Overview

• We continue to consider that Russian state-owned development corporation VEB.RF (VEB) has an almost certain likelihood of receiving extraordinary support from the Russian government in all circumstances.
• We are therefore affirming our 'BBB-/A-3' long- and short-term foreign currency issuer credit ratings and our 'BBB/A-2' long- and short-term local currency ratings on VEB.
• The stable outlook reflects that on Russia.

Rating Action

On July 26, 2021, S&P Global Ratings affirmed its 'BBB-/A-3' long- and short-term foreign currency issuer credit ratings and its 'BBB/A-2' long- and short-term local currency ratings on Russian state-owned development corporation VEB.RF (VEB). The outlook is stable.

Rationale

The ratings reflect our opinion of VEB as a government-related entity (GRE) with an almost certain likelihood of receiving extraordinary support from the Russian government in the event of financial difficulties.

Accordingly, we equalize our ratings on VEB with those on Russia (see "Russia 'BBB-/A-3' Foreign Currency And 'BBB/A-2' Local Currency Ratings Affirmed; Outlook Stable," published July 16, 2021). In accordance with our criteria for GREs, we base our view of an almost certain likelihood of extraordinary government support on our assessment of VEB's:

• Critical role for Russia as the government's prime public development institution, a role that cannot be readily undertaken by a private entity. The VEB group's assets currently represent a sizable 3% of Russia's GDP; and
• Integral link with Russia. This is because of VEB's unique status as a state corporation operating under an institution-specific law, with strong oversight from the federal government, the key members of which are on the supervisory board. All of VEB's strategic decisions are made with the approval of the supervisory board. Also, the government has a proven track record of providing timely support to VEB in all circumstances, including through annual direct capital injections to VEB and a budgeted commitment for further injections. Furthermore, high-ranking government and central bank officials have reiterated the government's strong commitment to VEB since the imposition of U.S. sectoral sanctions.

In late 2020, the Russian government announced the reform of the country's development institutions, which we believe will boost VEB's role as the state's key policy arm with the aim of filling market gaps and providing development finance. The new framework legislated in July 2021 aims at streamlining existing development institutions, placing some of them under VEB's supervision, and calibrating their policy mandates so that they correspond to national long-term development goals. We understand that SME Corporation (total assets over Russian ruble [RUB] 210 billion or 0.2% of GDP) will ultimately be consolidated into VEB's group. The bank will coordinate setting policy and performance targets for other institutions and supervise their risk-management policies. VEB will not assume any assets or liabilities of development entities outside its group.

This broad policy initiative will likely be reflected in VEB's new long-term strategy for 2021-2024, which is currently under discussion. It will likely feature new mandates, on top of existing functions of supporting infrastructure, urban economy, high-value-added manufacturing, boosting non-commodity exports, and catalyzing private investments. At the same time, VEB will remain a government agent for managing external sovereign debt, as well as an asset manager of the Russian state pension fund, with assets under VEB's management totaling about RUB1.9 trillion (1.6% of 2021 GDP).

In our view, the reform as well as the size and type of projects VEB has financed continue to make it almost irreplaceable either by any other Russian development institution or by a commercial bank. This is although the bank's loan portfolio has shrunk since its peak in 2015, after access to foreign capital markets was lost due to international sanctions. VEB currently participates in more than 200 projects with a total value of RUB10.8 trillion and VEB's stake of about RUB3.8 trillion. We forecast VEB will moderately expand its loan book during the next 18-24 months. We also note that the institution is also used as one of the support channels to the economy amid the COVID-19 pandemic: since last spring VEB has issued guarantees against commercial bank's low-interest loans to businesses of RUB600 billion (0.5% of GDP).

We expect VEB's loan growth to be supported by regular capital injections. Government capital support of RUB300 billion is also possible under the "callable capital" scheme. Although the legal framework for this scheme was set up only in early 2019 and needs to be tested, the government has publicly expressed its willingness and commitment to support VEB's business growth. We note that, in recent years, the government's plans to financially support VEB have been met in full and on time.

After capital injections in past years, the government significantly boosted VEB's capital again in 2020. Following the sale of 50% of Sberbank from Russia's central bank (CBR) to the government, CBR's deposit previously held in VEB was converted into equity. Factoring in other cash injection, in 2020 VEB's capital buffer increased by over 60% compared to end-2019, lifting its capital adequacy ratio calculated under the CBR's rules to 17.0% from 13.6% in 2019.

In 2020, VEB reported a modest net profit of RUB8.4 billion after cumulative net losses of about RUB850 billion over 2014-2019. Past losses stemmed from provisioning needs against the loan book's impairment. The public nature of the bank's business model, including its exposure to risker projects suggests that VEB's future profitability will remain constrained. Net losses are also possible, but not at the same magnitude as in the past several years considering improvements in VEB's risk management and underwriting standards.

Despite improvements in asset quality in recent years on the back of concerted efforts by both management and the government, as of year-end 2020 Stage III loans classified under International Financial Reporting Standard 9 stood at slightly below a sizable 40% of the bank's gross loan book. A notable share of loans issued by VEB over the past several years has been extended to distressed borrowers, specifically large Russian corporate groups. At the same time, we believe that the majority of legacy problem exposures have been addressed by now, and we expect a gradual improvement of the bank's asset quality in the medium term.

By mid-2021, VEB repaid a major part of its external public debt issued before 2014. The next scheduled payments on external bonds are $1 billion in 2022, $1.75 billion in 2023, and $1 billion in 2025. Given existing liquidity buffers (cash and cash equivalents stood at about 10% of total assets as of March 31, 2021) as well as the bank's tested ability to issue in the domestic market, we do not see risks to foreign debt repayment/refinancing plans. We also understand that, in light of international sanctions imposed on VEB in 2014 that constrain its access to foreign capital markets, the government intends to keep supporting the bank's foreign-currency debt repayments via direct capital injections, in line with its track record since 2015, when it explicitly assumed and then financed VEB's external debt-servicing needs.

Given VEB's high strategic importance to the government, we view the bank's liabilities as resilient to a loss of market confidence. At the end of the first quarter of 2021, about 23% of the bank's liabilities stemmed from the National Welfare Fund, the Russian government, and the CBR.

Because we equalize our ratings on VEB with those on the sovereign, we do not consider the institution's stand-alone credit profile to be a rating driver. This reflects our view that the likelihood of extraordinary government support to service debt is almost certain, and we currently do not consider this support subject to transition risk.

Outlook

The outlook on VEB mirrors the outlook on Russia. Future rating actions in the next 18-24 months on VEB, positive or negative, will likely mirror those on the sovereign.

Downside scenario

We might take a negative rating action--even if the sovereign rating remains unchanged--if we concluded that the potential strategic shifts for VEB, as well as government policies, had resulted in a weaker public policy role for VEB or a weaker link with the state. For example, this could be signaled by a rapidly rising risk of a material weakening of VEB's capitalization or liquidity.

Upside scenario

We would likely upgrade VEB if we took a similar action on Russia.

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• Russia 'BBB-/A-3' Foreign Currency And 'BBB/A-2' Local Currency Ratings Affirmed; Outlook Stable, July 16, 2021

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