S&P downgrades Kazakh Agrarian Credit Corporation to ‘BB’

Kazakhstan: Credit Rating

On June 30, 2017, S&P Global Ratings lowered its long-term foreign and local
currency issuer credit ratings on KACC to ‘BB’ from ‘BB+’. At the same time,
we lowered the Kazakhstan national scale rating to ‘kzA’ from ‘kzAA-‘. We
affirmed the short-term ratings at ‘B’. The outlook is negative.

The downgrade primarily reflects our view of the gradual decline in the
Kazakhstani government’s willingness to provide resources for timely debt
service to the government-related entity (GRE) sector in case of need. This is
evidenced by the authorities’ comparatively limited involvement in ensuring a
timely payment on the obligations of several GREs in Kazakhstan over the past
18 months.

Nevertheless, we still believe that the KazAgro group remains an essential
government tool, and the likelihood of the group receiving extraordinary
support from the government remains almost certain. KACC remains a
strategically important institution within the KazAgro group. Correspondingly,
the ratings on KACC incorporate several notches of support, being higher than
what its intrinsic, stand-alone creditworthiness would warrant. We now assess
at ‘b’ KACC’s creditworthiness on an autonomous basis, that is without
factoring in the potential for extraordinary government support.

Under our approach, by extraordinary support we typically mean support to
ensure the full and timely servicing of an organization’s debt in a stress
scenario. Government transfers that sustain or expand the activities of an
institution, such as government programs aimed at development of specific
projects or supporting certain economic sectors, form part of our assessment
of ongoing support. The latter is incorporated into our analysis of
stand-alone creditworthiness.

Over the past 18 months, there have been several instances whereby timely
extraordinary government support was weaker than we would have expected. The
cases involved two 100%-government owned GREs: the railway company Kazakhstan
Temir Zholy (KTZ) and the energy company Samruk-Energy, both of which are key
subsidiaries of the Samruk-Kazyna holding company.

We have observed that in the case of KTZ, the administrative procedures for
receiving extraordinary support were complex and time consuming. Last year KTZ
still did not have financing secured for its $350 million notes three weeks
before the maturity on May 11, 2016 (see “Research Update: Railway Operator
Kazakhstan Temir Zholy And Subsidiary Kaztemirtrans ‘BB’ Ratings On
CreditWatch Negative,” published April 20, 2016). Later, the government did
not intervene in a timely manner to prevent late payment of more than five
business days by Vostokmashzavod, a relatively small subsidiary of KTZ, on its
payments to Halyk Bank on its loan of $31.9 million, which is partially
guaranteed by KTZ. The event came close to triggering the cross-default
clauses on KTZ’s bonds. We subsequently lowered our ratings on KTZ in October
2016 (“Research Update: Railway Operator Kazakhstan Temir Zholy Downgraded To
‘BB-‘ On Weaker Assessment Of Government Support; Outlook Negative,” Oct. 19,

Currently, Samruk-Energy, another portfolio company of Samruk-Kazyna, is
facing the upcoming maturity of $500 million in Eurobonds in December 2017. We
understand that within about half a year before the repayment, the available
cash and equivalents and committed lines covered only about one-half of the
annual liquidity needed for 2017. We have therefore lowered our ratings on
Samruk-Energy by a cumulative two notches over the last six months and they
currently remain on CreditWatch negative (“Research Update: Kazakh Electricity
Group Samruk-Energy Cut To ‘B+’ And ‘kzBBB-‘ On Increasing Refinancing Risk;
Still On CreditWatch Neg,” April 12, 2017).

In our opinion, these precedents indicate declining willingness of the
government to provide extraordinary support to the GRE sector. Against this
background, we also note that, in general, the government provides no explicit
guarantees on the liabilities of the GRE sector.

