Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) ratings, including a Long-Term Issuer Default Rating (IDR) of ‘BB-’ with a Stable Outlook and a Viability Rating (VR) of ‘b’. 

NBU’s Long- and Short-Term IDRs reflect Fitch’s view of a moderate probability of support from the Uzbek authorities in case of need, as reflected by the Support Rating (SR) of ‘3’ and Support Rating Floor (SRF) of ‘BB-’. We believe the government of Uzbekistan has a high propensity to support NBU. This view is based on NBU’s high systemic importance, as reflected in its largest share of banking-system assets (25% at end-2019) and NBU being the only bank designated as a D-SIB by the Central Bank of Uzbekistan (CBU), and in its full state ownership. Our view of support propensity also captures NBU’s clearly defined policy role, including the financing of Uzbekistan’s long-term infrastructure and development projects and state-owned enterprises.

NBU was not included in the list of state banks that the government targets to privatise by end-2025, according to the medium-term strategy for banking system development published in 2Q20. Under state ownership, Fitch believes that NBU will retain its important policy role while expanding its retail- and corporate-banking franchises.

In Fitch’s view, the authorities have a moderate ability to provide support to NBU as measured by the sovereign’s rating of ‘BB-’. The banking system’s total assets of USD29 billion at end-2019 amounted to 38% of GDP and were equal to Uzbekistan’s international foreign-currency reserves. Our assessment of support ability also considers Uzbekistan’s highly concentrated banking sector (with state-owned banks accounting for about 85% of end-2019 sector assets), the sector’s high loan dollarisation (48%) and the liability structure of the banking system, with a high reliance on external funding.

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

The ‘b’ VR of NBU reflects its strong franchise, adequate asset quality and healthy capitalisation that is supported by equity injections from the state. The rating also captures high balance-sheet dollarisation, rapid growth in recent years, which has resulted in a largely unseasoned loan book, a high reliance on funding from foreign banks and international financial institutions (IFIs) and modest core profitability.

Notwithstanding the fallout from the COVID-19 outbreak, Fitch forecasts that the Uzbek economy will continue to grow in 2020 (1.6% according to our June forecast) and accelerate to 6.8% in 2021. As part of measures to mitigate the economic impact of the pandemic, the CBU has recommended that banks (including NBU) provide payment holidays to 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.

IFRS 9 Stage 3 loans accounted for 3.2% of NBU’s gross loans at end-2019 and were fully covered by total impairment reserves. Stage 2 exposures made up a further 1.3% of gross loans. Combined Stage 2 and 3 exposures accounted for 4.5% of gross loans and were reasonably covered (75%) by loan loss allowances. Asset quality remained stable in 1H20 based on management accounts. NBU has been growing rapidly in recent years, particularly in policy lending, executing its role of a state agent. Most development loans were provided to state-owned or -related companies, resulting in reported high exposure to related parties (56% of loans at end-2019). They were mostly in foreign currency, leading to high loan-book dollarisation of 60%.

Fitch views NBU’s loan book as largely unseasoned. Policy loans are typically long-term and often issued with grace periods. At the same time, asset-quality risks are partially mitigated by state guarantees on some of NBU’s largest exposures. Fitch estimates around 45% of NBU’s total gross loans at end-2019 were state-guaranteed.

Profitability is moderate with operating profit-to-risk-weighted assets (RWAs) at 1.7% in 2019. Net interest margin is under pressure from NBU’s low-margin policy lending, but improved to 3.4% in 2019 from 2.7% in 2018 due to a shift into commercial and retail lending. Loan impairment charges consumed a moderate 21% of pre-impairment profit in 2019, but profitability was weighed down by modest margins, as reflected in a 9% return on equity.

Following a large recapitalisation by the state in 2017-2019 to support NBU’s lending growth and further development and transfer of some of policy loans to the Fund of Reconstruction and Development of Uzbekistan, the bank’s Fitch Core Capital-to-regulatory RWAs improved to a healthy 20% at end-2019. The bank’s regulatory capital ratios were also high, with a Tier 1 capital ratio of 23% and a total CAR of 27%, providing a comfortable cushion over regulatory minimum requirements.

Fitch views NBU’s funding profile as structurally weak due to a high reliance on borrowing from international banking groups and IFIs. External funding accounted for 53% of NBU’s non-equity funding at end-1H20, with state funding making up another 12%. The maturity schedule of the bank’s borrowings is mostly aligned with long-term loan repayments (about 70% of NBU’s total borrowings mature after more than two years from end-1H20). However, short-term foreign-currency borrowings were still material, with around UZS5.1 trillion being due within 12 months at end-1H20, equal to 86% of liquid assets at the same date.

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

-The support-driven ratings could be upgraded if the Uzbek sovereign is upgraded.

-An upgrade of the VR could stem from improvements in the Uzbek operating environment, a sustained stable asset quality performance, an improvement in profitability, a decrease in balance-sheet dollarisation and an improved funding structure.

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

-The support-driven ratings could be downgraded if the Uzbek sovereign is downgraded, or if Fitch changes its view on the Uzbek authorities’ ability or propensity to support the bank.

-The bank’s VR could be downgraded as a result of material asset-quality deterioration or excessive growth if not fully offset by fresh equity injections from the state. Deterioration of NBU’s liquidity buffers, particularly in foreign currency, as a result of insufficient cash flows being generated by NBU’s loan book could be credit-negative, if not offset by liquidity injections from the state.