TEXT - Fitch raises Development Bank of Kazakhstan rating

Wed Nov 21, 2012 11:02am EST

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(The following statement was released by the rating agency)
    Nov 21 - Fitch Ratings has upgraded Development Bank of Kazakhstan's (DBK)
Long-term foreign currency Issuer Default Rating (IDR) to 'BBB' from 'BBB-', and
its Long and Short-term local currency IDRs to 'BBB+' and 'F2' from 'BBB' and
'F3', respectively. At the same time, Fitch has upgraded KazAgroFinance's (KAF)
Long-term IDR to 'BB+' from 'BB'. A full list of rating actions is provided at
the end of this commentary.

RATING ACTION RATIONALE

The rating actions follow Fitch's upgrade of Kazakhstan's Long-term foreign 
currency IDR to 'BBB+' from 'BBB' and Long-term local currency IDR to 'A-' from 
'BBB+' on 20 November 2012 (see 'Fitch Upgrades Kazakhstan to 'BBB+'; Outlook 
Stable' at www.fitchratings.com). The Outlook on the ratings reflects that on 
the sovereign IDRs.

RATING DRIVERS - DBK

The IDRs reflect a high probability that support would be forthcoming to the 
bank from the government of Kazakhstan, if needed. This view is based on DBK's 
ultimate sovereign ownership, its important policy role as a development 
institution, the close association between the authorities and the bank, giving 
rise to significant reputational risk in case of a bank default, and the 
currently still moderate cost of any potential support relative to the 
sovereign's financial resources. The one-notch differential between the 
sovereign and the bank's IDRs captures Fitch's concerns about the bank's 
increased leverage funded by wholesale debt, and some risk that the sovereign 
would cease to provide full support to DBK and other quasi-sovereign entities 
before it defaulted on its own debt.

The National Welfare Fund Samruk Kazyna, which is wholly owned by the 
government, controls 100% of the bank's share capital. DBK's board is chaired by
deputy prime minister of Kazakhstan. DBK's close association with the government
means, in the agency's view, that the bank's default would have considerable 
adverse consequences. These could include reputation damage for the national 
authorities with related risks of important project disruption and a potentially
wider negative spill-over effect in terms of the economy's access to foreign 
capital. The cost of any potential support that might be required by DBK is 
moderate given that its entire third-party (from non-government sources) debt at
end-9M12 equated to USD4.5bn or 2.3% of Fitch's forecast for Kazakhstan's 2012 
GDP.

The likelihood that support could be required by DBK is high given the bank's 
weak standalone profile. Non-performing loans (NPLs, more than 90 days overdue) 
remained at a very high level of 41% at end-9M12 after some reduction from 45% 
at end-2011 mainly due to one loan which has been restructured but is yet to 
demonstrate an improved performance. NPL coverage by loan impairment reserves 
(LIRs) was also poor with unreserved NPLs exceeding USD305m or 20% of Fitch Core
Capital (FCC) at end-9M12. Fitch expects continued slow recovery of problem 
exposures, mainly through restructuring and additional financing, but management
has informed Fitch that some of the loans might also be transferred to a 
related-party fund with a mostly neutral effect on the bank's capitalisation.

DBK's single-name concentration risk stems primarily from its two largest 
balance sheet and off-balance sheet exposures which, net of LIRs, aggregately 
accounted for 110% of FCC at end-2011. Fitch derives some comfort from the fact 
that the largest (79%) of these related to a subsidiary of an investment-grade 
corporate. More broadly, given the pronounced scale of the national industrial 
programme, DBK will likely continue adding lumpy credit exposures. Fitch would 
be concerned about any rapid business expansion should it be undertaken without 
considerably sounder underwriting standards in view of the poor lending track 
record and the high-risk nature of the investment projects financed.

DBK has continued to build up third-party debt recently, but liquid assets held 
against it have remained sizeable. At end-2011, the latter stood at USD2.5bn, or
54% of total liabilities, and comprised of cash and investment-grade debt 
securities. Fitch believes that DBK's long-term liquidity position should 
benefit from the planned elimination of a USD0.8bn wholesale redemption spike 
falling in 2015, as the bank has offered holders of these bonds an exchange into
longer-tenor instruments.

Capitalisation is somewhat uncertain despite the reasonable reported levels of 
the Basel I Tier I capital adequacy ratio (CAR) at 16.2% and FCC/weighted risks 
at 15.4% at end-2011. The uncertainty is because of the single-name 
concentrations, high level of unreserved NPLs, and material exposure to Kazakh 
commercial banks (USD0.6bn; mainly, 'B' rating category), as well as other 
long-term loans with various signs of credit weakness (Fitch estimates USD0.4bn 
at end-2011).

