Rating action

Scope Ratings UK Limited (Scope) has today downgraded its issuer rating on JSC MFO Micro Business Capital (MBC) to B from B+ and revised the Outlook to Stable from Negative.

Rating rationale

The rating downgrade reflects the erosion of MBC’s capital adequacy metrics and Scope’s expectations that these are unlikely to return to their historically higher levels in the medium-term, as well as volatile earnings.

The B issuer rating reflects the following credit considerations:

MBC ranks among the largest microfinance organisations (MFO) in Georgia, with a business model focused on collateralised loans to micro-organisations, SMEs and the agriculture sector. As part of the business strategy, MBC recently applied for a microbank license, which in Scope’s view, would benefit the execution of the strategy, offering greater diversification and opportunities on both sides of the balance sheet. However, reaping the benefits of this potential legal status change, such as gathering customer deposits to reduce funding costs, is likely to take some time.

While MBC maintains an adequate buffer above the minimum regulatory capital required for MFOs, its capital base has eroded meaningfully. This erosion mainly stems from the continuous amortisation of subordinated loans and large losses in 2022 deriving from trading in foreign currency on an open balance sheet position, and in 2023 by higher cost of risk and operational expenses. Scope notes that the capital position has stabilised since March 2023, however it is still far below previous levels. The capital adequacy ratio reached 22% at end-August 2023 (end-August 2022: 20.5%), about 400 bp above the requirement.

MBC has managed to diversify its funding mix, but foreign currency mismatch is material and hedging this risk weighs heavily on overall funding costs. MBC relies on a mix of local commercial banks, bond issuances and international financial institutions to fund its lending activities. The first bond issuance was materialised in December 2022 and together with access to international financial institutions has allowed to reduce funding costs. Still, foreign currency mismatch is material, with 47% of funding in US dollars. Hedges are in place, but their cost is weighing on earnings, representing 22% of net revenue before FX costs in 2022.

MBC’s liquidity has been volatile in the past 2 years. Due to the pressure to obtain financing at lower costs, MBC has been facing some periods of tight liquidity, however, managing to maintain levels above the regulatory requirement. Under the National Bank of Georgia’s regulation, MFOs must hold at least 18% of cash against debt maturing within six months.

Profitability metrics have deteriorated to levels lower than peers, evidencing the entity’s higher sensitivity to operational costs. However, from the second part of 2023 and after some organizational changes, performance from core operations has improved, with lower hedging costs and higher loan recoveries. Despite the improvement, we weigh on the additional expenses required to implement the banking license that will add pressure to profitability in the medium-term.

Asset quality metrics remain sound after a temporary deterioration in the first half of 2023. Net-write offs have increased in the last year due to slower collections and recoveries. At end-August 2023, loans past due by more than 30 days were 1.4% of gross loans (and about 87% are covered with guarantees) while restructured loans were 1.2% of gross loans.

MBC remains active in environmental, social and governance areas and preparing for the digital transition (ESG factor). Scope acknowledges the role microfinance organisations play in empowering local communities, improving financial inclusion, developing the domestic economy and increasing their relevance for its clientele.

One or more key drivers of the credit rating action is considered an ESG factor.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that MBC will continue to work on improving core profitability. MBC’s medium-term strategy, which includes the possibility of becoming a microbank, requires an extended period to implement, execute and reach results.

What could move the rating up:

• A track record of sustained and consistent improvements in earnings capacity
   
• A material improvement in capital metrics and sound liquidity management

What could move the rating down:

• Further pressure on profitability due to a lower ability to generate sustained revenue, higher funding costs and/or higher impairment charges
   
• Material deterioration in the company’s liquidity position as well as in its solvency metrics

Overview of rating construct

Operating environment: constraining

Business model: focused

Initial mapping refinement: high

Initial mapping: b/b+

Long-term sustainability (ESG-D): developing

Adjusted anchor: b

Earnings capacity and risk exposures: neutral

Financial viability management: adequate

Additional rating factors: neutral factor

Standalone assessment: b

External support: not applicable

Issuer rating: B

Stress testing & cash flow analysis
No stress testing was performed. No cash flow analysis was performed.

Methodology
The methodology used for this Credit Rating and Outlook, (Financial Institutions Rating Methodology, 7 February 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions - Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/uk-regulation. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Rating if the Credit Rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Rating: public domain, the Rated Entity, and Scope Ratings’ internal sources.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting the Credit Rating originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Rating and Outlook and the principal grounds on which the Credit Rating and Outlook are based. Following that review, the Credit Rating was not amended before being issued.

Regulatory disclosures
This Credit Rating and Outlook are issued by Scope Ratings UK Limited at 52 Grosvenor Gardens, London, United Kingdom, SW1W 0AU, Tel +44 20 7824 5180. The Credit Rating and Outlook are EU-endorsed.
Lead analyst: Alvaro Dominguez Alcalde, Analyst
Person responsible for approval of the Credit Rating: Nicolas Hardy, Executive Director
The Credit Rating/Outlook was first released by Scope Ratings on 3 February 2020. The Credit Rating/Outlook was last updated on 27 October 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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