Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed Uzbekistan-based Ipoteka-Bank’s Long-Term Issuer Default Ratings (IDRs) at ‘BB-’. The Outlook is Stable.

Ipoteka’s ‘BB-’ Long-Term IDRs are driven by potential support from the Uzbekistan sovereign (BB-/Stable) in case of need. The bank’s Support Rating (SR) of ‘3’ and Support Rating Floor (SRF) of ‘BB-’ consider Uzbekistan’s moderate ability to provide support as well as its high propensity to support Ipoteka based on its majority state ownership, which has a high influence on our assessment, as well as the potential low cost of support for the bank relative to the sovereign’s foreign currency reserves and a track record of support for the country’s public sector banks that dominate the banking sector.

Fitch has affirmed Ipoteka’s sovereign supported ratings, despite the recently published medium-term strategy for banking system development, which targets the privatisation of the bank by end-2022. This is because (i) Fitch believes the government will maintain a high propensity to support the bank as long as it is state-owned and controlled; and (ii) the agency’s base case is that Ipoteka’s business model transformation prior to full privatisation will take significant time and therefore the sale of a majority stake by end-2022 is uncertain.

In considering the sovereign’s ability to provide support Fitch assesses positively the moderate size of the banking sector relative to the economy (total assets of US$29 billion with a loans/GDP ratio of 50% at end-2019), while Uzbekistan’s foreign currency reserves are relatively large at around US$29 billion. However, support considerations also include the high concentration in the banking sector where state-owned banks represent around 85% of sector assets, sector loan dollarisation of close to 48% and vulnerability to external shocks given a commodities-based economy whose external finances rely on remittances.

Ipoteka’s ‘b’ VR is influenced by the challenging operating environment in Uzbekistan, potential deficiencies in underwriting standards, the bank’s still limited commercial franchise, rapid loan growth and high single-name concentrations in the loan book. Fitch views positively plans to transform the bank’s business model and the strengthening of management and governance, prior to privatisation, especially in light of the agreement with the International Financial Corporation (IFC) to acquire a 15% stake in Ipoteka.

The ratio of impaired loans (Stage 3 loans under IFRS 9) to gross loans at Ipoteka was a low 1.7% at end-2018 (latest available IFRS data), which is a sector feature in Uzbekistan. Non-performing loans (NPLs, loans overdue over 90 days) were equal to an even lower 0.2% of gross loans at end-1Q20 in regulatory accounts due to early write-offs of impaired exposures. At the same time, the cost of risk was close to 1% in recent years, which indicates reasonable loan book quality to date. Our assessment of the bank’s asset quality also considers the unseasoned nature of new lending, especially mortgages, as loan growth has been high in recent years (which is a market feature in Uzbekistan), while the majority of newly issued loans have grace periods on the payment of principal. Dollarisation of the loan book is moderate at 25% of gross loans at end-1Q20, comparing with the sector average of 48% at the same date.

Loans to corporate customers accounted for 70% of gross loans at end-2019 and were highly concentrated at the top, with the two largest state-related borrowers accounting for 40% of the total. However, the remaining part of corporate loans was much more granular. Ipoteka is planning to gradually decrease the largest exposures to 10% of corporate loans by end-2020.

Retail loans (a further 30% of gross loans) were mainly represented by mortgages, the majority of which (79%) were issued under the state-led programmes. Ipoteka began to actively grow in mortgage lending since 2017, so the portfolio is only starting to season as the grace periods on principal are usually three years.

Ipoteka’s profitability has been affected by subsidised policy lending in recent years. However, the share of these loans was moderate compared with larger state-owned banks, and therefore Ipoteka reported a higher operating profit-to-risk-weighted assets (RWAs) ratio of 2.2% in 2018, and a ratio of 3.2% in 2019 based on the regulatory accounts. We expect higher loan impairment charges in 2020 due to i) the negative implications from the coronavirus pandemic and the lockdown in Uzbekistan; and ii) the seasoning loan book, as grace periods on mortgages originated in 2017 expire.

Capitalisation is strong, as the bank has received US$288 million of new equity from the state since 2015, and about US$143 million in 2019 alone, aimed at supporting Ipoteka’s growth. Current capital buffers (Tier 1 and total regulatory capital ratios were 20% and 22% at end-1Q20, respectively) over the minimum required levels (10% and 13%) provide room for further growth at least for the next several years, given Ipoteka’s target of 15% loan growth for 2020 and a somewhat higher 20%+ in 2021.

The bank relies on state funding in the form of direct loans and deposits from government and quasi-government institutions, which accounted for 57% of total liabilities at end-2019. Non-state customer funding represented another 21% of end-2019. Foreign-currency funding provided by international financial institutions (IFIs, 14% of liabilities at end-2019) was generally long term with manageable repayments in 2020 equal to US$60 million. Repayments to IFIs in the upcoming years are generally reliant on the quality of Ipoteka’s loans.

The bank’s liquidity buffer, comprising cash, short-term placements with the Central Bank of Uzbekistan and other banks was 10% of end-2019 assets. Net of upcoming wholesale debt repayments, liquid assets were sufficient to cover a moderate 11% of customer accounts. Additional liquidity is available from the Central Bank of Uzbekistan under repurchase agreements with sovereign debt securities (1% of Ipoteka’s assets or another 5% of customer accounts).

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action on Ipoteka’s support-driven IDRs, SR and SRF could result from a strengthening of the sovereign’s credit profile and would mirror changes to Uzbekistan’s sovereign ratings.

An upgrade of the VR would require a substantial improvement in Uzbekistan’s operating environment and strengthening of the bank’s commercial franchise and business model.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative rating action on Ipoteka’s support-driven IDRs, SR and SRF could result from a weakening of the sovereign’s credit profile and would mirror changes to Uzbekistan’s sovereign ratings. The ratings could also be downgraded if a majority stake in the bank is sold to a private shareholder, and Fitch assesses the reliability of support from the new owner as significantly lower than from the Uzbek authorities currently.

Ipoteka’s VR could be downgraded as a result of material deterioration in asset quality, excessive loan growth or capital weakness in the absence of fresh capital injections.

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.