Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned Uzbekistan-based Ipoteka-Bank (Ipoteka) Foreign and Local Currency Long-Term Issuer Default Ratings (IDRs) of ‘BB-’. The Outlook on the IDRs is Stable. The agency has also assigned the bank a Viability Rating (VR) of ‘b’. A full list of rating actions is at the end of this rating action commentary.

Ipoteka’s ‘BB-’ Long-Term IDRs reflect Fitch’s view of a moderate probability of support from the Uzbekistan sovereign (BB-/Stable) in case of need, as reflected in the bank’s Support Rating (SR) of ‘3’ and Support Rating Floor (SRF) of ‘BB-’. This view is based on full state ownership, which has a high influence on the ratings, the low cost of potential support relative to the sovereign’s foreign currency reserves, Ipoteka’s role as a policy bank where it extends mortgage loans, and a track record of support for the country’s public sector banks that dominate the banking sector. 

The sovereign’s ability to provide support is solid, in our 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 FC reserves are relatively large at around USD27 billion. However, support considerations also factor in high concentration in the banking sector where state-owned banks represent around 80% of sector assets, sector loan dollarisation of close to 60% and vulnerability to external shocks given a commodities-based economy whose external finances rely on remittances. 

Ipoteka is the fourth-largest bank in Uzbekistan where it controlled a 9% share of system assets and deposits and 10% of system loans at end-1H19.

Plans to sell a controlling stake in Ipoteka by end-2022 are in place, according to a government decree dated 25 June 2019. In our view, change of ownership could take time and until this occurs, the state remains committed to supporting the bank. This explains the IDRs’ Stable Outlook. 

Ipoteka’s ‘b’ VR is heavily influenced by the challenging operating environment in Uzbekistan, potential deficiencies in underwriting standards, the bank’s limited commercial franchise, rapid loan growth and high single-name concentrations in the loan book.

Ipoteka has a strong franchise in the domestic mortgage lending market where it controls a share of around 20%. The bank is the main operator of the state-funded affordable housing programmes under which mortgage loans are extended at subsidised rates and on preferential terms. The government’s intention is to gradually phase out these programmes from 2020 in favour of market-based mortgage lending, but we expect Ipoteka to remain one of the leading mortgage banks in Uzbekistan going forward.

Plans to transform the bank’s business, in line with privatisation, are underway. We view this positively, especially as proposals include the potential for the International Financial Corporation (IFC) to acquire a 15% stake which could help improve corporate governance over time. 

Like many state-owned banks in Uzbekistan, Ipoteka is reliant on state capital and funding support. Since 2015, the bank received about USD145 million of common equity from the state, including USD50 million in 1H19. Additionally, over 70% of the bank’s liabilities at end-2018 comprised state-related funds.

Impaired loans represented only 1.7% of gross loans at end-2018, but loan growth has averaged an annual 44% over the past four years and this distorts asset quality figures. This is the case for many Uzbek banks. Our assessment is that a truer picture of asset quality will emerge across the sector once loan books season. 

Concentrations by single borrower are high, as is the case for several peers. At end-2018, the 25-largest exposures represented 56% of gross loans. The three-largest exposures, representing 48% of the loan book, are large state-owned entities and the largest exposure (28% of loans) benefits from a state guarantee. The remaining loans are quite granular and comprise loans to SMEs in manufacturing, services and textile industries. Devaluation of the soum, as was the case in 2017, can be detrimental to asset quality as borrowers with local currency revenues struggle to meet rising debt servicing costs as a result of a weaker local currency . The low dollarisation of Ipoteka’s loan book (39% at end-2018) compared with other local state-owned banks is credit-positive, in our view. 

In 2018, Ipoteka reported reasonable performance with a net return on average assets and equity, respectively of 1.1% and 12.3%. Performance metrics compare favourably with peers’ as Ipoteka’s share of less profitable, directed corporate lending is low compared with other state-owned peers and margins on subsidised loans are relatively high and stable. 

Capitalisation levels are determined by the state, as is the case for peers, and regular capital injections ensure that regulatory capital adequacy ratios are maintained above minimum requirements. Our assessment is that capitalisation is tight, considering risks. Fitch Core Capital (FCC) represented 13.7% of regulatory risk-weighted assets (RWAs) at end-2018. Regulatory Tier 1 and Total capital ratios improved to 13.2% and 17.5% at end-1H19, respectively, following a USD50 million capital contribution from the state. The bank’s planned 30% loan growth in 2019 will likely put pressure on capital ratios.

The bank relies on state funding in the form of direct loans and deposits from government and quasi-government institutions. Non-state customer funding represented 16% of end-2018 liabilities, while wholesale borrowings (mostly from international financial institutions), represented a further 13%. The bank’s liquidity buffer, comprising cash, short-term placements with the Central Bank of Uzbekistan and local banks, and government bonds, was 7% of end-2018 assets. This is low, but adequate considering the stable and predictable nature of funds provided by the state. Net of upcoming wholesale debt repayments, liquid assets were sufficient to cover a moderate 12% of customer accounts, which we view as adequate.
Similar to other Uzbek state-owned banks, Ipoteka has an ESG Relevance Score of ‘4’ for Governance Structure as the State of Uzbekistan is highly involved in the bank at board level and in the business. Therefore, environmental, social and governance assessments are relevant to Ipoteka’s ratings but are not rating drivers.

Rating actions on Ipoteka’s support-driven IDRs, SR and SRF will likely result from a strengthening or weakening of the sovereign’s credit profile and mirror changes to Uzbekistan’s sovereign ratings. The ratings are also sensitive to ownership changes especially if this triggers a reduction in the state’s propensity to support the bank. However, the Outlook on the sovereign ratings is Stable and ownership changes are not imminent. 
Ipoteka’s VR could be downgraded as a result of deterioration in asset quality, excessive loan growth or capital weakness in the absence of fresh capital injections. 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.