Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Uzbek Industrial and Construction Bank (UPSB), Joint Stock Commercial Bank Asaka (Asaka), OJSC Agrobank (Agro) and Microcreditbank (MCB) at ‘BB-’. The Outlook on all four banks is Stable. A full list of rating actions is at the end of this rating action commentary.

The affirmation of the four banks’ IDRs reflects Fitch’s view of a moderate probability of support from the government of Uzbekistan in case of need, as reflected by the banks’ Support Ratings (SRs) of ‘3’ and Support Rating Floors (SRFs) of ‘BB-’. This view is based on majority state ownership, low cost of potential support relative to the sovereign international reserves, the banks’ policy roles (to a lesser extent at MCB) and a track record of capital and liquidity support.

The sovereign’s ability to provide support is solid, in Fitch’s view, given the moderate size of the banking sector relative to the economy (total banking sector assets of USD25 billion with a loans/GDP ratio of 41% at end-2018), while Uzbekistan’s international reserves are relatively large at around USD27 billion. However, support considerations also factor in high concentration in the banking sector (state-owned banks accounted for 83% of total end-2018 sector assets), high loan dollarisation (56% at end-2018) and vulnerability to external shocks, as exports are commodities-driven, while external finances rely on remittances.

The Stable Outlooks on the four banks’ ratings reflect the Stable Outlook on the sovereign.

The affirmation of the VRs reflects Fitch’s view of the still challenging operating environment in Uzbekistan, potential deficiencies in underwriting standards, the banks’ limited commercial franchises, elevated loan growth and high balance sheet concentrations and dollarisation (UPSB and Asaka).

The one-notch higher VRs of UPSB and Asaka of ‘b’ reflect the banks’ solid and stable asset quality metrics, partly owing to their access to better-quality public-sector entities (in oil & gas, chemical, auto industries), moderate profitability and adequate capitalisation, supported by regular fresh equity injections from the state aimed to support growth.

Agro’s and MCB’s lower VRs of ‘b-’ reflect their exposure to higher-risk lending segments (agriculture and small and medium entities), including rural areas of Uzbekistan and weak profitability resulting from significant operating expenses to maintain country-wide branch networks and significant headcount.

UPSB

Impaired loans (captured by Stage 3 category under IFRS9) equalled a small 2% of gross loans and were 82% covered by loan loss allowances (LLAs) at end-2018. Risks stemming from high dollarisation (76% of gross loans at end-1Q19) and single-name concentration (three largest borrowers making up 60% of the loan book) are to a large extent mitigated by the availability of tied funding from the state and government guarantees on 46% of gross loans at end-1Q19.

UPSB’s stable, albeit low profitability (operating profit/risk-weighted assets (RWAs) ratio at 1.3% in 2018) reflects its involvement in directed lending, with below-market loan yields funded by cheap state resources, resulting in a modest net interest margin of 2%-3% in recent years. The bank maintains better operational efficiency (cost-to-income ratio of 57% in 2018) and limited credit losses (27% of pre-impairment operating profit) than peers, hence slightly higher bottom-line profitability (return on average assets of 0.8% in 2018).

The bank’s capital position is moderate, as reflected by a 16% Fitch Core Capital (FCC) to RWAs ratio at end-2018. Regulatory ratios were slightly lower than FCC (Tier 1 and total capital ratios at 12.6% and 13.5%, respectively, vs. the minimum regulatory levels of 10% and 13%, respectively).They should improve in view of new capital contribution from the state expected by management in 2019. This should prop up the bank’s currently low loss absorption capacity, with additional LLA possible on just 1% of gross loans at end-2018 before breaching the regulatory minimums.

State funds continue to be UPSB’s primary funding source (59% of total liabilities at end-1Q19). These mostly comprise long-term loans from Uzbek Fund for Reconstruction and Development (UFRD) and loans from the Ministry of Finance. Wholesale funding (mostly from Chinese banks and IFIs) was another 24% of liabilities, while non-state deposits added a small 12%. The liquidity buffer amounted to 9% of total assets at end-2018, well above planned repayment amounts, with the remaining liquidity sufficient to cover 30% of customer deposits.

Asaka

The share of impaired loans (Stage 3 loans under IFRS 9) was 2% of gross loans at end-2018, fully covered by LLAs. The loan book was highly dollarised (77%) and heavily concentrated at the top, reflecting the state-directed nature of lending. However, asset quality risks are partly mitigated by the availability of state guarantees on largest exposures, which constituted 56% of gross loans at end-2018.

Profitability is only modest, with the ratio of operating profit to RWAs equal to 0.8% in 2018. Net interest margin is pressured by low-marginal state-directed lending as Asaka charges about 1%-3% premium over the cost of respective funding on such exposures. Profitability was further undermined by elevated operating expenses (70% of gross revenues in 2018) and moderate impairment charges equal to 47% of pre-impairment operating profit.

Capitalisation is moderate at Asaka, with a FCC ratio equal to 13.5% at end-2018. Regulatory capitalisation is also moderate, with the Tier 1 capital ratio equal to 11.9% at the same date (10.0% regulatory minimum), allowing to additionally reserve a low 1% of gross loans. The bank plans to maintain 1% headroom over the minimum required capital ratios in the medium term. At the same time, Fitch understands Asaka is dependent on fresh equity injections from the state, as earnings retention is low, while elevated loan growth is expected to continue in 2019.

Asaka is significantly reliant on wholesale funding, as reflected by a 402% loans to deposits ratio at end-2018. A significant part of total liabilities (57%) is attributed to the state, Central Bank of Uzbekistan (CBU) and a state-related UFRD, and was on-lent to local largest manufacturers under government decrees. Funding from foreign banks and IFIs made up another 23% of liabilities at end-2018, while customer accounts made up only 18% at the same date. Liquidity was moderate, as Asaka could repay 23% of total customer accounts with its available liquidity buffer at end-2018, given that wholesale debt is generally long-term and repayments are manageable in the upcoming 12 months.

