Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Uzbek Industrial and Construction Bank Joint-Stock Commercial Bank (UICB) at ‘BB-’. The Outlook is Stable. Fitch has also affirmed the bank’s Viability Rating (VR) at ‘b’. 

The affirmation of UICB’s IDRs reflects Fitch’s view of a moderate probability of support from the government of Uzbekistan (BB-/Stable), in case of need, as reflected by a Support Rating (SR) of ‘3’ and a Support Rating Floor (SRF) of ‘BB-’. This view is based on majority state ownership, significant systemic importance (UICB is the second-largest bank in Uzbekistan, with 13% of sector assets at end-1Q21), the low cost of potential support relative to the sovereign’s international reserves and a record of capital and liquidity support.

According to the government’s strategy for banking sector reform published in 2020, UICB is among the banks due to be privatised in the medium term. According to the authorities, the bank will receive a USD75 million loan from the International Finance Corporation in 2021, which will be converted into a minority stake in the bank following the completion of the business transformation process. A sale of a controlling stake to a strategic investor is planned by end-2023. UICB’s medium-term strategy targets a shift from state-directed lending to a commercial business model focused on developing the SME and retail segments.

Despite the bank’s 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) under Fitch’s base case the change of control will not happen for at least the next two years and is subject to successful business-model transformation; (iii) UICB has significant systemic importance and continues to finance strategically important sectors of the economy (oil & gas, energy and chemical industries). In addition, there is uncertainty about the identity of any potential buyer of UCIB and their ability to support the bank relative to the Uzbek authorities’.

The authorities’ ability to provide support to the banking sector 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 UICB’ ratings reflects that on the sovereign.

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

UICB’s VR reflects a challenging and volatile operating environment, its highly concentrated and dollarised loan book, only moderate profitability to date and a high reliance on funding from foreign banks and international financial institutions (IFIs), which has increased in recent years. The VR also captures adequate capitalisation as well as the bank’s strong corporate franchise and improved quality of management and corporate governance.

Impaired loans (Stage 3 loans under IFRS9) increased materially since the start of the pandemic to 6.5% of gross loans at end-1H20 (the latest available IFRS accounts) from 2.8% at end-2019. Impaired loans were only about 0.5x covered by total loan loss allowances. Stage 2 loans were also significant (18% of gross loans at end-1H20) and we expect at least some of them to be transferred to the Stage 3 category in 2021-2022.

UICB provided temporary payment holidays for 36% of gross loans in 2Q20-3Q20, although most of these exposures have since returned to payment schedules. Credit risk also stems from a large single-name concentration of the loan book (the 25-largest borrowers at a high 52% of gross loans at end-2020), high loan dollarisation (70% at end-1Q21) as well as the unseasoned nature of recently issued commercial SME loans with long grace periods.

A shift to commercial lending has improved the bank’s performance. Net interest margin was 4% in 2020 (2019: 3%). The bank maintains high operating efficiency, as reflected in a cost-to-income ratio of 26% in 2020. This results in reasonable pre-impairment profitability (7% of average gross loans in 2020, versus 6% in 2019), which was firmly above the cost of risk (about 1% of average gross loans in 2020 under Local GAAP, compared to negative 0.2% in 2019). Return on net assets and equity was reasonable in 2020 at 1.9% and 12.3%, respectively.

Capitalisation is adequate, with Fitch Core Capital (FCC) equal to 17% of regulatory risk-weighted assets (RWAs) at end-1H20. At end-1Q21, regulatory Tier 1 and total capital ratios were also reasonable at 15% and 17%, respectively, comfortably above the minimum capital requirements of 10% and 13%, respectively. We estimate the bank could create additional reserves equal to a reasonable 5% of gross loans before capital ratios fall to regulatory minimums.

UICB’s main source of funding (63% of total liabilities at end-1Q21) are wholesale funds represented by long-term credit lines from foreign banks and IFIs (partially guaranteed by the government) and Eurobonds issued in 2019. Customer accounts, which primarily come from large corporate customers, were 20% of liabilities while state funding made up another 14%. Liquidity buffer (cash, short-term placements with the CBU and foreign investment-grade banks and sovereign securities) made up a limited 15% of total assets at end-1Q21 and covered 96% wholesale debt repayments due within the next 12 months. Fitch also believes the bank may receive liquidity support from the state, in case of need, as long as the government retains a controlling stake.