S&P: Croatia-Based Zagrebacka Banka Rating Raised To 'BB+' Following Sovereign Upgrade; Outlook Stable

S&P Global Ratings today raised its long-term rating on Zagrebacka Banka dd (Zaba) to 'BB+' from 'BB'. The outlook is stable.

The rating action mirrors our recent upgrade of Croatia. Now that the sovereign rating is 'BB+', we can factor one notch of extraordinary group support into our issuer rating on Zaba.

Our long-term rating on the bank remains capped at the sovereign level. This is because we think it highly unlikely that UniCredit's support would be sufficient to withstand Croatia defaulting.

With 2.8% GDP growth in 2017, Croatia is continuing the upward economic trend that started in 2015 after six years of recession. We now believe that the economy will grow by a cumulative 7.8% in 2018-2020, mainly driven by external and domestic demand.

These more favorable economic conditions, together with an active secondary market for nonperforming exposures (NPEs) disposals, should support a recovery in the domestic private sector's creditworthiness, in our view.

We are therefore expecting domestic banks' asset quality to gradually improve in 2018-2020. Specifically, we anticipate that Croatian banks will likely report a cost of risk as high as 180 basis points of their customer loans in 2018, while decreasing to a more normal level of about 109% in 2019. Our forecasts factor in the base-case scenario of an orderly resolution of Agrokor, which currently exposes the banking system to a rather large stock of NPEs.

In this context, we expect Zaba to remain focused on working-out its NPE portfolio over the next two years, although we anticipate that its NPE ratio will likely remain above the system average given its higher starting point--its NPE ratio was 15.4% as of end-2017 compared to a system average of 11.3%--and its higher-than-system-average exposure to Agrokor.

The bank is likely to increase its provisioning for its exposure to Agrokor in 2018. We incorporate this in our current capitalization forecast of 40-50 additional basis points, which informs our cost-of-risk projection.

At the moment, uncertainty lingers as to the final resolution of the Agrokor case but we expect to have more clarity before July this year. If the details of the resolution differ materially from our current assumptions, we will reassess our risk-adjusted capital (RAC) ratio forecast.

Our rating incorporates Zaba's high single-name concentration with its top-20 corporate exposures standing at about 0.9x its total-adjusted capital as of Dec. 31, 2017. This high concentration, resulting from its being a corporate bank in a small economy and its material exposure to Agrokor, will continue to weigh on the rating.

At the same time, we expect Zaba to continue reporting good capitalization and maintaining a RAC ratio between 9% and 10% (9.8% as of Dec. 31, 2017) over the next 18-24 months.

The outlook on Zaba is stable, mirroring that on Croatia. It incorporates our view that Zaba will preserve its strategic role within the UniCredit group over the next 12 months as an important conduit for the group's retail and corporate activities in Croatia and Bosnia and Herzegovina.

It also reflects our view that a potential deterioration in the bank's risk position and capital--either from a materially worse-than-expected resolution of Agrokor and/or the default of other large exposures--would not in and of itself lead to a downgrade. This is because we would incorporate another notch of extraordinary group support, in accordance with our methodology. Nevertheless, this is not our base-case scenario.

We could raise our long-term rating on Zaba following a similar action on the sovereign, all else remaining the same.

We could lower our long-term rating on Zaba if we lowered our rating on Croatia. We could also lower our long-term rating on Zaba if we came to believe that its strategic importance within the UniCredit group had materially diminished.
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