Kazakhstan-Based Halyk Bank Affirmed At ‘BB/B’ And Kazkommertsbank Upgraded To ‘B+/B’ On Acquisition By Halyk Bank

Kazakhstan: Credit Rating

FRANKFURT (S&P Global Ratings) July 18, 2017–S&P Global Ratings today
affirmed its ‘BB/B’ long- and short-term counterparty credit ratings on Halyk
Savings Bank of Kazakhstan (Halyk Bank). The outlook is negative. We also
affirmed our ‘kzA’ Kazakhstan national scale rating on the bank.

At the same time, we raised our long-term counterparty credit rating on
Kazkommertsbank JSC (KKB) to ‘B+’ from ‘B-‘. The outlook is negative. We
affirmed ‘B’ short-term counterparty credit rating on KKB. We also raised our
Kazakhstan national scale rating on the bank to ‘kzBBB-‘ from ‘kzB+’.

We removed all the ratings on Halyk Bank and KKB from CreditWatch, where they
were placed on June 14, 2017 (see “Kazakhstan-Based Halyk Bank And
Kazkommertsbank Ratings Now On CreditWatch On Very High Likelihood Of
Acquisition,” published on RatingsDirect).

The rating actions follow the completion of Halyk Bank’s acquisition of 96.8%
of KKB’s common shares on July 5, 2017. Halyk Bank now has control over KKB.

Our upgrade of KKB reflects our view that the acquisition has strengthened its
capitalization and that the bank now has a strategically important status
within Halyk Group. We believe Halyk Bank would provide support to KKB in case
of need.

We believe that KKB’s capital and earnings profile has strengthened, despite
the creation of significant additional provisions in June-July 2017, based on
a number of measures that include the following: a Kazakhstani tenge (KZT) 185
billion ($0.6 billion) capital injection by Halyk Bank on July 12, 2017; the
significant reduction of its risk-weighted assets following repayment by JSC
BTA Bank of its KZT2.4 trillion loan to KKB due to the government funds
received by BTA from the Problem Loans Fund (PLF); and recording a capital
gain of KZT170 billion due to revision of the terms of the PLF deposit
(including extension of its maturity and lowering the interest).

As a result of the abovementioned measures, we have revised our assessment of
KKB’s capital and earnings to weak from very weak. We expect our risk-adjusted
capital (RAC) ratio to be about 3.5%-4.0% following the acquisition and to
possibly increase to slightly above 4% by year-end 2018. We expect KKB to
still have limited capital buffers in the next two years, due to weak internal
earnings generation and no further capital injections currently planned by
Halyk Bank despite our expectation of a likely contracting balance sheet.
Consequently, KKB’s ability to absorb future loan losses remains restricted,
especially in view of its high single-name concentrations and high
concentrations in real estate construction and development.

We continue to assess KKB’s business position as moderate. This assessment
balances its market position as the second-largest bank in Kazakhstan by loans
and retail deposits, with market shares of about 11% and 16% and 223 branches,
with its less certain new strategy under Halyk Bank’s ownership and the
untested track record of its new management team (in place since July 2017) in
turning around the bank. The management team appointed by Halyk Bank inherited
the bank with the long track record of unsuccessfully struggling with a large
amount of legacy problem loans. These were generated through excessive
involvement in financing speculative investments in construction and real
estate prior to the 2008 crisis by KKB itself and BTA, a failed bank that KKB
acquired in 2014. Despite several changes of management in the past 10 years
and a change of ownership in 2014, KKB has not managed to meaningfully recover
its problem loans. Turning the bank around will be a serious test for the
newly appointed management team and Halyk Bank.

We consider KKB’s risk position weak, compared with other banks in countries
with the same economic risk as Kazakhstan, reflecting the bank’s high exposure
to construction and real estate on its loan books at about one-third of total
loans, high single-name concentrations, and a very high share of nonperforming
loans (NPLs; loans over 90 days overdue) at above 40% of the total remaining
loan book, according to our estimates. The NPLs were covered by specific
provisions by about 82%. We believe that Halyk Bank will unlikely need to
create significant additional provisions in the next 12 months because the
bank considers that KKB was adequately provisioned at acquisition.

