Fitch affirms ratings of Development Bank of Kazakhstan; outlook Stable

November 19. KASE. Fitch Ratings

Fitch affirms ratings of Development Bank of Kazakhstan; outlook StableFitch Ratings has affirmed Development Bank of Kazakhstan’s (DBK) Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘BBB’ and ‘BBB+’, respectively. The Outlooks are Stable. A full list of rating actions is at the end of this commentary.

KEY RATING DRIVERS – DBK

DBK’s ratings reflect Fitch’s view of the high probability of support being forthcoming from the government of Kazakhstan (BBB+/A-/Stable), if needed. This is based on (i) DBK’s ultimate sovereign ownership, (ii) the bank’s important policy role, (iii) the moderate cost of any support that might be required to DBK  and (iv) potential adverse economic consequences of a failure by the authorities  to support the bank.

The one-notch differential between the sovereign and the bank’s ratings reflects (i) DBK’s significant leverage, funded by wholesale debt, (ii) the somewhat loose  government supervision of the bank’s operations; (iii) the parent company’s limited standalone financial resources and, hence, potential delays in support if it is needed in a stress scenario; and (iv) the risk that the sovereign could cease to provide full support to DBK and other quasi-sovereign entities before defaulting on its own obligations, given the sizable debt of quasi-sovereigns relative to that  of the sovereign.

The government of Kazakhstan ultimately controls 100% of DBK’s share capital through the wholly-owned JSC National Management Holding Baiterek (BBB+/A-/Stable). In Fitch’s view, any default by DBK could have a considerable negative impact on the national economy, potentially posing disruption risks to some of the development projects financed by DBK and negatively affecting other quasi-sovereign entities’ access to, and cost of, foreign capital.

Fitch understands that DBK’s largest projects were approved at the highest political level as part of the national industrialisation programme (58% of gross loans at end-3Q14). However, Fitch considers the currently limited direct government supervision as a moderate corporate governance weakness. No government officials sit on DBK’s board of directors and only two members of the six-member board represent the parent company. The bank is also exempt from regulatory oversight from the National Bank of Kazakhstan (NBK).

The probability of DBK requiring support is relatively high given the bank’s reliance on non-government wholesale funding sources and its moderate capitalisation. The cost of supporting the bank, if needed, is currently modest, relative to sovereign financial resources, even allowing for potential considerable  growth. DBK’s third-party wholesale obligations were equal to 2.1% of GDP or  4.7% of official international reserves at end-3Q14, while 38% of the bank’s  funding was guaranteed by the JSC Sovereign Wealth Fund Samruk-Kazyna (BBB+/A-/Stable). DBK’s plans to increase the proportion of local currency borrowings in the near to medium term could also further reduce the potential burden of any support that may be required.

The bank’s capitalisation remains moderate in light of the high-risk nature of its development projects, very high concentrations and limited internal capital generation. The Fitch Core Capital (FCC)/ risk-weighted assets ratio of 18.5%, Basel I Tier I and total capital ratios of 18.7% and 19.3% at end-3Q14 may increase by about 190bp prior to end-2014 as a result of an upcoming equity contribution by the government. However, the increase might be offset by potential additional impairment provisions on foreign currency loans, which comprised 80% of the portfolio at end-3Q14.

Following DBK’s non-performing loan (NPL) transfers to a sister company in 2013 and 1H14, reported NPLs reduced to 6.7% of the portfolio and restructured loans made up a further 5.3% at end-3Q14. Net of reserves, together these totalled 16% of FCC. The bank’s unguaranteed exposure to the sister company comprised a further 10%. Fitch also believes that a loan to a metals and mining company, reportedly performing and equal to 29% of FCC, is highly risky and may put pressure on capitalisation.

The bank’s liquidity is currently comfortable due to its limited upcoming wholesale repayments amounting to USD500m in 4Q14-3Q15 or 10% of end-3Q14’s liabilities, with USD280m relating to its senior unsecured Eurobonds. DBK had USD1.4bn of liquid assets at end-October 2014, comprising mainly placements with NBK and repoable investment-grade debt securities.

RATING SENSITIVITIES – DBK

DBK’s IDRs are likely to remain one notch below those of the sovereign, and to move in tandem with them.

A marked weakening of the bank’s policy role or less close association with the Kazakh authorities could result in negative rating action, although neither scenario is expected by Fitch. The ratings could also come under downward pressure if leverage increases markedly and asset quality deteriorates sharply without adequate capital support being provided.

The ratings could be upgraded and equalised with the sovereign if the latter guarantees a large majority of DBK’s funding, capitalisation strengthens significantly potentially coupled with the government authorities’ closer involvement in the management of the bank.

The rating actions are as follows:

Local currency Long-term IDR: affirmed at BBB+/Stable

Local currency Short-term IDR: affirmed at F2

Long-Term IDR: affirmed at BBB/Stable

Short-Term IDR: affirmed at F3

Support Rating: affirmed at 2

Support Rating Floor: affirmed at BBB

Senior unsecured Long-term rating: affirmed at BBB

Short-term rating: affirmed at F3.

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