Although we continue to assess the likelihood of extraordinary government
support to the consolidated KazAgro group as almost certain, we no longer
equalize the group credit profile (GCP)–which reflects the creditworthiness
of the consolidated operations group, taking into account extraordinary
government support–with the ‘BBB-‘ sovereign credit ratings on Kazakhstan.
Our assessment of the GCP is now one notch lower, at ‘bb+’, which balances the
aforementioned negative trends against the still sizable risks for the
government emanating from not bailing out the entities within KazAgro Group if
they were under stress.

We view KACC as playing a strategically important role within the KazAgro
group. Our assessment balances the key role KACC currently plays for the
agricultural sector against the long-term goal of increasing private sector
involvement in the agricultural sphere. As we now assess KazAgro group’s GCP
at ‘bb+’, and reflecting KACC’s strategically important status within the
KazAgro group, our ratings on KACC are three notches higher than its ‘b’
stand-alone credit profile (SACP).

KACC was established in 2001 by government decree. The institution implements
several government programs and aims to develop Kazakhstan’s agricultural
sector by extending loans at favorable rates. Development goals include, among
others, increasing the sector’s productivity and improving its export
potential. Since 2007, KACC has operated as part of the KazAgro group, which
includes several other companies contributing to the development of the
sector. The corporation is fully owned by the parent company of the group,
KazAgro National Management Holding. The holding company, in turn, is fully
owned by the government.

In our view, KACC remains among the key institutions within the KazAgro group.
It is one of the largest in the group (with assets amounting to about 20% of
the group’s consolidated assets at end-2016) and its primary mandate of
extending government support to the agricultural sector and rural areas
remains important to the group’s long-term strategy. As before, KACC continues
to participate in various government programs aimed at developing Kazakhstan’s
agricultural sector. For example, the institution will play a role in
implementing the government’s new Agricultural Sector Development Program for
2017-2021, adopted in February 2017.

We expect that in the coming years KACC’s operations will remain broadly
similar to recent years, with an increasing focus on financing the
agricultural sector via financial institutions. However, we understand there
are also a number of changes planned. Specifically:

KACC has now received the status of financial agency and taken over the
financing of the spring harvest works from KazAgro Holding, which will
remain the case in the future.

Given the plans to privatize KazAgroFinance–a leasing company within
KazAgro Group–KACC will increasingly extend financing to the privately
owned leasing companies to broaden the availability of financing for the
agricultural sector and develop competition.

While the government is expected to continue channelling funds to KACC, a
broader focus on market funding is envisioned, whereby government funds
will be mixed with other resources. To that end, we understand that KACC
is in discussions about attracting loans from international financial

Over the longer run, the institution will increasingly shift to funding
the agricultural sector via commercial banks.

We also believe that there is a high likelihood of timely extraordinary
government support for KACC in the event of financial distress. Our view is
based on the entity’s:

Important role for the government. In addition to the aforementioned
functions, KACC provides cheap loans to non-agricultural businesses in
rural areas throughout Kazakhstan. Moreover, its wide presence across
Kazakhstan and accumulated expertise in the sector means another entity
would not easily be able to replicate its functions; and

Very strong link with the government of Kazakhstan, which wholly owns KACC
through KazAgro Holding. Privatization is not currently on the agenda and
the government closely monitors KACC’s activities through KazAgro Holding.
In 2016 the government made an equity injection into KazAgro Holding of
Kazakhstan tenge (KZT) 77 billion with the holding company consequently
capitalizing KACC for about KZT65 billion.

We have revised KACC’s SACP–which reflects the institution’s creditworthiness
without factoring in potential extraordinary government support–to ‘b’ from
‘b+’ because we have revised our assessment of the company’s business position
to weak from moderate. This reflects our view that the deterioration in the
Kazakh economy has rendered the entity’s business model more vulnerable and
less stable given that it is focused on the structurally risky and cyclical
agricultural sector. Our weak assessment also reflects KACC’s relatively small
size, with KZT280 billion (around US$0.9 billion) in assets as of March 31,
2017. This is comparable to Kazakh banks in the second tier of the domestic
system. At the same time, we understand that KACC plays an important public
policy role given that a sizable proportion of the Kazakh population is
employed in the agricultural sector. Specifically, the institution is the key
lender to small agricultural producers as well as to certain subsectors that
are currently less attractive for commercial banks. KACC’s overall share of
lending to the agricultural sector is estimated at about 15% (including
indirect lending through banks).

