Ben Aris -
There's still some way to go before Ukrainian banks look more like their Western peers, but they're getting there, fast.
Banks across Central and Eastern Europe are growing at exponential rates, but Ukraine's growth is amongst the fastest. Fast growth in balance sheets is the order of the day, driven by a burgeoning in retail lending.
Banks are being lifted by the general rising tide of economic growth. While gross domestic product (GDP) slumped during the Orange Revolution from a heady 12% in 2004 to under 3% in the first quarter of 2005, just as Viktor Yushchenko took over the reigns of power the economy stalled as businessmen universally put investment plans on hold until some political clarity returned it has recovered swiftly; this year GDP growth was up to 6.2% over the first nine months of this year, while foreign direct investment ballooned by 240% year-on-year to $3.6bn ensuring the continuation of the recovery.
Happily, the impressive economic growth has yet to feed through to inflation. Official wage growth is running at over 28% year-on-year and average wages are now about $156 per month, underpinning the retail business, but inflation remains at a moderate 5.8% over the first nine months of this year, down from its end-2005 rate of 10.3%.
The one bugbear is the appearance of a trade deficit when exports tanked during the Orange Revolution following several years of health surpluses. But the resumption of growth has eaten into this deficit, which narrowed to $100m by October and is on course to go into surplus next year.
Ukraine suffers form the classic emerging market problems: bank penetration is low but on a par with other countries in the region; banks are growing fast as they are starting from such a low base; and loans and deposits as a proportion of GDP were a miserable 34% and 32%, respectively, in 2005 whereas these numbers are in triple figures in Western economies.
Retail banking is the fastest growing segment, with balance sheets doubling in size in the last year. Retail loans (including mortgages) now make up nearly a third of all lending by banks, from next to nothing a few years ago.
However, as all of Ukraine's biggest banks are associated with one of the business "clans" that have divvied up the economy, corporate lending remains the bigger business: corporate loans account for 70% of the sector's average loan portfolio.
Foreign currency still plays too large a role in the economy for government central bankers to be sanguine half of all borrowing in Ukraine is in dollars but the share of hard currency debt is falling as the held its value against the stronger currencies of the West for several years now (despite a brief wobble during the height of the Orange Revolution at the start of 2005).
However, the banking sector remains very fragmented. There are currently a total of 169 banks in Ukraine, but unlike Russia there is no dominate banking group.
The state failed to exploit the virtual monopoly that Soviet-era banks like Oschadny Bank (the Ukrainian branch of Russia's Sberbank) enjoyed over retail banking, and commercial banks like market leaders Privatbank and Aval Bank quickly filled this gap to take a 9-12% share of the total sector assets, according to Renaissance Capital.
The sector has begun to transform with a string of acquisitions in the last year with foreigners prepared to pay astronomically high prices going for as much as 6x book value in the case of French bank Credit Agricole's purchase of Indexbank in March. Half a dozen deals have been done in the last year and more are expected as the only cap on the ongoing rapid growth is the banks' ability to boost their capital.
However, there is still a lot of work to do before Ukrainian banks start to look more like their Western peers. The transparency of banks is typically poor and risk management shoddy.
That said, progress is being made: the former savings Oschadny Bank was one of the worse bad debt offenders, but has restructured and seen its non-performing loan (NPL) portfolio fall from 23% of all loans in 2005 to 12% in August. As for the rest of the sector, officially the next worst bank is Pravexbank with a NPL ratio of 3.6%, according to the National Bank of Ukraine. And the average NPL ratio for the sector has fallen from 6.7% in 2001 to 2.4% by the end of last year.
"If we are to believe the available data and ignore exceptions such as Oschadbank, sector asset quality looks healthy. However, as in most countries in the CEE/CIS region, these numbers come with a note of caution," wrote David Nangle, a bank analyst with Renaissance Capital in a recent report. "The system hasn't been stress tested. While the pace of growth has been phenomenal over the past five years, a lot of banks are simply learning on the job, and the expertise provided by foreign banks has only been made available recently."
Most of the progress that has been made has been forced on the banks as they turn to international capital markets to raise fresh capital. Syndicated loans are becoming common, but they remain in the order of a few tens of millions of dollars as the two sides take their time to check each other out.
Falling capital adequacy ratio (CAR) remains the biggest headache for fast growing banks with the sector average down to 15% from over 20% a few years ago.
Ukrsotsbank had to freeze its lending in June as it approached the lower limit on capital adequacy imposed by the central bank's prudential rules. But the bank was soon back in action after the owners decided to invest in the banking business and gave it a shot of fresh capital (see related story).
Cashing in on banking
There is clearly a lot of money to be made from investing in the Ukrainian banking sector, yet portfolio investors have almost no opportunity to invest, as almost none of the banks are listed, leaving all the hay to be made by the strategic investors.
Most banks have plans to IPO in the coming years, but with retail lending volumes doubling every year it is clearly too early to sell out.
"The capitalisation of Ukraines banks is still relatively low, while the potential for growth is tremendous," says Igor Gilenko, president of Nadra Bank. "We dont intend to sell for the moment as we are still in a fast growth phase, but part of our strategic plan is to reach the point where we will have a liquidity event."
Early to see the potential of retail banking, Nadra bank began an aggressive campaign to capture a significant share of the retail market in 2000 by issuing debit cards. The business took two years to build up, but today Nadra bank has 15% of the card market against its 5% share of total individual deposits, putting it in third place behind market leaders Aval Bank and Privatbank.
"In 2000 there was no financial retail market to speak of," says Gilenko. "The entire banking business was corporate. By 2002 we had worked out a five-year development plan that we are still implementing. And the market is growing much faster than we expected."
Originally, the shareholders had intended to create a universal bank, but by the millennium it was clear that retail custom was accelerating and the banks strategy was updated in 2003 give a stronger emphasis on retail operations.
Like many of the other banks, Nadra is thinking about an IPO, but in the meantime is actively talking to potential partners about a possible private placement; selling a small stake in the bank to raise fresh money to continue the expansion has become attractive, while selling a large share to capitalise on fast growth is still a few years in the future.
"In the past 18 months we have also had a spate of smaller stock placements in the market by Nadra, Ukrinbank, Rodovoid, Forum & Megabank, which all have a carry along listing, some of which are in GDR/ADR format," says Renaissance Capital's Nangle. "Given the pace of growth in the market, we do however expect more banks to look to the capital markets to fund growth and for those banks that have already dipped their toe in the water to do something more substantial in the not too distant future."
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