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. The Outlook on the ratings reflects that on the sovereign IDRs.

DBK

Rating drivers

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 US $4.5 bln 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 $305 mln 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 $2.5 bln, 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 $0.8 bln 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 ($0.6 bln; mainly, B rating category), as well as other long-term loans with various signs of credit weakness (Fitch estimates $0.4 bln at end-2011).

Fitch understands that DBK may receive further equity injections to support growth (the first since a $1.1 bln 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 $1.2 bln or 20% of total assets at end-2011.

Key sensitivities

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.

KAF

Rating drivers

The IDRs reflect a moderate probability of support from the Kazakh authorities. The company’s ratings also factor in the company’s small size ($0.9 bln 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 $434 mln 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 $106 mln 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 $85 mln reserves of liquid assets (about 24% of total liabilities).

Key sensitivities

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.

Rating actions

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