S&P affirms ratings of Development Bank of Kazakhstan; outlook Negative

/Standard & Poor's, London, November 24, 14, heading by KASE/ – Standard & Poor's Ratings Services today affirmed its foreign and local currency counterparty credit ratings on the state-owned Development Bank of Kazakhstan (DBK) at 'BBB+/A-2'. The national scale rating is 'kzAAA'. The outlook is negative. The ratings on DBK reflect our classification of the bank as a government-related entity (GRE) and our assessment that there is an almost certain likelihood that the government of Kazakhstan would provide timely and extraordinary support to DBK if it ran into financial difficulties. In accordance with our criteria for rating GREs, our view of the likelihood of extraordinary government support is based on our view of: - DBK's integral link with the government, which indirectly owns 100% of DBK, and regular injections into the bank's capital. In our view, the government's management of its shares in DBK through National Management Holding Baiterek puts the government in a stronger position to define DBK's strategy and align it with government socioeconomic policy priorities. - DBK's critical role as the government's primary financial vehicle for implementing its industrialization agenda. DBK provides long-term credit to the nonextractive sectors of the economy, particularly the industrial and manufacturing sectors. DBK is a 100% government-owned financial development institution established in 2001 in accordance with presidential decree and law "On Development Bank of Kazakhstan." Since its founding, DBK's mandate has been to serve as the main financing vehicle supporting economic diversification; the Kazakh economy remains highly dependent on the extractive sectors. DBK loans are aimed at contributing to sustainable development of the national economy by investing in the non-oil sector. DBK offers long-term financing of investment projects that have a significant socioeconomic impact on the economy. In our view, the 2013 transfer of DBK's shares to Baiterek from Samruk-Kazyna-- with the government retaining indirect ownership--has improved oversight and governance of the bank. Baiterek was established by the government in 2013 as a joint stock company. It provides financial and investment support to the noncommodity sectors and manages 10 development institutions. DBK is by far the largest of these, accounting for 58% of the holding's total assets. Indeed, Baiterek was established specifically to enable the government to focus more on development institutions and to improve these institutions' efficiency and corporate governance, and to increase synergies between Baiterek's different subsidiaries. In 2013, DBK significantly improved its asset quality. The quality of the loan portfolio had deteriorated because of DBK's role in the government's measures to combat the 2007-2009 financial crisis. DBK transferred a significant portion of its nonperforming loans (NPLs, loans over 90 days overdue) that had built up following the crisis to the Investment Fund of Kazakhstan (IFK, another Baiterek subsidiary). This has enabled DBK to concentrate on financing new projects. DBK's public policy role has increasingly focused on funding the government's industrialization program. In 2014, the government adopted its second five-year program focused on industrial development, the State Program of Industrial and Innovative Development (SPIID) 2015-2019. SPIID is part of the Strategic Development Plan 2020, which, in turn, is part of the Kazakhstan 2050 national vision. Industrial innovation development is key to the government's socioeconomic policies. DBK is the main financial operator involved in delivering SPIID. In July 2014, DBK's board approved the bank's strategy for 2014-2023. The strategy aims to significantly increase DBK's portfolio over the next 10 years. DBK has also been instructed to implement new financing tools, including project financing and syndicated financing, for which the government will need to adopt some changes in legislation. Under this strategy, for the first time, DBK will be involved in interbank lending and encouraged to enhance cooperation with commercial banks. DBK is also tasked with providing longer and cheaper financing in local currency for the economy. The strategy also includes a focus on improving business processes and information technology management, human resources policy, public relations policy, and improving risk management. The key performance indicators (KPIs) under the strategy through 2023 include: - Increasing the financing volume to almost four times the current level, or Kazakhstani tenge (KZT) 4.4 trillion, from KZT1.3 trillion in 2014. - Increasing the loan portfolio to more than KZT2.6 trillion from KZT0.7 trillion, with a target for the total amount of loans to be more than 75% the amount of assets. - Decreasing provisions to 8% or less, from 10% in 2014. - Maintaining debt at 6x capital. To