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Although banks' asset quality continues to deteriorate the problems are Manageable

Almaty, April 30, 2008

Interfax-Kazakhstan - Although asset quality continues to deteriorate, the problems are manageable, due to the loss absorption capacity of the banks and ongoing state support, said Standard and Poor’s (S&P).

Standard & Poor's expected this deterioration in asset quality, given that the former fast loan growth can no longer flatter nonperforming loan (NPL) ratios and the natural seasoning effect of loans. We will continue to evaluate the situation, and any signs of material deterioration beyond our expectations would trigger negative rating actions. We do not consider that asset quality problems have peaked. The trends in the economy, in particular the real estate market, and the banks' ability to finance this fragile sector, will be crucial over the next six months to a year in deciding whether Kazakh banks face a soft or hard landing.

Banks continue to proactively manage their liquidity in an environment of tightened liquidity. However, a secondary effect of the liquidity crunch is its impact on asset quality: given the abrupt tightening of bank financing to the economy, there is a slowdown in economic activity. Asset quality pressures are exacerbated by the higher cost of borrowing and the sharp reduction in real estate prices. The construction sector and estate-related credits, including mortgages, are affected the most by the lack of financing, with average real estate prices having dropped by more than 30%. Government initiatives to help complete construction projects are having some limited positive impact. Despite the strong pent-up demand, sales have dropped significantly because of the lack of bank financing and anticipation of further price reductions. Banks' exposure to this sector amounts to about 20% of their total loans, but the sector is not over the worst yet.

We estimate that the level of problematic assets is much higher than the low numbers of NPLs reported by banks. This is because in our assessment of the level of problematic assets we consider: the entire balance of overdue loans (not just the late portion); restructured loans; foreclosed collateral; and credits related to all the above. However, even factoring some further deterioration in asset quality due to the seasoning of portfolios, we still believe asset quality problems remain manageable and within expectations of our last rating actions.

Asset quality problems have been contained by several government initiatives to support the construction sector, and the fact that there is a significant export sector, from oil and gas, metals, and grain, which generate some economic activity. Outside the construction and real estate related sectors, banks' corporate portfolios appear relatively sound. However, consumer loans and mortgages (which were the focus of several aggressive banks) are also showing negative asset quality trends. Ultimately, we consider that banks' high interest margins, growing levels of loan loss reserves, and good equity base are sufficient to absorb current levels of asset quality problems.

Furthermore, we believe that if problems increase, regulatory forbearance could play a larger role in assisting banks to smooth their problems. Such support would help to maintain final counterparty credit ratings, lower stand-alone ratings, and factor in higher uplift for government support. We believe that only systemically important banks would benefit from government support.

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