Fitch Ratings - Moscow - 17 May 2021: Fitch Ratings has affirmed Microcreditbank's (MCB) Long-Term Issuer Default Ratings (IDRs) at 'BB-' with a Stable Outlook and Viability Rating (VR) at 'b-'.

The Long-Term IDRs of MCB are driven by a moderate probability of support from the government of Uzbekistan (BB-/Stable) as reflected by a Support Rating (SR) of '3' and a Support Rating Floor (SRF) of 'BB-'. This view is based on the bank's majority state ownership, important role in the government's economic and social policy, the low cost of potential support relative to the sovereign's international reserves, and a record of capital and liquidity support.

The Long-Term IDRs factor in MCB's policy role as an agent for state-sponsored subsidised lending to SME and retail clients in rural regions of Uzbekistan. Under the strategy for banking sector reform published in 2020, MCB will retain its focus on development lending and remain in state ownership in the long term.

The authorities' ability to provide support is underpinned by the moderate size of the banking sector relative to the economy (total assets were 63% of GDP at end-2020) and large international reserves (USD35 billion at end-2020). However, our assessment of support ability also factors in high concentrations in the banking sector (with state-owned banks accounting for 85% of end-1Q21 sector assets), high loan dollarisation (50% at end-1Q21), large share of external funding in the banking sector and vulnerability to external shocks in a volatile operating environment, as government finances are sensitive to commodity exports and remittances.

The Stable Outlook on MCB' ratings reflects that on the sovereign.

The affirmation of MCB's VR reflects a challenging operating environment, weaknesses in underwriting standards, high lending growth especially in foreign currency (FC), only moderate profitability and high reliance on funding from foreign banks and international financial institutions (IFIs). The rating also captures exposure to higher-risk lending segments (agriculture, SME and retail borrowers with belowaverage incomes), mainly in rural areas of Uzbekistan, and weak operating efficiency resulting from a labour-intensive business model and a costly country-wide branch network.

Loans in the three lowest categories (a proxy for impaired loans) under local GAAP increased to 1.9% at end-1Q21 from 0.6% at end-2019. Impaired loans were 51% covered by specific reserves at end-1Q21. Loan book concentration is moderate, with the 25-largest exposures accounting for 24% of gross loans at end-2020.

Asset-quality risks stem from high loan growth (73% in 2020, adjusted for currency moves), still developing underwriting standards and increasing share of FC loans (33% in at end-2020, up from 8% at end-2018). MCB has been rapidly growing in recent years, particularly through loans under statedevelopment programmes, which are long-term and often issued with grace periods. This, together with a high share of restructured loans (27% of gross loans at end-2020), results in a largely unseasoned loan book and untested asset quality, in Fitch's view.

Accrued but not received interest increased to 14% of Tier 1 capital at end-1Q21 from 2% at end-2019), reflecting weakened performance of the loan book. Pre-impairment profit (local GAAP data) increased to 3% of average loans in 2020 from 1.5% in 2019, but was lower 0.9% and 0.7%, respectively, if adjusted for accrued but not received interest. Loan impairment charges consumed 41% of reported pre-impairment operating profit in 2020 (83% in 2019), and return on average equity was a moderate 6%. MCB's capitalisation benefits from regular capital contributions from the state. The bank received about UZS1 trillion (USD100 million-equivalent) Tier 1 support in 2018-2019 and management expects an additional UZS400 billion in 2021. At the same time, we view MCB's capitalisation as only moderate due to a focus on high-risk development lending, limited pre-impairment profitability and high growth.

Its estimated Fitch Core Capital (FCC) to regulatory RWAs decreased to 14% at end-1Q21 from 26% at end-2019. Its regulatory Tier 1 ratio of 14.5% and total capital adequacy ratio of 14.6% at end-1Q21 were reasonably above required minimums of 10% and 13%, respectively.

Customer accounts made up only 13% of MCB's total liabilities at end-1Q21, resulting in a very high loans-to-deposits ratio of 337%. State-related funding equaled 39% of total liabilities at end-1Q21, while wholesale funding accounted for another 48% and comprised mainly loans from foreign banks and IFIs (18%) and local banks (18%). MCB's stock of liquid assets at end-2020 covered only 71% of planned wholesale funding repayments for the next 12 months. We believe the bank will attract additional long-term IFI funding in 2H21 and the state will provide MCB with liquidity support in case of need.