Clare Nuttall in Almaty -

Kazakhstan's economic growth is accelerating, though bank lending is continuing to lag the recovery and the volume of loans this year will be almost half of what it was expected to be, according to a new report from VTB Capital.

Overall, VTB has raised its 2010 economic growth forecast for Kazakhstan from 2.3% to 5.3%, while keeping its longer-term forecast to 2013 at 5-5.5% per annum. However lending, which is continuing to lag the recovery, is now expected to grow by just 7.9% in 2010, well below the 13.6% previously forecast. "While banks have been reporting some recoveries in resilient industries like agriculture and trade, the 'big picture problem' with asset quality is still far from resolved and continues to weigh on banks' balance sheets. As it is still complicated, this might further hinder banks from expanding their operations rapidly," says VTB in a report entitled "Kazakh Banks: Same Universe, Different Worlds," which looks at the relative performances of the country's two largest banks, Halyk and Kazkommertsbank (KKB).

Halyk Bank's recent underperformance is unjustified and its valuation is attractive, argues VTB in the report, and although KKB is having a "difficult year," the completion of its loan portfolio reshuffle by the end of this year is expected to be a turning point.

At present, KKB is being largely traded as an option on the recoverability of its loan portfolio. VTB believes the recovery rate of just 28% - similar to two other of the country's biggest lenders, BTA Bank and Alliance Bank - implied by current price levels is too conservative. "While we realise all the associated risks (in particular, timing), we believe that recovery rates will ultimately be around 40%, translating into our new 12-month target price of $9.50," the report says.

Deposit outflows

VTB notes the robust growth of deposits within the Kazakh banking system in the first five months of this year, supporting its forecasts of a 6-9% increase in deposits between the 2010 and 2013 financial years. It anticipates that funds from mainly state-owned corporates and the Kazakh state, via deposits from the Samruk-Kazyna sovereign wealth fund, will continue to be the cornerstone of banks' funding.

However, there are plans to scale down state and quasi-state deposits held at Halyk and KKB. This was confirmed by the recent announcement by state-owned KazMunaiGas EP that it would decrease the volume of deposits placed with the two banks from $3.1bn today to $750m by the end of 2011. "In our view, withdrawing the deposits would have a positive effect on Halyk Bank given its current high level of liquidity," says the report. Halyk's margins have come under pressure recently due to its high level of liquidity; this currently stands at over 40% of assets. The bank is unlikely to have difficulty in raising new funds if it needs to do so in future.

For KKB, despite being in a very different position from Halyk, the reduction in deposits "will not be critical" says VTB. "The bank has been successful in building its deposit base in 2010 and will be able to replace funds from the market. It might also receive support from the state with the outflow of deposits being partially compensated for by state funding."

Overall, however, 2010 is turning out to be quite a difficult year for KKB. "The bank is finally recognising all the NPLs [non-performing loans] in its loan book, revenues (and margins) are under pressure and the market is worried about a turnaround due to the loan book reshuffle," says VTB. "While we see no triggers for the stock in the short term, we assume upside potential given the current pricing of KKB's shares, as we believe all the negatives are priced in."

NPLs have increased to a high of 26.4% as KKB reviews its loan book. Restructured loans account for around 25% of the total portfolio, and KKB's management estimates that 30% of these will become non-performing. Provisions have been increased to 19.8% of the loan portfolio. However, VTB believes that net formation of new NPLs is close to its end. "In our view, management's intention to clean up the balance sheet through reshuffling (hard collection) and writing off bad debts will help the bank to improve its performance in the coming quarters," says the report. "Therefore, we might see upside risks to our valuation and clear upside potential for the stock performance in the long run once visibility improves."