achieve these KPIs, DBK will require a KZT150 billion capital injection from the government, and plans to raise KZT1.3 trillion on the domestic market, and $5.9 billion in international markets. DBK received a KZT50 billion budget loan from government in October 2014, and expects to receive an additional KZT50 billion loan and a KZT25 billion equity injection before the end of the year. The stand-alone credit profile (SACP) is 'b+', reflecting DBK's anchor of 'bb-', as well as its "adequate" business position, "strong" capital and earnings, "moderate" risk position, "below average" funding, and "strong" liquidity, as our criteria define these terms. One of DBK's strengths is its strong capitalization, which is supported by shareholder capital injections and strong liquidity. Offsetting these strengths are its concentrated wholesale funding, high industry concentrations in the loan book, volatile and low core profitability, and a weak loss track record compared with Kazakh commercial banks that have not been restructured. Our assessment of DBK's business position as "adequate" balances its public policy role as a specialized development institution against its aim of financing infrastructure and industrial projects in the private and public sectors and its significant size against the government-directed nature of its lending. DBK is Baiterek's largest subsidiary and accounted for 58% of Baiterek's consolidated assets at year-end 2013. That said, DBK had assets of KZT1.2 trillion ($6 billion) in mid-2014, making it somewhat smaller than the largest two commercial banks--Kazkommertsbank JSC (KKB) and Halyk Savings Bank of Kazakhstan (Halyk), both of which have assets of more than KZT2.7 trillion. Our assessment of DBK's capital and earnings as "strong" reflects our expectations of continued regular and sizable capital injections from the government. We forecast that our risk-adjusted capital (RAC) ratio would weaken from its current levels, but stay above 10% in the next 12-18 months, due to expected loan growth. It was 13.8% at year-end 2013. As of Nov. 1, 2014, DBK's Basel II capital adequacy ratio was 21.8%. If the bank's future capital policy, philosophy, and growth rates were to differ materially from our current assumptions, we could reassess our view of its capitalization. DBK's income has been volatile and core profitability low over the past five years and we expect it to remain so. In the first half of 2014, DBK barely broke even. It was hampered by significant losses on currency exchange swaps--the tenge was devalued in February 2014. In 2013, net profit was boosted by a sizable one-off KZT23 billion gain after the terms of a loan from Export-Import Bank of China were modified. The bank aims to achieve a KZT3 billion profit for full-year 2014, based on a strong third quarter. Our "moderate" assessment of DBK's risk position mainly reflects weaker loss experience than Kazakh commercial banks that have not been restructured, a very high share of loans in foreign currencies, and high industry concentrations. DBK's loss track record compares poorly with nonrestructured commercial Kazakh banks. Because it transferred most of its NPLs to IFK in late 2013 and the first half of 2014, NPLs reduced to 7.8% at mid-2014 (including NPLs on leases) from 41.5% at year-end 2012. Despite DBK's strategic aim of financing the non-oil sector of the economy, the loan portfolio remains heavily concentrated in the oil and gas (specifically: oil refining and gas processing), mining, metallurgy, and energy sectors. In our opinion, DBK's funding is below average, reflecting high refinancing risk due to its concentrated wholesale funding profile. We assess liquidity as "strong," reflecting significant holdings of liquid assets. The negative outlook on DBK mirrors our outlook on the sovereign ratings on Kazakhstan. We would likely revise the outlook on DBK, or raise or lower the ratings on DBK if we took similar rating actions on the sovereign. We could lower the rating if we no longer assessed extraordinary government support as almost certain--for example, if we consider that policy changes had weakened the bank's role, or if we saw signs of weakening government support. We expect the government to continue to show strong ongoing support for DBK through its long-term commitment to increase the bank's capital, as outlined under the bank's new strategy. We do not anticipate any change to policy or the regulatory framework that would weaken the bank's key role in the government's development plans. However, a deviation from DBK's role in government policy, or signs of weakening government support--for example, if an increase in the bank's capital become less forthcoming in the future--could cause us to lower the ratings. Primary Credit Analyst: Ana Jelenkovic, London (44) 20-7176-7116; ana.jelenkovic@standardandpoors.com Secondary Contact: Annette Ess, CFA, Frankfurt (49) 69-33-999-157; annette.ess@standardandpoors.com [2014-11-28]