Fitch affirms ratings of 4 Uzbek banks with strong capitalization

By  Trend

Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Uzbek Industrial and Construction Bank Joint-Stock Commercial Bank (UPSB), Joint Stock Commercial Bank Asaka (Asaka), OJSC Agrobank (Agro) and Microcreditbank (MCB) at 'B+' with Stable outlook, the press service of the ratings agency stated.

The affirmation of the Long-Term Foreign-Currency IDRs and Support Rating Floors (SRFs) of all four banks at 'B+' reflects Fitch's view that there is a high propensity that the Uzbek authorities would provide support to these banks, in case of need. This view is based on the state majority ownership, systemic importance (UPSB and Asaka), the banks' policy roles (to a lesser extent at MCB) and the track record of capital and liquidity support.

The sovereign's ability to support the banks is solid, in Fitch's view, as the banking sector is moderate in size relative to the economy (total banking sector assets of $21 billion with loans/GDP ratio of 44 percent at end-2017), while the country's foreign currency reserves are relatively large at around $27 billion.

However, support considerations also factor in the state-owned banks' high share of the sector (around 82 percent of total assets) and their dependence on government support, the economy's structural weaknesses and vulnerability to external shocks as exports are commodities driven and concentrated on a few countries, while external finances also heavily rely on remittances.

The affirmation of UPSB's and Asaka's VRs at 'b' reflects their reasonable performance and asset quality metrics, helped by the access to better-quality public-sector corporates (from oil & gas, chemical, auto industries) and loan repayments under state guarantees, which cover on average 58-60 percent of loans at both banks. Agro's and MCB's lower VRs (b-) consider their higher-risk profiles, given their primary exposure to the vulnerable agricultural and small business lending segments, and weak profitability metrics, also constrained by low operating efficiency due to labor-intensive business models.

The VRs also consider all four banks' solid capital positions, strengthened with recent cash injections to support growth targets and/or improve solvency (Agro, MCB) and comfortable liquidity positions, underpinned by the stable funding from the government institutions and public-sector corporates. At the same time, the VRs continue to reflect Uzbekistan's challenging operating environment, the banks' limited commercial franchises, high balance-sheet concentrations, and potential deficiencies in underwriting standards, also due to involvement in directed lending, potentially leading to high credit and operational risks.

Non-performing loans (NPLs, loans overdue over 90 days) were low, ranging from 0.1 percent to 2.3 percent at all four banks at end-2017, fully reserved. MCB's asset quality metrics were also helped by the recent sizeable balance-sheet clean up. Loan books are more concentrated and dollarized at UPSB (87 percent) and Asaka (78 percent), although underlying risks are mitigated by the availability of state guarantees or the exporting borrowers' foreign-currency revenues. Agro's and MCB's loans are mostly in local currency and more granular by borrower, while concentration on the agriculture industry (higher at Agro) also exposes them to the risk of commodity (e.g. cotton, grain) price fall.

Profitability metrics (net of one-off FX-revaluation gains, linked to the sharp local currency devaluation in 2017) remained moderate at UPSB and Asaka with pre-impairment profit to average equity ratio of around 12 percent and 9 percent, respectively, reflecting the mostly low-margin state-directed nature of the banks' operations. Asaka's loan impairment charges surged to 5.8 percent of average gross loans in 2017 from 1.3 percent in 2016, resulting in a 6 percent return on average equity (ROAE, including FX revaluation gains). UPSB reported a 54 percent ROAE, also supported by almost zero impairment charges.

Agro's and MCB's profitability is undermined by high operating expenses at 88 percent and 106 percent in 2017, respectively, as these two banks have to maintain large branch networks and headcount to serve clients in rural areas of Uzbekistan. Agro's pre-impairment profit (net of FX-revaluation gains) was a moderate 11 percent in 2017, underpinned by increased commission income from currency conversion operations and remittances (almost 90 percent increase compared with 2016). Loan impairment charges were almost zero, resulting in 15 percent ROAE. MCB's pre-impairment profit was a negative 16 percent, while higher impairment charges (at 3 percent of average gross loans) were fully offset by the FX revaluation gains resulting in negative ROAE of the same 16 percent.

Capitalization was strong at all four banks, with the Fitch Core Capital (FCC) to risk-weighted assets ratio 19 percent at UPSB and Asaka, 31 percent at MCB and FCC to total assets ratio at 27 percent at Agro. Additional loss absorption capacity was moderate at UPSB and Asaka (the banks could increase loan loss allowances by 3 percent and 5 percent of end-2017 gross loans, respectively, without breaching the minimum required levels) and reasonable at Agro and MCB (27 percent and 33 percent of additional loan loss allowances, respectively). New equity injections are also planned for 2018.

The banks' funding is mainly sourced from customer accounts and government and quasi-government entities. Given USPB's and Asaka's significant involvement in directed lending, the share of government-related funding is particularly high at both banks (UPSB: 80 percent of liabilities, including government-guaranteed external borrowings of 25 percent, at end-2017; Asaka: 47 percent). This has been moderate at Agro (around 19 percent), although it fluctuates during the year in line with the seasonal pattern for directed agricultural lending; customer deposits (53 percent) are rather granular. MCB's funding is largely derived from clients (81 percent), with a public-sector corporates accounting for around 45 percent of liabilities.

Liquidity was comfortable at all four banks thanks to solid buffers of liquid assets (net of potential repayments of wholesale debt maturing within 12 months) equal to 21 percent-35 percent of total customer funding at end-2017 (Asaka, Agro, MCB) or nearly 100 percent at UPSB. Foreign currency liquidity is also comfortable, as conversion limitations were abandoned after the som depreciation.

Rating action on UPSB's, Asaka's, Agro's and MCB's support-driven IDRs could result from a strengthening or weakening of the sovereign's credit profile. A weakening of the state's propensity to support the banks may result in a downgrade.

All four banks' VRs could be downgraded as a result of deterioration in the banks' asset quality if this is not fully offset by fresh equity injections. Upgrades of the VRs could result from improvements in Uzbekistan's operating environment and strengthening of the banks' commercial franchises, although upgrades of Agro's and MCB's VRs would also require improvements in the banks' asset quality and performance.