At the same time, we positively view the following changes to the bank’s risk
position, which happened as part of the acquisition:
BTA repaid its KZT630 billion and $5.6 billion credit line. KKB wrote off
the remaining BTA exposure of KZT64.8 billion. BTA exposure accounted for
about 58% of KKB’s gross loans prior to the acquisition. Repayment
substantially decreased KKB’s risk-weighted assets, which had a positive
impact on the capital requirements at KKB.
KKB acknowledged the low asset quality of its loan book and created large
additional provisions increasing the provisioning levels to about 55% of
total loans.
We view Halyk Bank together with newly acquired KKB as having high systemic
importance in Kazakhstan, and we consider the government to be supportive of
the domestic banking sector. Our assessment of the systemic importance of the
combined entity reflects its size as the largest banking group by assets and
by retail deposits, and the important role the combined bank plays in
financing the economy and servicing a significant number of corporate and
retail clients. We therefore think that the government will likely provide
support to Halyk Bank and KKB in case of need to maintain stability of the
banking sector. For KKB, we believe that such support would be provided
through Halyk Bank.

We view KKB as a strategically important subsidiary of Halyk Bank, taking into
account its significant size and franchise, especially in retail business, as
well as cross-default provisions in Halyk Bank’s Eurobonds documentation with
regards to its material subsidiaries. We therefore expect Halyk Bank to
provide support to its newly acquired subsidiary in the case of need. We
believe that KKB will more likely receive support from the group rather than
directly from the government, and not from both. Thus, we incorporate three
notches above KBB’s stand-alone credit profile (SACP) into its ratings to
reflect the potential group support.

Halyk Bank
The affirmation of our ratings on Halyk Bank following the acquisition of KKB
reflects our expectation that the pressure on its SACP immediately after the
acquisition will be largely offset by the government support provided as a
part of the acquisition agreement between the government and all parties
involved. Additionally, we expect that the government will likely provide
additional support to the combined group in case of need in order to maintain
stability of the banking sector, given its high systemic importance in the
banking system of Kazakhstan.

We revised our assessment of Halyk Bank’s SACP to ‘bb-‘ from ‘bb’, reflecting
pressure on its capitalization from the acquisition of undercapitalized KKB,
deterioration of its risk profile due to acquisition of KKB, a bank with
significantly weaker credit quality, as well as further integration risks.

We still see Halyk Bank’s business position as strong, supported by solid
market shares of the combined group that we currently estimate at around 38%
by total assets, loans, and retail deposits, and a wide network of more than
700 branches (combined, Halyk and KKB) throughout the country. However, we
believe that the integration of KKB may be a challenge for Halyk Bank, taking
KKB’s much weaker credit standing into account and the still-weak economic
conditions in Kazakhstan. Halyk Bank’s management has yet to demonstrate that
it is able to establish sound internal control and risk-management systems in
KKB, and turn it into a sustainable profit generating business. We could
revise our assessment of Halyk Bank’s business position downwards if we
considered that the group’s currently strong profitability and business
stability deteriorates materially due to the acquisition.

We revised our assessment of Halyk Bank’s capital and earnings assessment to
moderate from adequate to reflect the pressure on consolidated group’s capital
adequacy from the acquisition of undercapitalized KKB. We therefore now
forecast that the group’s RAC ratio will be in the range of 5.5%-6.5% during
the next 12-18 months, down from 9.3% that Halyk Bank had at the end of 2016.
We expect the group’s credit costs to be around 2.3%-2.5% in the next 12-18
months, assuming that additional provisions created as part of the deal are
sufficient to address KKB’s asset quality. We anticipate no lending growth for
the group in 2017, since we assume that the two banks will be busy with the
integration process. We think that the group might restart some lending, with
loan growth of about 3%-5% per year in 2018-2019, which is in line with the
projected sector average. Although we expect the group to show positive
financial results in 2017, its return on equity will likely decline from the
22% it posted in 2016, however, staying above 10%.

