On August 14, Fitch Ratings published a survey of Kazakhstan banks for the 2nd quarter of 2018 with the key data from regulatory financial statements of banks and disclosed information obtained mainly from sources such as the National Bank of the Republic of Kazakhstan ("NBK") and the Kazakhstan Stock Exchange.

According to the agency, the indicator of non-performing loans in the sector (loans overdue more than 90 days) remained unchanged in 2Q2018 at about 13% of gross loans (adjusted for write-offs at Kazkommertsbank ("KKB")). However, the quality of assets remains weak, as the quality of bank assets is negatively affected by accrued but not received interest, high-risk currency and/or restructured loans, some of which include deferrals for repayment of interest or principal.

The agency notes that the NBK suspended licenses of three small banks (Bank of Astana, Qazaq Banki and Eximbank) in 2Q2018, and the problems with capital adequacy/liquidity in these banks have not yet been resolved. Fitch believes that the financial difficulties and suspension of banks’ licenses show that the regulatory easing for the recognition of problem loans and their reservation are declining. The small size of troubled banks limits the risk of spreading problems to the banking sector as a whole, but increasing regulatory pressure can speed up the banks consolidation process.

According to the source, other indicators of banks as a whole remained stable in 2Q2018. Return on average capital in the sector was high at 22% in 1H2018, while the average capital adequacy and liquidity indicators remained good. At the same time, these indicators differ significantly from bank to bank, and there are still several banks with low profitability and a weak capital/liquidity reserve in the sector.

Our opinion. We share the agency's conclusions, which coincide with our opinion in the previously published analytical report on the development of the banking system in June. In its review, Fitch notes a significant increase in retail lending (+4.5%), the main driver of which is unsecured high-yield consumer lending. At the same time, corporate credit growth according to Fitch data will be restrained as a result of low demand and a limited number of high-qualitative borrowers. In our opinion, this low demand for corporate loans and a lack of qualitative borrowers is connected with the presence of structural problems in the economy and a significant predominance of the public sector.

According to Fitch, the indicator of problem debts overdue for over 90 days (NPL90+) in the banking sector as a whole by the end of the first half of the year compared to the first quarter of 2018 decreased by 1.8pp and amounted to 11.1%. However, Fitch analysts make an amendment to the fact that this indicator does not fully reflect the real state of loan portfolios of banks. In our reports, to determine the real state of the loan portfolio of banks and the sufficient amount of created provisions, we use the share of uncollected real interest income from accrued income. Based on the calculations of this indicator, we conclude that there is a much greater volume of problem debts in the banking system and an insufficient level of created reserves, than it is officially reflected in the reports of banks. We also mention a decrease in this indicator for a number of large banks (with the exception of ATF Bank and Tsesnabank), as a result of the state support provided and subsequent active work on the recovery of the loan portfolio.

Fitch also notes a relatively high level of accumulated liquidity (45%) in the banking system, such a high level of accumulated liquidity, as we have indicated in our monthly report on banks for June, is related to the lack of qualitative corporate borrowers in Kazakhstan's economy. Most of this liquidity is being sterilized by the national bank in the form of short-term notes and deposits, ensuring that they yield at the level of the lower limit of the NBK's base rate. If this rate is reduced under the pressure of declining profit margins, banks will have to send these funds to an even larger increase in unsecured consumer lending. In conditions of a weakening of the tenge, there is also a possibility of this excess liquidity to be directed to the foreign exchange market in order to obtain speculative income.

According to Fitch's report, the interest margin of the banking sector increased from 4.7% in 2017 to 5.1% in 2018. In our view, this growth is due to the increased focus of banks on high-yield unsecured consumer lending against a background of a gradual decline in deposit rates. Besides the banks' efforts increasing concentration on the consumer lending segment, the banking sector's profit growth in 2018 is connected to the receipt of a significant amount of money in the banking system, within the framework of state support for the banking sector. The inflow of these funds allowed banks to write off previously hidden problem loans and then send the released funds to purchase government securities that provide banks with a regular fixed income.