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S&P Global Ratings raised its long-term ratings on National Bank For Foreign Economic Activity of the Republic of Uzbekistan (NBU) and KDB Bank Uzbekistan JSC to 'BB-' from 'B+' and affirmed its 'B' short-term ratings on the two banks. The outlooks are stable.

The rating actions follow 'BB-/B' ratings assignment to the Republic of Uzbekistan on Dec. 21, 2018. S&P's view of the sovereign's creditworthiness previously constrained the ratings on the two banks at 'B+'.

For NBU, this is because S&P considers the creditworthiness of state-owned banks to be correlated to that of the sovereign. S&P's ratings on KDB are also capped by rating on Uzbekistan, despite the bank's ownership by, and strategic importance to, a higher-rated foreign entity.

S&P's ratings on Uzbekistan are supported by the government's strong fiscal and external positions. These strengths predominately arise from the government's large asset position, which stems from the past policy of transferring part of the revenues from commodity sales to the Uzbekistan Fund for Reconstruction and Development (UFRD). At the same time, S&P's ratings are constrained by Uzbekistan's low economic wealth, as measured by GDP per capita. In S&P's view, future policy responses may be difficult to predict, given the highly centralized decision-making process and that accountability and checks and balances between institutions are relatively underdeveloped. S&P's ratings are also constrained by low monetary policy flexibility.

S&P's ratings on NBU reflect the bank's diversified business model, with leading market positions in state development projects and other nongovernment segments. The bank's relatively modest core profitability by domestic standards is constrained by the limited net interest income, as NBU acts as the state's agent in financing targeted industries at capped margins set by government decrees. While the bank has a proven track record of maintaining stable profitability over the cycle, S&P believes that earnings capacity is still lagging behind expected asset growth. Finally, S&P considers the bank's funding diversification to be better than local peers' and liquidity as adequate. S&P's assessment of NBU's risk profile balances marked ongoing support from the sovereign (direct and indirect via state guarantees) with high concentrations, a significant amount of foreign currency lending, and a fast expansion strategy.

S&P assess the bank's stand-alone credit profile at 'bb-'. S&P considers the bank has high systemic importance within the banking sector of Uzbekistan and is a government-related entity (GRE) with a very high likelihood of extraordinary government support. However, S&P's ratings do not reflect this in the form of an uplift, as the stand-alone credit profile (SACP) is at the same level as the sovereign rating.

The stable outlook on NBU reflects S&P's view of the balance between expected continued state support over the next 12 months and high economic and industry risks for banks operating in Uzbekistan.

S&P considers state-owned banks' creditworthiness to be closely linked to that of Uzbekistan. Therefore, S&P is unlikely to raise the ratings on NBU over the next 12 months unless our view of the sovereign's creditworthiness improves. S&P views an upgrade driven by improvements in bank-specific factors as unlikely over the next year.

S&P could downgrade NBU over the next 12 months to reflect heightened economic and industry risk, for example caused by a deterioration of the sovereign's creditworthiness. A downgrade linked to bank-specific factors is remote, as this would require both material weakening of NBU's currently adequate asset quality and deterioration of capitalization (with projected risk-adjusted capital [RAC] ratio declining to below 3 percent).

S&P's ratings on KDB Uzbekistan reflect its small lending franchise, stable depositor base, high liquidity cushion, and funding metrics that S&P sees as much stronger than those of peers. S&P also incorporates in the ratings the bank's strategic intention to rapidly expand its lending business over the next two years. Following the assignment of ratings to Uzbekistan, S&P views the capitalization of KDB as a positive rating attribute, owing to high amount of placements with the central bank of Uzbekistan (about 20-25 percent of assets). Previously, in the absence of a sovereign credit rating on Uzbekistan, S&P applied more conservative risk weights in calculating of the RAC ratio for KDB. S&P expects that the bank will be able to maintain a solid capital buffer, with a RAC ratio of close to 10.8 percent at year-end 2019. S&P have therefore revised upward the SACP on the bank to 'bb-' from 'b+'.

S&P considers KDB Uzbekistan a strategically important subsidiary of Korea Development Bank (AA/Stable/A-1+). There is a high likelihood that the parent would provide extraordinary support to KDB in the form of capital or liquidity if needed. S&P may rate strategically important subsidiaries up to three notches above their SACP. However, S&P caps the ratings on KDB at the level of the foreign currency long-term sovereign rating on Uzbekistan.

The stable outlook on KDB largely mirrors the stable outlook on Uzbekistan.

S&P could raise the long-term rating on KDB or revise the outlook to positive over the next 12 months if S&P took a similar rating action on the sovereign, assuming that there is no change in the commitment of the parent, Korea Development Bank, to provide extraordinary support to its Uzbek subsidiary if needed.

S&P could take a negative rating action if S&P took a similar rating action on the sovereign. Although unlikely, a significant deterioration of the bank's SACP and changes in parent's commitment to provide extraordinary support could also prompt a negative rating action.

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