Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed Joint Stock Commercial Bank Asaka’s (Asaka) Long-Term Issuer Default Ratings (IDRs) of at ‘BB-’ with Stable Outlooks. The agency has also affirmed the bank’s Viability Rating (VR) at ‘b’.

The affirmation of Asaka’s IDRs reflects Fitch’s view of a moderate probability of support from the government of Uzbekistan in case of need, as reflected by the bank’s Support Rating (SR) of ‘3’ and Support Rating Floors (SRF) of ‘BB-’. This view is based on majority state ownership, significant systemic importance, important roles in government economic and social policy, the low cost of potential support relative to the sovereign international reserves and a record of capital and liquidity support.

According to the government’s strategy for banking sector reform published in 2020, Asaka is among the banks due to be privatised in the medium term. According to the authorities, prior to privatisation an international financial institution (IFI) will acquire a minority stake in the bank’s capital and the bank will undertake business model transformation. Once that is completed, the government expects to sell a controlling stake to a strategic investor (planned by end-2023). Asaka’s medium-term strategy targets shifting from directed lending to a commercial business model with a focus on developing SME and retail segments.

Despite the ongoing preparation for privatisation, Fitch still factors in potential state support because (i) Fitch expects the government will continue to support state-owned banks as long as they remain in majority state ownership; (ii) according to Fitch’s base case scenario the change of control will not happen within at least the next two years and will depend on successful business model transformation; and (iii) Asaka has significant systemic importance and continues to finance strategically important sectors of the economy. In addition, there is uncertainty about the creditworthiness of a potential buyer and its ability to support the bank relative to the Uzbek authorities.

The authorities’ ability to provide support is underpinned by the moderate size of the banking sector relative to the economy (total assets were 63% of GDP at end-2020) and large international reserves (USD35 billion at end-2020). However, our assessment of support ability also factors in high concentrations in the banking sector (with state-owned banks accounting for 85% of end-1Q21 sector assets), high loan dollarisation (50% at end-1Q21), a high share of external funding in the banking sector and vulnerability to external shocks in a volatile operating environment, as government finances are sensitive to commodity exports and remittances.

The Stable Outlook on the bank’s IDR reflects that on the sovereign.

The affirmation of Asaka’s VR at ‘b’ reflects the challenging operating environment, high lending growth in recent years, which was supported by new equity injections from the state, the unseasoned loan book and untested asset quality, high balance sheet dollarisation and dependence on foreign funding. The rating also captures a good corporate franchise, a high share of state-guaranteed exposures, an adequate capital cushion and moderate profitability.

Loans in the bottom three regulatory categories (a proxy for impaired loans) accounted for a moderate 4.4% at end-1Q21 and were 80% provisioned. About 30% of Asaka’s borrowers applied for credit holidays in 2020. According to management, the majority of these loans returned to schedule by 4Q20. Fitch estimates about 10% of Asaka’s loans were restructured (tenor extension or grace periods), some of which will migrate to impaired later in 2021-2022.

Asaka’s gross loans grew 5x times in 2017-1Q21. The growth was mostly in long-term corporate financing (partially under government’s development programs) and many loans were granted with grace periods up to three years, therefore Fitch views Asaka’s loans book as unseasoned. Lending dollarisation was high 68% at end-1Q21, which is also risky as only a limited number of borrowers have revenues in foreign currency. State guarantees covering 40% of Asaka’s loans at end-2020 mitigated asset quality risks.

Profitability is modest, due to a narrow net interest margin (2.5% in 1Q21 under local GAAP, annualised) as Asaka charged only up to 2% premium on development loans. Impairment charges accounted for only 17% of pre-impairment profit in 2020 and 1Q21 (helped by provision reversals). However, most of the largest loans were still in grace periods. The profit before tax to average risk-weighted assets (RWA) ratio remained low at about 1% in 2020-1Q21. Pre-impairment profit provides only a modest cushion against a potential uptick in loan impairment charges. The annualised return on equity was 4.6% in 1Q21.

The Fitch core capital/regulatory RWA ratio was a healthy 18.2% at end-2019 (last available IFRS) and we estimate it decreased to about 15% in 2020 as RWA grew by 30%, while return on equity was only 6% (based on local GAAP) . The regulatory Tier 1 ratio was 15.6% and total capital adequacy ratio was 16.6% at end-1Q21, both reasonably above the required minimums of 10% and 13%.

Funding structure is a rating weakness. Asaka is significantly reliant on wholesale funding, as reflected by the loans/deposits ratio of 448% at end-1Q21. Deposits made up only 19% of Asaka’s funds, while borrowings from foreign creditors was 51%. The external funding repayment schedule is manageable as Asaka’s cushion of liquid assets at end-1Q21 covered 128% of wholesale external debt maturing in next 12 months. We believe that while the bank is under the state’s ownership, the government will support Asaka with liquidity in case of need.