Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of three Uzbekistan-based private banks, Joint Stock Innovation Commercial Bank Ipak Yuli (IY) and PJSB Trustbank (TB) at ‘B’ and of JSCB Universal Bank (UB) at ‘B-’. The Outlooks on all banks are Stable.

The Long-Term IDRs of the three banks are based on their intrinsic creditworthiness, as reflected in their Viability Rates (VRs). The ‘b’ VRs of TB and IY capture their good asset quality and robust profitability, and stable capital and funding profiles. UB’s VR is one notch lower, reflecting the bank’s much more aggressive loan growth in recent years, looser underwriting standards, some corporate governance weaknesses and weaker performance.

All banks’ ratings are constrained by Uzbekistan’s still challenging and volatile operating environment which, in Fitch’s view, has a higher relative influence on credit profiles of TB and IY.

The banks operate in a low-income economy (per capita GDP was USD1,700 in 2019). The banking system is highly dollarised, with foreign currency (FC) loans making up 58% of sector loans at end-3Q19, and dominated by state-owned banks that accounted for 86% of total assets. Positively, healthy economic growth in Uzbekistan (we expect real GDP growth at 5.5% in 2019 and 5.9% in 2020) and gradually improving banking penetration support the sector’s dynamics.

In Fitch’s view, the ongoing structural banking reform, aimed at curtailing policy lending and reducing the dominance of the state in the banking system, could positively affect the Uzbekistan banking sector.

Asset quality metrics are strong at all three banks, with the latest reported impaired (Stage 3) loans making up 1.6% of gross loans at TB and 2.4% at IY and UB. These were fully covered by loan loss allowances (LLAs) at TB, while YI and UB had somewhat lower reserve coverage (90% and 69%, respectively).

We consider TB’s and IY’s asset quality as relative rating strength for both banks. TB benefits from a large proportion of low-risk assets (44% of end-1H19, mainly liquidity with Central Bank of Uzbekistan (CBU)), and low dollarisation of its loan book (12% of gross loans at end-10M19 compared with 49% at IY). Credit risks at IY are mitigated by lower single-name concentration (the 20-largest exposures made up 20% of gross loans at end-3Q19 compared with 43% at TB and 36% at UB), and good coverage by hard collateral. UB’s asset quality is weaker, reflecting recent loan growth (about 60% in 10M19, annualised, FX-adjusted), high concentrations, and greater exposure to long-term, FC-denominated, non-amortising project finance loans, potentially indicating some deficiencies in underwriting standards.

TB and IY have demonstrated robust and stable profitability in recent years, with operating profit/risk-weighted assets (RWAs) ratios of, respectively, 8% and 6% in 6M19. These are supported by the banks’ strong margins (11% at IY; 16% at TB), high operating efficiency (cost-to-income ratio of about 40% in 6M19) and low funding costs (especially at TB due to cheap funding from related party). UB’s performance is markedly weaker (operating profit/RWAs at 2% in 2018), undermined by high cost of funding and operating expenses (cost-to-income ratio at over 70% in recent years).

Capitalisation is moderate at all three banks, considering asset quality risks and rapid growth. Regulatory capital ratios were tighter at IY, with Tier 1 and Total capital equalling, respectively, 11% and 14% of regulatory RWAs at end-3Q19, only slightly above the regulatory minimums of 10% and 13%, respectively. Regulatory capitalisation at TB and UB was somewhat higher (Tier 1 ratios at 13% and 15%, respectively), providing them with better loss absorption capacity (7%-8% of gross loans versus 2% at IY).

Customer accounts remain by far the main source of funding for TB (over 90% of total liabilities at end-1H19) and UB (about 85% at end-10M19). They are highly concentrated at TB, with a single, related-party customer (Uzbekistan Commodity Exchange, UzEx) making up a sizable 61% of customer accounts at end-1H19, but liquidity risks are mitigated by high stability of its accounts in recent years.

IY’s funding is roughly equally split between customer accounts and wholesale funding. The latter were formed by long-term borrowings from international development institutions and foreign commercial banks, which mitigate short-term refinancing risks.

Liquidity profiles were comfortable at all three banks, with liquid assets (cash on hand and short-term placements with the CBU) covering 29% of customer accounts at UB at end-10M19, 37% at IY at end-1H19, and a high 50% at TB at end-1H19.

The banks’ ‘5’ Support Ratings and Support Rating Floors of ‘No Floor’ capture their very limited franchises in a highly concentrated banking sector and thus their low systemic importance, so support from the Uzbek authorities cannot be relied upon in case of need.

Upside for TB and IY could stem from an improvement of Uzbekistan’s operating environment, including successful completion of the banking reform, further progress in enhancing supervision and continued macro-economic stability in the country, if they maintain reasonable and stable financial profile metrics.

Upgrade of UB requires material improvements in the bank’s underwriting standards and risk controls translating into stronger asset quality and higher profitability.

The banks’ VRs and, consequently, IDRs could be downgraded in case of notable deterioration of the asset quality, impacting profitability, unless compensated by fresh capital injections from shareholders. A downgrade of TB’s ratings could also stem from weakening of the business relationship between the bank and UzEx, resulting in lower stability of the latter’s accounts with TB. UB’s IDRs could be downgraded if corporate governance weaknesses result in marked weakening of the bank’s financial metrics.

Fitch does not anticipate changes to the Support Ratings and Support Rating Floors due to limited systemic importance of these three banks.