The ratings on Uzbekistan-based Turkiston Bank reflect its b+ anchor, as well as our view of the bank’s weak business position, strong capital and earnings, weak risk position, average funding, and adequate liquidity, as S&P’s criteria define these terms. The stand-alone credit profile is b-.

Under their bank criteria, S&P uses the Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank’s anchor, the starting point in assigning an issuer credit rating (ICR). Their anchor for a commercial bank operating only in Uzbekistan is b+. The economic risk score for Uzbekistan is 7. Uzbekistan’s economy is predominantly state-owned, undiversified, and commodity-dependant, with high political risks and an unfavourable investment climate. But a low degree of financial intermediation, relatively low levels of corporate and personal indebtedness in both private and public sectors, and limited cross-border borrowing help shelter the country’s small banking industry somewhat from global external shocks. The industry risk score for Uzbekistan is 9. The Uzbek banking industry is undermined by very weak institutional and legal frameworks, limited transparency and disclosure, a lack of business and funding diversification, and dominance of state-owned banks, which distort domestic competition.

The S&P’s assessment of Turkiston Bank’s business position as weak reflects its very small and narrow franchise and a lack of product and customer diversity. Although the bank has been operating since 1997, its market share has remained insignificant at about 0.2% of banking system assets. Compared with some other small Uzbek banks, Turkiston has a reasonable performance track record and can no longer be considered a start-up operation. As of Dec. 31, 2011, the bank’s assets under International Financial Reporting Standards (IFRS) totalled Uzbek sum (UZS) 50 billion (about $28 million). Currently, it focuses on small-and-midsize enterprises in specific districts of Uzbekistan’s capital, Tashkent. Its customer base includes mobile operators, transport companies, trade enterprises, and some public authorities, which is not typical for small privately owned banks. Turkiston Bank’s franchise benefits from its top management’s personal and business connections. Given that the Uzbek banking system is highly concentrated and dominated by state-owned banks, Turkiston Bank has limited opportunities to achieve significant business diversification over the medium term, in our view. At the same time, we anticipate that the bank will expand its assets by 30% annually over 2012-2013, which would be in line with the sector average.

S&P’s assessment of Turkiston Bank’s capital and earnings as strong mainly reflects the bank’s projected risk-adjusted capital (RAC) ratio before adjustments for diversification and concentrations of 13%-15% over the next 12-18 months, although we also consider the low absolute amount of the capital base could make the bank more vulnerable in a stress situation. In S&P’s view, the bank does not currently have sufficient earnings capacity to support internal capital generation, taking into consideration its planned asset growth. At the same time, S&P note that Turkiston Bank’s profitability significantly improved in 2011. Its return on equity increased from 5% in 2010 to 16.7% in 2011. This was mainly due to:

• Lower provisioning expenses, as the bank started to work out problem loans;
• Higher fee and commission income, as a number of new large clients came to the bank.

However, the bank lacks a license for foreign currency operations, which is important for fees and commission revenue growth; this constrains the bank’s profitability. At the same time, Turkiston Bank has enjoyed a stable, high net interest margin of about 10% for the past five years.

S&P consider Turkiston Bank’s risk position to be weak, mainly due to its very high lending concentrations, particularly in its corporate loan portfolio. The top 20 borrowers accounted for about 90% of the total loan portfolio or twice the total equity at year-end 2011. At the same date, however, the bank reportedly had no loans overdue by more than one day. This is highly unusual, but reflective of the small number of mainly relationship-driven borrowers. S&P expect the bank’s asset quality metrics to deteriorate to levels closer to those of its domestic peers – i.e., nonperforming loans to total loans in the range of 2%-5% – as the loan portfolio matures.

S&P assess Turkiston Bank’s funding as average and liquidity as adequate. The bank has a relatively low loan-to-deposit ratio (84% as of Dec. 31, 2011) and limited dependence on interbank borrowing. Of total assets, 27% were funded by equity as of Dec. 31, 2011. However, S&P consider the banks funding base to be undiversified and limited. The top 20 depositors accounted for 62% of the total deposits at year-end 2011. The bank maintains a sizable liquidity cushion, which it needs because a high proportion of its corporate deposits are demand accounts. Cash and cash equivalents, together with short-term interbank placements, comprised 34% of total assets at year-end 2011.

The bank is owned by a number of enterprises and private individuals. S&P consider the ability of the shareholders to provide support in times of stress as uncertain and do not include any notches of uplift for parental support into the ratings. S&P deem Turkiston Bank to be of low systemic importance for the Uzbek banking system due to its low market share in retail deposits, and accordingly do not incorporate any uplift for extraordinary government support.

Outlook

The stable outlook balances S&P’s expectation that the bank will maintain strong capitalization and adequate liquidity metrics despite the likelihood of continuing high levels of asset growth against our expectation that asset quality will deteriorate closer to industry-average levels.

Even though they currently consider the possibility to be remote, S&P would consider a positive rating action if Turkiston Bank were to significantly improve the diversity of its loan portfolio, decrease single-name concentrations, and widen its product range and customer base. This could help lift our assessment of its risk or business position to moderate.

S&P could lower the ratings, if the bank were to suffer material deterioration of its capital base such that the RAC ratio before adjustments fell below 10%. A significant liquidity shortage might also lead to negative rating actions.