We also believe that Halyk Bank’s risk profile weakened following the
acquisition, reflecting the risks related to KKB’s high exposure to the
problem real estate and construction sector, high single-name exposures, and
substantially worse asset quality. We estimate consolidated group’s NPLs at
about 23%-25% of total loans. To some extent, this is mitigated by the overall
provisions coverage levels of 118%-127% (post-acquisition). We understand that
Halyk Bank will aim to bring down consolidated NPLs. We expect the share of
NPLs to decrease to around 15% of total loans in the next two years through
writing down and restructuring problem loans at KKB.

We believe that Halyk Bank’s consolidated funding profile remains strong. The
group’s joint market share in retail deposits was around 38% as of June 1,
2017. We estimate that around 80% of the group’s consolidated funding comes
from customer deposits, including around KZT700 billion (around 9% of total
funding) provided by state organizations under state development programs. We
expect both retail deposits and government-related funding to remain stable
due to the strong brand recognition, solid market positions of the banks, and
established connections with cash-rich government-related entities (GREs).

We expect Halyk Bank’s liquidity to remain adequate, since the group has ample
liquidity buffers combining liquid assets of Halyk Bank and currently excess
liquidity at KKB following the repayment of BTA loan. We estimate that
consolidated liquid assets amounted to one-half of consolidated total assets
following the acquisition. We assume that the group will utilize this
liquidity gradually to repay the most expensive liabilities and moderately
increasing lending starting from next year.

We view Halyk Bank (together with newly acquired KKB) as having high systemic
importance in Kazakhstan, and therefore include one notch of uplift in the
ratings above its SACP.

The negative outlook on KKB reflects the negative outlook on its parent, Halyk
Bank, and our view that Halyk Bank’s ability to provide support to KKB may
reduce if Halyk Bank’s own creditworthiness deteriorates significantly. It
also reflects pressure on KKB’s capitalization from possible creation of
significant additional provisions in the next 12 months.
We could take a negative rating action in the next 12 months if we observed
material deterioration in KKB’s asset quality, creation of significant
additional provisions, or fast asset growth not in line with its
capitalization levels. This could significantly weaken its capital buffers,
resulting in the projected RAC ratio declining to below 3%.
Weaker-than-expected ties with Halyk Bank and potential support could also
cause us to review KKB’s group status and reduce the notches of group support
that we current factor in our ratings on KKB.
We could revise the outlook to stable in the next 12 months if we revise the
outlook on Halyk Bank to stable, assuming that at the same time KKB’s credit
profile does not deteriorate and Halyk Bank’s support does not diminish. We
would view positively significant improvements in KKB’s asset quality closer
to peers’ levels through recovery, write off, or sale of its legacy problem
loans, and improvements in its profitability through improved interest
received, net interest margin, and costs optimization.

A substantial strong track record of financial and management support from
Halyk Bank and the successful integration of KKB coupled with performance in
line with our expectations might lead us to revise upward our assessment of
KKB’s group status, which could positively impact our ratings on the bank, all
else remaining equal.

Halyk Bank
The negative outlook on Halyk Bank reflects the risks related to integration
of KKB, which we envisage to be particularly challenging in the next 12 months
in view of KKB’s significantly weaker credit profile and the tight operating
conditions for banks in Kazakhstan.

We would lower our ratings on Halyk Bank in the next 12 months if we
considered that the combined banking group is unable to work out KKB’s legacy
problem assets reasonably quickly, resulting in significant pressure on Halyk
Bank’s profitability and stability of its earnings. We would also take a
negative rating action if Halyk Bank were to create loan-loss provisions
significantly above the level that we currently anticipate or incurred other
unexpected losses that would lead to our RAC ratio falling below 5% on a
consolidated basis.

We could revise the outlook on Halyk Bank to stable in the next 12 months if
the combined bank demonstrated the ability to turn around KKB and maintain
sound operating performance, resulting in a RAC ratio sustainably above 7%. We
would also need to see sustainable improvement of the asset quality of KKB and
of Halyk Bank on a consolidated level, with NPLs gradually decreasing to
levels comparable with peer banks, that is to below 15% of total loans on a
consolidated basis.