Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned Uzbekistan-based Joint-Stock Commercial Bank Qishloq Qurilish Bank (QQB) 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.

QQB’s ‘BB-’ Long-Term IDRs reflect Fitch’s view of a moderate probability of support from the Uzbekistan government (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 the bank’s 97% state ownership, which has a high influence on the ratings, the low cost of potential support relative to the sovereign’s foreign currency (FC) reserves. It is also underpinned by QQB’s role as a policy bank providing most mortgage loans in rural areas of Uzbekistan and a track record of state support for the country’s public sector banks, which 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 risks in state-owned banks representing over 80% of sector assets, sector loan dollarisation at above 60% and in a commodities-based economy whose external finances rely on remittances, exposing it to external shocks.

QQB’s franchise is fairly small. It is the seventh-largest bank in Uzbekistan with a 4% share of system assets and deposits and 5% of system loans at end-1H19.

Fitch understands from management that the government of Uzbekistan has no current plans to privatise QQB. The bank will likely remain under strategic state ownership in the foreseeable future.

QQB’s ‘b’ VR is heavily influenced by a challenging operating environment in Uzbekistan, potential deficiencies in underwriting standards, the bank’s specialised franchise, and rapid loan growth.

QQB has a share of around one-third of the local residential mortgage market. It is the main operator of the state-funded affordable housing programme for rural communities whereby mortgage loans are extended at subsidised rates and on preferential terms. The programme is due to close by end-2021 and the government intends to promote market-based mortgage lending in the country from 2020, but in our view QQB will likely continue to retain its strong position in rural mortgage lending.

Like many state-owned banks in Uzbekistan, QQB is reliant on state capital and funding support. The bank received over USD150 million of common equity from the state over the period 2013-2017. Additionally, over 70% of the bank’s liabilities at end-2018 comprised state-related funds or wholesale borrowings received by the government and passed through to the bank.

At end-2018 QQB reported impaired loans (Stage 3 loans under IFRS9) equivalent to 2.7% of gross loans, which is slightly above the median for other Fitch-rated Uzbek state-owned banks (2%). However, asset quality figures are distorted by high annual loan growth of over 30% over the past four years. Strong loan growth is currently a feature of Uzbekistan’s banking sector. In addition, the bulk of new mortgage loans are issued under grace periods and at lower interest rates during the first five years, which eases borrowers’ debt servicing needs. Our assessment is that a truer picture of asset quality will emerge across the sector once loan books season.

Positively, QQB’s loan book is granular, with the 25-largest borrowers accounting for a small 9% of gross loans at end-1Q19. These comprise loans to local developers and SMEs in manufacturing, services and textile industries. QQB also benefits from low dollarisation of the loan book (10% at end-1H19), which is far below the sector average (around 60%).

Performance is moderate, with a return on average assets and equity respectively of 1.1% and 12.3% during 2018. QQB reports stable profitability metrics because it earns a fixed margin on long-term subsidised mortgages. The cost-to-income ratio was high at 70% in 2018.

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. QQB’s capitalisation is quite tight for the bank’s risks. Fitch Core Capital (FCC) equalled 12.2% of regulatory risk-weighted assets (RWAs) at end-2018. As the bank continued to pursue active loan growth in 1H19, regulatory Tier 1 and Total capital ratios declined to 10.3% and 13.2%, levels which are only marginally above the regulatory minimums of 10% and 13%, respectively. Fitch understands from management that additional capital injections are likely in 2H19.

The bank relies on state funding in the form of direct loans and deposits from government and quasi-government institutions as well as on funds provided by international financial institutions and channelled through the Ministry of Finance. These accounted for about three-fourths of end-2018 total liabilities. Non-state customer funding represented a moderate 17% of end-2018 liabilities. The bank’s liquidity buffer, comprising cash, and short-term placements with the Central Bank of Uzbekistan and local banks, amounted to a tight 6% of end-2018 assets. Liquid assets, net of upcoming wholesale debt repayments, were sufficient to cover only 4% of total customer deposits. However, liquidity risks are manageable given the stable and predictable nature of funding provided by the state.

Rating actions on QQB’s support-driven IDRs, SR and SRF will likely result from a strengthening or weakening of the sovereign’s credit profile and will mirror changes to Uzbekistan’s sovereign ratings. A weakening of the state’s propensity to support the bank may result in a downgrade, although this is currently not expected by Fitch.