Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Uzbek Industrial and Construction Bank (UIСB, also known as Uzpromstroybank), Joint Stock Commercial Bank Asaka, OJSC Agrobank (Agro) and Microcreditbank (MCB) at ‘BB-’, with Stable Outlooks. Fitch has also affirmed the banks’ Viability Ratings (VR). A full list of rating actions is at the end of this commentary.

The affirmation of the 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, significant systemic importance (UICB, Asaka and Agro), important roles in government economic and social policy (Agro and MCB), the low cost of potential support relative to the sovereign international reserves and a track record of capital and liquidity support.

Fitch has affirmed the ratings of UICB and Asaka, notwithstanding the recently published medium-term strategy for banking system development, which targets the privatisation of these banks by end-2025. This is because (i) Fitch expects the government will continue to have a very high propensity to support the banks as long as they are state-owned; and (ii) the agency’s base case is that the government will retain majority ownership in both banks for at least the next three years.

At the same time, Fitch believes both banks will significantly redevelop their business models and improve governance structures prior to privatisation (with the assistance of IFIs that may become minority shareholders prior to full privatisation). We have stopped factoring policy roles into our assessment of support for UICB and Asaka as we expect them to continue their transition to commercial business, which began with transfers of some of their policy loans to the Uzbekistan Fund for Reconstruction and Development (UFRD) in 4Q19.

The ratings of Agro and MCB factor in their policy roles as agents for state-sponsored subsidised lending to SME and retail clients in rural regions of Uzbekistan. According to the strategy, Agro and MCB will retain their focus on development lending and will remain state-owned.

The authorities’ ability to provide support to banks is strong for the sovereign rating ‘BB-’, in Fitch’s view, given the moderate size of the banking sector relative to the economy. Total assets of USD29 billion at end-2019 amounted to 38% of GDP and were equal to Uzbekistan’s international foreign currency reserves. However, our assessment of support ability also factors in concentration in the sector (with state-owned banks accounting for about 85% of end-2019 sector assets), high loan dollarisation (48%) and vulnerability to external shocks, as external finances rely on commodity exports and remittances.

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

UICB’s senior unsecured debt rating is aligned with the bank’s Long-Term IDRs.

The affirmations of the four banks’ VRs reflect the challenging operating environment, some weaknesses in underwriting standards, high lending growth (particularly at MCB and Agro), high volumes of long-term foreign currency (FC) lending (partially under state development programmes), only moderate profitability and high reliance on funding from foreign banks and IFIs (particularly at Asaka, UICB and MCB). The ratings also capture good capitalisation metrics at all four banks, supported by equity injections from the state in recent years, including in 2019.

The VRs of Asaka and UICB are one notch higher due to the banks’ stronger corporate franchises, as reflected by higher market shares (both banks accounted for 13% of sector assets at end-4M20) and therefore access to better-quality public-sector companies. After transferring most of their directed loans to the UFRD in 4Q19 (equal to about a third of each bank’s gross loans) Asaka and UICB are now undergoing transformation towards more commercial business models.

Agro and MCB VRs of ‘b-’ reflect their exposure to higher-risk lending segments (agriculture, SME and retail borrowers with below-average incomes), mainly in rural areas of Uzbekistan, and weak operating efficiency resulting from expensive country-wide branch networks and significant headcount.

All four banks have been rapidly growing in recent years, particularly through loans under state-development programmes, which are long term and often issued with grace periods, resulting in largely unseasoned loan books. Foreign currency lending (represented mainly by long-term project financing exposures, particularly high in Asaka and UICB) has been funded mostly with credit lines from international banks and IFIs. Repayments of these facilities are modest in next 12 months as they are linked to schedules of issued foreign currency loans.

Despite the COVID-19 outbreak, Fitch forecasts that the Uzbek economy will continue to grow in 2020 (2.0% according to our April forecast) and accelerate to 6.8% in 2021. As part of measures to reduce the economic impact of the pandemic, the Central Bank of Uzbekistan (CBU) has recommended that banks provide payment holidays for all retail borrowers and individual entrepreneurs for up to six months, which will result in an increase in accrued but not received interest and greater volumes of loans of untested quality.

UICB

Impaired loans (the bottom three risk categories in regulatory accounts) made up low 1% of gross loans at end-1Q20 and were 3x times covered by impairment reserves. Dollarisation was high 68% at end-1Q20 and the loan book was highly concentrated, with the top 20 exposures at end 2019 representing 42% of total gross loans.

UICB’s profitability is somewhat stronger than peers. Following transfer of low-margin directed loans and new loan issuance at market rates, its net interest margin increased to 5% in 1Q20. Together with good operating efficiency, as reflected by a cost-income ratio of around 20%, this resulted in healthy pre-impairment profit at 7% of average loans in 1Q20 (annualised). Impairment charges consumed a moderate 50% of pre-impairment profit, so the annualised return on equity (ROAE) was a reasonable 14%.

UZS3 trillion capital injections from the state in 2019 supported the bank’s capital position. We estimate the Fitch Core Capital (FCC) to regulatory risk-weighted assets (RWA) ratio of 16% at end-1Q20, viewed as moderate by Fitch in light of potential asset quality risks. The regulatory Tier 1 ratio was higher 18.3%, the total CAR was 21.3%, both ratios comfortably above the minimum regulatory levels of 10% and 13%, respectively.