Agro

Agro has a much more granular and moderately dollarised (9%) loan book than UPSB and Asaka, as the bank targets farmers, individuals and small businesses all over Uzbekistan. Impaired loans (bottom three risk categories out of five under local legislation; the bank has not yet published end-2018 IFRS report) were equal to a low 2% of gross loans at end-2018, while reserve coverage of impaired loans was a moderate 70%. Impaired loans origination was a moderate 3% in 2018 and Agro can expect some recoveries given that agricultural loans under government decrees are insured.

Profitability is weak at Agro, as reflected by a 0.3% operating profit to RWAs ratio in 2018. Net interest margin improved to 8% in 2018 (vs. 6% in 2017), thanks to a larger share of commercial lending under market interest rates. However, high operating expenses (76% of gross revenues) and moderate impairment charges (0.6% of average loans) resulted in a break-even bottom-line result (return on average equity of 0.2% in 2018).

Capitalisation was adequate at Agro at end-2018, with the regulatory Tier 1 and Total capital ratios (19.9% and 20.0%, respectively) well above the minimum levels (10% and 13%, respectively) and providing a sizable additional loss absorption capacity equal to 9% of gross loans. Recapitalisation of Agro in 2018 for UZS840 billion (8% of end-2018 RWAs) should support growth in short-term financing to local farmers and entrepreneurs.

Wholesale funding accounted for 55% of total liabilities at Agro, justifying a high loans to deposits ratio of 325% at end-2018. Funding from the state and state-related funds accounted for 73% of wholesale funding, while the rest is attributed to foreign banks and IFIs, reflecting Agro’s policy role of financing the agricultural sector. Customer accounts added 33% of total liabilities and were pretty granular. Liquidity is tight given the significant amount of short-term wholesale funding, so Agro relies on refinancing of maturing debt and repayments of short-term loans.

MCB

Loan quality, as reported under IFRS9, is quite good, with impaired loans at a low 1.4% of gross loans at end-2018 and fully covered by LLAs. In Fitch’s view, MCB’s underwriting standards are relatively weak, particularly for loans issued under government-sponsored programmes (46% of gross loans at end-1Q19). However, potential credit risks are mitigated by low loan dollarisation (11% at end-1Q19) and granularity of the loan book, with the 25 largest exposures making up moderate 16% of gross loans at end-2018.

Profitability is MCB’s relative rating weakness, although it returned to marginally positive levels after a few years of loss making performance. Low operational efficiency continues to undermine the bank’s earnings generation, with a high cost-to-income ratio of 91% in 2018. Thanks to reduced impairment charges, MCB managed to post positive bottom-line profit (return on average assets at 0.6%) in 2018.

MCB’s capitalisation benefits from regular capital contributions from the state, with about USD60 million of fresh injections earmarked for 2019. This has propped up the bank’s capital ratios, with FCC at 22% of regulatory RWAs at end-2018 (Tier 1 and total capital ratios under local GAAP were both 21%). This capital cushion provides headroom for loss absorption capacity as additional LLAs could be created on 19% of gross loans at end-2018.

MCB is reliant on state-related funding, which equalled 57% of total liabilities at end-2018. This primarily comes from long-term deposits placed by state-owned companies and public institutions (23%) although there are also outstanding loans from the UFRD and the government. Non-state customer accounts were a moderate 24% while wholesale funds (another 16%) mostly comprised borrowings from local banks. MCB’s stock of liquid assets fully covered planned repayments for 2019 (state funding only), while the remaining portion was equal to a modest 17% of total customer accounts at end-2018.

Rating action on the banks’ support-driven IDRs could result from a strengthening or weakening of the sovereign’s credit profile. A weakening of the state’s propensity to support the banks may result in a downgrade, although this is currently not expected by Fitch.

All four banks’ VRs could be downgraded as a result of deterioration in the banks’ asset quality or excessive growth if this is not fully offset by fresh equity injections. Upgrades of the VRs could result from improvements in Uzbekistan’s operating environment and strengthening of the banks’ commercial franchises, although upgrades of Agro’s and MCB’s VRs would also require improvements in the banks’ profitability and strengthening of underwriting standards.

UPSB

Long-Term Foreign- and Local-Currency IDRs affirmed at ‘BB-’; Outlooks Stable

Short-Term Foreign- and Local-Currency IDRs affirmed at ‘B’

Support Rating affirmed at ‘3’

Support Rating Floor affirmed at ‘BB-’

Viability Rating: affirmed at ‘b’

Asaka

Long-Term Foreign- and Local-Currency IDRs affirmed at ‘BB-’; Outlooks Stable

Short-Term Foreign- and Local-Currency IDRs affirmed at ‘B’

Support Rating affirmed at ‘3’

Support Rating Floor affirmed at ‘BB-’

Viability Rating: affirmed at ‘b’

Agro

Long-Term Foreign- and Local-Currency IDRs affirmed at ‘BB-’; Outlooks Stable

Short-Term Foreign- and Local-Currency IDRs affirmed at ‘B’

Support Rating affirmed at ‘3’

Support Rating Floor affirmed at ‘BB-’

Viability Rating: affirmed at ‘b-’

MCB

Long-Term Foreign- and Local-Currency IDRs affirmed at ‘BB-’; Outlooks Stable

Short-Term Foreign- and Local-Currency IDRs affirmed at ‘B’

Support Rating affirmed at ‘3’

Support Rating Floor affirmed at ‘BB-’

Viability Rating: affirmed at ‘b-’