanbaatar, reported total assets of MNT1.8 trillion (US$1.1 million) as of end-2013.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

The first name below is the lead rating analyst for this Credit Rating and the last name below is the person primarily responsible for approving this Credit Rating.

Hyun Hee Park
Analyst
Financial Institutions Group
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Stephen Long
MD - Financial Institutions
Financial Institutions Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077