Fitch understands that DBK may receive further equity injections to support 
growth (the first since a USD1.1bn contribution in 2009). DBK's weak internal 
capital generation weakness is evidenced by the significant interest accrued but
not received in cash (average 22% of total accrued interest in 2009-9M12; in 
aggregate equal to about half of reported pre-impairment profit for the period 
and the average Fitch comprehensive income / average assets ratio of only 0.3% 
for the same period. The latter is due to significant loan impairment charges. 
Furthermore, additional material profit and loss volatility has arisen in recent
years as a result of internal model-based valuation of corporate bonds with an 
aggregate value of USD1.2bn or 20% of total assets at end-2011. 

KEY SENSITIVITIES - DBK

DBK's Long and Short-term IDRs are likely to move in tandem with the sovereign 
IDRs. The ratings could come under downward pressure if leverage increases 
further and asset quality continues to deteriorate without capital support being
provided. A marked weakening of the bank's policy role or less close association
with the Kazakh authorities could also result in negative rating action, 
although this is not expected by Fitch.

RATING DRIVERS - KAF

The IDRs reflect a moderate probability of support from the Kazakh authorities. 
The company's ratings also factor in the company's small size (USD0.9bn total 
balance sheet at end-2011) and, hence, cost of support, the track record of 
government-provided non-equity funding and capital, and the historically low 
leverage the company operates with. KAF is fully owned by National Holding 
KazAgro, which in turn is fully owned by the government.

KAF's sub-investment grade rating, and the current three notch differential 
between the company's IDR and that of the Kazakh sovereign, reflect KAF's less 
prominent policy role as a development institution and lesser importance for the
country's economy and financial system relative to other development 
institutions in Kazakhstan, in particular DBK. It also takes account of the 
company's indirect government ownership, which may in some scenarios impact the 
timeliness of support. In Fitch's view, KAF's policy role in providing financing
for the agricultural sector could quite easily be performed by another of the 
entities owned by KazAgro, if needed.

KAF's non-performing loans and leases stood at a significant 14% of the 
portfolio at end-2011. Restructured loans and leases made up an additional 21%. 
Total IFRS LIRs stood at only 8% of total lending, meaning only very modest 
reserve coverage of problem exposures. Asset quality and provisioning metrics 
remained broadly flat in 9M12. 

Notwithstanding its poor credit portfolio quality KAF's capitalisation is 
currently sufficient to withstand additional significant impairment. At end-2011
the company could create an additional USD434m of LIRs (equal to 64% of gross 
loans and leases) before the Basel I Tier I CAR would have fallen to 10%. 
Capitalisation has been maintained at a high level with the Basel I Tier I CAR 
at an average level of 60% during 2009-2011 due to solid equity injections 
typically provided for in government regulations. Fitch notes that KAF's 
leverage may increase somewhat due to more active third-party borrowings, which 
is in line with the authorities' recently outlined plans to change the system of
subsidies provision to the agriculture sector.

The company's current third-party debt level was moderate at end-2011 with 
USD106m of borrowings from financial institutions (35% of total funding). Being 
wholesale funded and having a strong capital buffer, KAF does not aim to 
maintain a strong liquidity cushion at all times. However at end-9M12 it held a 
solid USD85m reserves of liquid assets (about 24% of total liabilities). 

KEY SENSITIVITIES - KAF

KAF's IDRs are unlikely to be upgraded to investment grade level even if the 
sovereign is further upgraded, given its limited policy role. The ratings would 
likely be downgraded in case of a sovereign downgrade. In addition, the ratings 
could come under downward pressure in case the company's financial profile 
deteriorates considerably without support being forthcoming.

The rating actions are as follows: 

DBK
Long-term foreign currency IDR upgraded to 'BBB' from 'BBB-'; Outlook Stable
Short-term foreign currency IDR affirmed at 'F3'
Long-term local currency IDR upgraded to 'BBB+' from 'BBB'; Outlook Stable
Short-term foreign currency IDR upgraded to 'F2' from 'F3'
Support Rating affirmed at '2'
Support Rating Floor revised to 'BBB' from 'BBB-'
Long-term senior unsecured programme and debt ratings upgraded to 'BBB' from 
'BBB-'
Short-term senior unsecured programme rating affirmed at 'F3'

KAF
Long-term foreign and local currency IDRs upgraded to 'BB+' from 'BB'; Outlook 
Stable
Short-term foreign currency IDR affirmed at 'B'
National Long-term rating upgraded to 'AA-(kaz)' from 'A(kaz)'; Outlook Stable
Support Rating affirmed at '3'
Support Rating Floor revised to 'BB+' from 'BB'

 (Caryn Trokie, New York Ratings Unit)
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