The Loans-to-deposits ratio was high 411% at end-1Q20 as UICB predominately finances long-term development projects with foreign currency borrowings from international banks and IFIs (50% of total liabilities) and state funding (20%). Liquid assets represented 9% of total assets at end-1Q20, comfortably covering deposits by 44%. While external funding repayments in next 12 months slightly exceeded the liquidity cushion, we believe the state will support the bank with liquidity in case of need (including through access to UZS1.5 trillion CBU liquidity facility).

Asaka

The share of impaired loans was 3.8% of gross loans at end-1Q20, 86% covered by loan reserves. The loan book was highly dollarised (60%) and heavily concentrated, reflecting the development nature of lending. However, asset quality risks are partly mitigated by the availability of a state guarantee on Asaka’s largest exposure, which accounted for about a third of gross loans at end-1Q20.

Profitability is only modest, with the ratio of operating profit to RWAs equal to 0.7% in 1Q20 (annualised). Net interest margin is pressured by low-marginal development lending as Asaka usually charges about 1%-3% premium over the cost of the funding on such exposures. Profitability was further undermined by high operating expenses and elevated impairment charges equaled 91% of pre-impairment operating profit in 2019.

Following a massive recapitalisation by the state in 2018-2019, we estimate Asaka’s FCC to regulatory RWAs capital ratio improved to 20.6% at end-1Q20. The regulatory capital ratios were also high, with the Tier 1 capital ratio of 18.6% and the total CAR of 19.8%, providing a comfortable cushion over the minimum requirements. However, we view Asaka’s capitalisation as only moderate due to potential asset quality and only modest ability to reserve problem assets through pre-impairment loans (estimated at 4.6% of average loans in 2019).

Asaka is significantly reliant on wholesale funding, as reflected by a 309% loans-to-deposits ratio at end-2019. A significant 55% of total liabilities is attributed to the foreign banks and IFIs borrowings, while state funding made up another 11%. Liquid assets represented 11% of total assets at end-1Q20. Foreign external funding maturity profile is comfortable medium-term and liquid assets 5x covered repayment for next 12 months.

Agro

Agro has a more granular and less dollarised (19%) loan book than UPSB and Asaka, as the bank targets farmers, individuals and small businesses in Uzbekistan, but also participates in large-ticket cluster financing. Impaired loans were equal to low 1.1% at end-1Q20 as the bank writes off problems swiftly, reserve coverage was adequate 77%. However, loan impairment charges to average gross loans ratio was rather high 3%. Asset quality risks stem from the bank’s exposure to agricultural sector and long-term development lending.

Profitability is weak at Agro, as reflected by 0.4% operating profit to RWAs ratio in 1Q20 (annualised). Net interest margin was moderate 6%, but high operating expenses (cost-to-income ratio of 55%) and impairment charges consumed 86% of pre-impairment profit, resulting in a weak annualised ROAE of 2% in 1Q20.

To support Agro’s development role and lending growth, the state injected about UZS4 trillion of equity in the bank since 2016. An estimated FCC to regulatory RWAs ratio was 20% at end-1Q20, the reported regulatory Tier 1 ratio was 19.5% and total CAR was 20.5%, both reasonably above the regulatory minimums.

Foreign and state funding together accounted for 57% of total liabilities at Agro, justifying a high loans-to-deposits ratio of 361% at end-1Q20. Funding from the state and state-related funds accounted for 44% of liabilities, while 13% were borrowings from international banking groups and IFIs. Customer accounts were granular. The maturity profile of external foreign funding is comfortable Agro’s, existing liquid assets at end-1Q20 (represented 7% of total assets) 6x covered external liabilities due in next 12 months.

MCB

Impaired loans accounted for 2.6% of gross loans at end-1Q20 and were fully covered with reserves. In Fitch’s view, asset quality risks stem from high loan growth (73% in 2019, FX-adjusted), still developing underwriting standards and increasing loan dollarisation (36% in at end-1Q20, up from 11% at end-1Q19). Loan book concentration is moderate, with the top 20 exposures accounting for 24% of total loans at end-1Q20.

Profitability is MCB’s relative rating weakness, although this has improved in recent years and the bank returned to positive (albeit marginal) pre-impairment and bottom-line profit. The net interest margin was a healthy 10% in 2019. However, due to MCB’s focus on lending in rural regions, the bank’s operational efficiency is weak, as reflected by a cost-income ratio of 72%. Loan impairment charges consumed 72% of pre-impairment profit and the ROAE was low 1.4% in 2019. Fitch expects the bank’s performance to deteriorate in the current downturn, which could result in loss before impairment.

MCB’s capitalisation benefits from regular contributions from the state. We estimate the FCC to regulatory RWAs capital ratio was a good 21.4%. The regulatory capital ratios were also high, with the Tier 1 capital ratio at 21.2% and the total CAR at 21.3%, providing a comfortable cushion over the minimum requirements. However, we view MCB’s capitalisation as only moderate due to its focus on risky development lending and limited pre-impairment profitability.

MCB is reliant on state-related funding, which equaled 36% of total liabilities at end-1Q20. Foreign banks and IFIs funding represented another 31%. While MCB’s stock of liquid assets covered only 63% of planned foreign debt repayments for next 12 months, we believe the bank will attract long-term IFI funding in 2020 and the state will provide MCB with liquidity support in case of need (i.e. if foreign currency loans do not generate sufficient cash flows to service these obligations).