Other factors influencing our SACP are the ‘bb-‘ anchor that we apply to banks
and bank-like institutions operating only in Kazakhstan, as well as KACC’s
very strong capital and earnings position, moderate risk position, below
average funding, and moderate liquidity.

Our very strong capital and earnings assessment reflects S&P Global Ratings’
risk-adjusted capital (RAC) ratio for KACC of 39% at the end of 2016.
Historically the RAC has not been lower than 25%. This reflects a robust
capitalization policy, but in our view is required given the risky operating
environment and business concentration in the agriculture industry. The main
source of equity is capital injections from the government, which has so far
been supportive (it injected a total of about KZT46 billion of new equity
during 2011-2015 and an additional KZT65 billion in 2016). Being a development
institution, KACC is not targeting profit maximization.

We expect the RAC ratio to remain above 18.5% in 2017-2018, based on the
following assumptions:

Loan growth of 60% in 2017 and 40% in 2018 under the state development

No new capital injections in our forecast for 2017-2018 (although we don’t
exclude the possibility that additional injections might take place in

Dividend payouts equal to 50% of net income in 2017-2018;

Credit costs at around 3.5%-4.3% in 2017-2018, in line with 4.3% as of
end-2016 (which is higher compared to prior periods due to methodological
changes) and slightly higher than banking sector expectations; and

Return on average equity at around 2.6% in 2017-2018.

Our risk position assessment balances KACC’s lending concentration in the
cyclical and weather-dependent agricultural sector with low single-name
concentrations and immaterial foreign currency lending. Asset quality is
broadly in line with peers and we do not expect sharp improvements in the
quality of the loan book (KACC’s loans overdue by more than 90 days formed
12.5% of total lending and restructured loans were 13.5% as of March 31, 2017)
in 2017-2018 due to the difficult economic environment. Provision coverage of
problem loans (more than 90 days overdue and restructured) is historically low
(similar to banks in Kazakhstan) but we note an improvement to 57% as of March
31, 2017 from 50% at end-2015. Collateral typically covers that exposure by
more than 100% for KACC. Single-name concentrations are low compared with
Kazakh banks, with the 20 largest borrowers representing 34% of KACC’s total
adjusted capital on March 31, 2017. Foreign exchange risks are minimal as the
company’s loan portfolio and liabilities are predominantly in tenge.

We assess KACC’s funding as below average given the concentration of funding
sources, which depend on the government’s willingness to provide financing at
short notice. Although KACC does not have access to central bank liquidity, we
note its other available sources of quick liquidity in case of need,
specifically the estimated KZT52 billion available cushion from the parent
holding. KACC has direct lending through its parent company KazAgro (10% of
the funding base as of March 31, 2017) and debt securities mature in 2021-2023
(40% of the funding base as of March 31, 2017). We also note positive
developments in diversity and availability of funding as KACC was included in
the list of agents that can directly receive budgetary funding from the state,
and is negotiating with several international financial institutions for
additional financing.

We assess liquidity as moderate due to the cyclical nature of cash flows. A
substantial portion of loans have bullet redemptions in the fourth quarter of
each year, coinciding with the repayment of budget loans. Cash and money
market instruments have grown to 25% from 9.3% for the first quarter of 2017
due to seasonal loans from the Kazakhstan government.

The negative outlook on KACC mirrors our outlook on the sovereign ratings on
Kazakhstan. We would likely lower our ratings on KACC if we took a similar
rating action on the sovereign. We could also lower the ratings on KACC if we
saw signs of waning government support to the group or, more broadly, to other
government-related entities over the next 12 months.

We would likely revise the outlook to stable or if we took a similar rating
action on Kazakhstan.