OREANDA-NEWS. Kazakh banks' low ratings already capture the risks arising from sizable legacy asset quality problems and emerging challenges stemming from the fall in oil prices and potential tenge devaluation, Fitch Ratings said at its ninth annual conference on Kazakhstan in Almaty.

Most Kazakh banks' ratings continue to be in the low 'B' category, with the exception of Halyk Bank of Kazakhstan (BB/Stable/bb). The ratings chiefly reflect significant volumes of underserved impaired loans, limited loss absorption capacity and - at some banks - weak operating profitability.

The operating environment remains a moderately supportive factor for the ratings given the sovereign's fairly strong financial position and Fitch's 2.5% GDP growth forecast for 2015. However, a further fall in the oil price would be negative for both the sovereign credit profile and the country's banks.

Asset quality remains the main risk for the sector, notwithstanding a moderate reduction in non-performing loans (NPLs) in 2014 mainly as a result of loan write-offs. NPLs comprised a high 24% of sector gross loans at end-2014, accrued interest amounted to a further 12%, and restructured loans were also at double-digit levels at most rated banks. Banks' existing capital buffers, together with government funds committed to the Problem Loans Fund, could in aggregate be sufficient to absorb unreserved NPLs and accrued interest, but not restructured loans. Loan growth moderated to 6% in 2014 from 12% in 2013 due to the more limited availability of tenge funding, and we are not expecting higher growth this year than in 2014.

A potential devaluation of the tenge could exacerbate asset quality problems, as net FX loans markedly exceed the equity of large rated banks. The direct hit to banks' Tier 1 capital ratios from a 30% devaluation would be a moderate 0.3-1.5 ppts, although this could be significant for some banks where capitalisation is already tight. Additional pressure may arise from the planned toughening of capital requirements, unless the National Bank of Kazakhstan (NBK) delays implementation or provides forbearance. For more information on possible devaluation effects, see 'Fitch: Tenge Devaluation Would Pressure Kazakh Banks', dated 8 April 2015, available on www.fitchratings.com.

Profitability of the sector, excluding restructured banks, is reasonable, with a return on average equity of 15% in 2014, supported by high-margin retail lending and the lower cost of FX funding. However, performance is weaker than this at most large banks, and may weaken further in 2015 due to likely increases in impairment charges and margin pressure from higher hedging/funding costs.

Tenge liquidity has tightened somewhat, reflecting increased dollarisation of customer deposits (to 58% at end-2014 from 37% at end-2013) and more limited refinancing from NBK aimed at preventing pressure on the currency and FX reserves. However, the state and quasi-state entities remain key providers of bank funding, accounting for more than 20% of sector liabilities at end-2014.