The agency noted that the outlook on both banks is stable.

“Since the decline in raw material prices in 2014-2015 and recession in economies of some of Uzbekistan’s major trade partners, such as Russia, external pressure has remained considerable for Uzbekistan’s economy. Along with declining inflows and remittances, we anticipate Uzbekistan’s current account will weaken and stay marginally above zero in 2016 and 2017. We believe that this increased external pressure, the still rapid expansion of credit to the nonfinancial sector of at least 20%-25%, and the gradually slowing economy will result in higher economic imbalances. We consequently revised down our economic risk score under our Banking Industry Country Risk Assessment (BICRA) to ‘8’ from ‘7’ and reclassified Uzbekistan into the group of countries with ‘9’ BICRA scores. Other countries we classify in group ‘9’ are Azerbaijan, Argentina, Cambodia, Kenya, Lebanon, Tunisia, and Vietnam,” the agency said.

“We believe that the change in economic risk will affect the capital adequacy of most Uzbek banks by no more than 70 basis points and will not lead to a revision of our view of their capital and earnings. Two banks, however, are more affected by this change: Halk Bank and Turkiston Bank,” S&P Global Ratings said.

HALK BANK (B/Stable/B)

“Halk Bank’s financial profile will be resilient to increasing economic risks over the next 12-18 months, in our view. However, under our base-case scenario, we think that the bank will remain reliant on the government’s recapitalization program to continue its operations while meeting all capital adequacy requirements (12.8% as of Nov. 1, 2016, versus the 11.5% regulatory minimum). We now project our risk-adjusted capital (RAC) ratio for Halk Bank (before adjustments for concentration and diversification) will remain at 5.0%-5.5% over the next two years. Our updated forecast incorporates capital support totaling Uzbekistani sum (UZS) 200 billion (about US$60 million), out of which an additional UZS115 billion will be approved in January 2017 that we did not previously incorporate in our forecast. We also note that the bank’s management is committed to building additional capital buffers by improving operating efficiency and moderately increasing lending volumes, which we see reflected in its gradually improving net interest margin,” the agency underlined.

“The stable outlook on Halk Bank reflects our view that its state ownership and ongoing government support will prove sufficient to preserve its creditworthiness over the next 12 months,” the agency noted.

“We could lower the ratings over the next 12-18 months if, contrary to our expectations, we observed that capital injections from the government were delayed or totaled less than we currently incorporate in our forecast. A negative rating action could also be triggered by the bank’s implementation of a more aggressive capital management strategy, with higher-than-expected growth of risk-weighted assets that doesn’t foster the growth of the capital base and reduces capital buffers below sustainable levels,” S&P Global Ratings noted.

“We see the potential for an upgrade of Halk Bank as limited over the next 12-18 months, since that would require substantial strengthening of its loss-absorption capacity through stronger bottom-line earnings. A positive rating action would also be contingent on more conservative capital management that ensured regulatory capital ratios stayed sustainably above the minimum requirement by more than 100 basis points,” the agency stated.

TURKISTON BANK (B-/Stable/C)

“While the deteriorating operating environment significantly impairs Turkiston Bank’s capitalization under our definition (due to the rise in risk-weights under our RAC calculation), we view the bank as able to withstand mounting pressure and continue its business operations over the next 12-18 months. We have revised our capital and earnings assessment for Turkiston Bank to adequate from strong and expect the RAC ratio to be 7.5%-9% over the next 12-18 months. Despite our revised capital and earnings assessment, we affirmed the ratings, as we believe that Turkiston Bank’s creditworthiness does not meet our criteria for assigning a ‘CCC’ rating. In particular, Turkiston Bank demonstrates clear signs of business recovery since the regulator authorized a foreign currency license in the first half of 2016,” S&P Global Ratings said.

“We believe that Turkiston Bank strengthened the ties with its customers in 2016 and managed to broaden and diversify its funding. During the first 10 months of 2016, the stable deposit base (time deposits and funds blocked for conversion) increased by 50%. This growth is approximately 3x the growth of the stable deposit base in 2015, when the bank was operating without a foreign currency license. Additionally, Turkiston Bank managed to markedly improve the stability of its funding base, and, contrary to the beginning of the year, the majority of accounts are now primary, which tend to be less confidence-sensitive than secondary accounts. Finally, the larger amount of clients with primary accounts has contributed to the greater amount of net fee and commission income, which we expect to have doubled in 2016 compared with 2015 results,” the agency said.

The agency said: “The stable outlook on Turkiston Bank reflects our view that, over the next 12-18 months, the bank will be able to cope with the challenging operating environment and retain adequate capital and liquidity comparable with that of peers.”

S&P Global Ratings could consider a negative rating action if:

• The agency observed poor liquidity and asset and liability management--possibly exacerbating risks connected with potential volatility of the bank’s funding base, particularly regarding the amount and stability of customer deposits--and deterioration of the franchise leading to significant weakening of liquidity and funding metrics to levels lower than peers’; or
• The bank’s capitalization deteriorates due to higher-than-expected credit losses or growth of assets with the projected RAC ratio decreasing to below 7%.

S&P Global Ratings believes that a positive rating action is remote at this stage.