Bank financial strength rating (BFSR) affirmed at E+


Moscow, June 23, 2009 -- Moody's Investors Service has today downgraded the following global scale ratings of International Bank of Azerbaijan
(IBA) (Azerbaijan): long-term and short-term local currency deposit ratings to Baa3/Prime-3 from Baa2/Prime-2, and long-term foreign currency subordinated debt rating to Ba1 from Baa3. The outlook on these ratings is now negative.

In addition, Moody's has changed the outlook on the Ba2 long-term foreign currency deposit rating of IBA to stable from positive following the recent change in outlook on Azerbaijan's Ba2 foreign currency deposit ceiling to stable from positive. Moody's notes that the long-term foreign currency deposit rating remains constrained by the country ceiling.

The bank's other ratings -- short-term foreign currency deposit rating of Not Prime, and bank financial strength rating (BFSR) of E+ -- are not affected by these actions and have therefore been affirmed.

REFINED SYSTEMIC SUPPORT ASSESSMENT

Today's rating action concludes the review for possible downgrade initiated by Moody's on 26 May 2009, which focused on Azerbaijan's ability to provide support to its banking system, as outlined in the rating agency's Special Comment entitled "Financial Crisis More Closely Aligns Bank Credit Risk and Government Ratings in Non-Aaa Countries", published in May 2009.

Moody's has refined its assessment of the ability of the Azerbaijani state to provide systemic support as the worsening of the local economy and the resulting reduced financial capacity and policy flexibility may adversely affect the Azerbaijani government's ability to support the banking sector.

Moody's previously used the local currency deposit ceiling (LCDC; Baa1 in the case of Azerbaijan) as the main input for its assessment of the ability of the national government to support the banks. Although anchoring the probability of support at the LCDC is appropriate in most circumstances -- regarding the provision of liquidity to a selected number of institutions over a short period of time -- this might overestimate the capacity, and even willingness, of a central bank to support financial institutions in the event of a banking crisis becoming both truly systemic and protracted.

Moody's therefore believes that the government's local currency debt rating (usually adjusted by no more than two notches of uplift due to the array of tools available to the central bank to support the banking
system) should have a greater weight when considering the ability of the government to provide systemic support.

The refined approach allows two notches of uplift from the government bond rating as the main input for its assessment of the ability of the national government to support the banks; however, given the weakening economic condition in Azerbaijan, Moody's considers a one-notch uplift to be more appropriate, reflecting the rating agency's view that the probability of the risk that systemic banking losses in the system will occur is medium. Thus, the anchor used for measuring the influence of the systemic support on banks' ratings is now Azerbaijan's government bond rating of Ba1 plus one notch, resulting in a Baa3 input.

As a result of the amended support considerations, IBA's GLC deposit ratings of Baa3 receives a five-notch uplift from the Baseline Credit Assessment (BCA) of B2, based on Moody's assessment of a very high probability of systemic support in case of need. This is based on the bank's dominant market share in Azerbaijan and its vital importance to the country's payments system.

Amid the recent crisis, the Azerbaijani government has been supportive by providing short-term liquidity to a number of banks facing repayments of foreign debt. At the same time, the credit stress in the banking system has increased significantly, with non-performing and restructured loans reaching double-digit levels. The total foreign borrowings of Azerbaijani banks amount to a manageable level of around US$2 billion, with approximately half to be repaid this year; the bulk of this amount is due from IBA as the largest bank in the system.

According to Moody's, IBA remains the largest and the only state-controlled bank in the country. The bank enjoys a strategic role and government commitment since it has historically been instrumental in implementing state investment and economic policies, acting as an agent of the government in financing large-scale projects of national importance to Azerbaijan.

WEAKENING FINANCIAL FUNDAMENTALS

The negative outlook on IBA's local currency deposit rating and foreign currency subordinated debt rating reflects Moody's concerns that the weakening operating environment in Azerbaijan, coupled with the funding constraints are likely to adversely affect IBA's asset quality, liquidity and, ultimately, capitalisation going forward.

Moody's is anticipating potential credit problems within the corporate segment as it accounts for the largest portion of IBA's loan book (86%).
The rating agency is mainly concerned about those industries that are most exposed to the economic downturn and to the fall and volatility in commodity prices -- construction and manufacturing sectors in particular.
The bank's credit exposure to the construction and aluminium sector -- which has been particularly affected by the crisis -- exceeds 200% of its Tier 1 capital. Also, the high level of borrower concentration adds volatility to the bank's asset quality indicators, as the default of only one large borrower would inevitably result in material deterioration of the portfolio's quality.

PREVIOUS RATING ACTIONS AND METHODOLOGIES

On 19 June 2009, Moody's changed to stable from positive the outlook on the Republic of Azerbaijan's Ba2 country ceiling for foreign currency bank deposits and the Baa2 country ceiling for foreign currency bonds.
The local currency country ceilings for bonds (A3) and bank deposits
(Baa1) were affirmed, both with stable outlook. Similarly, there is no change in the Prime-2 country ceilings for short-term ratings for foreign currency bonds and Not Prime bank deposits.

The last rating action on IBA was on 26 May 2009, when Moody's placed the
Baa2 global local currency deposit rating and Baa3 foreign currency subordinated debt rating on review for possible downgrade.

The principal methodologies used in rating this issuer were "Bank Financial Strength Ratings: Global Methodology" (February 2007) and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" (March 2007), which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

Headquartered in Baku, Azerbaijan, International Bank of Azerbaijan reported total assets of AZN3.8 billion (US$4.8 billion) and shareholders' equity of AZN384.4 million (US$479.9 million) under IFRS at year-end 2008.