COMMENT: Is VTB back from the dead?

COMMENT: Is VTB back from the dead?
At first glance VTB Bank’s Q1 results were good.
By Mark Adomanis in Philadelphia May 24, 2016

At first glance VTB Bank’s results were good – about as good as could reasonably be expected in an economic environment like the one Russia has at the moment. The bank’s net interest income (the difference between what VTB earned on its loans minus what it has to pay to its depositors) was up a staggering 122% from the first quarter of 2015.

In other good news, provisions (essentially, write-downs on loans that VTB’s management reasonably expects will go bad) were still significant, about RUB40bn (€532mn) of provisions compared with RUB98bn in net interest income, but were down from the first quarter of 2015 by about 17%.

Calculating a percentage increase on VTB’s post-provision net interest income actually isn’t possible. That’s not because the math is overly complex, but rather because in the first quarter of 2015 VTB’s provisions were so enormous that they actually turned its net interest income negative. Rather than getting caught up in year-over-year percentage changes, a far more intelligible approach is to simply look at VTB’s actual post-provision income over the past several years.

In this regard, at least, 2016 wasn’t merely better than the annus horribilis of 2015, it was arguably the best start to a year that the bank has ever had. 

So, is everything okay at the house that Andrey Kostin built? Does anyone who expressed skepticism about VTB’s prospects now have egg on their face?

Well, not exactly. First of all, the results above are for a single quarter only. Yes, they were good, but as everyone knows finance can be an extremely volatile industry. The gods of the market were reasonably kind to Russia in early 2016 (oil prices modestly rallied and the ruble strengthened a little bit against the dollar), but they are under no such obligations for the rest of the year. A sudden drop in oil prices, which is admittedly a bit unlikely but far from impossible, would suddenly put an awful lot of pressure back on the Russian economy in general and VTB in particular.

Looking more closely at the numbers, there are also some legitimate questions about how sustainable the bank’s first-quarter performance is over a longer timeframe. On a year-over-year basis, the bank's total assets actually shrank by about 6.2%, with loans shrinking even more rapidly (-8.4%). That change reflects both some currency adjustments (dollar-denominated loans decreased in value due to the ruble’s strengthening), as well as some badly needed house-cleaning. But, pretty obviously, VTB can’t simultaneously increase its interest income and pare back its book of loans forever – that’s a strategy with a pretty short runway.

Indeed, viewed on a longer time horizon, there has actually been a gradual erosion in VTB’s net interest margin: even with the sharp decline in the bank’s loan balance, the remaining loans are slightly less profitable than back at the start of 2014.  

So, on the one hand, it appears that VTB’s management is belatedly taking action to clean up some of the worst mistakes made during a truly frenetic 2015, when the gross amount of loans and advances to customers shot up by a whopping 50% (more than 2x the trend growth rate). Taking this painful medicine up front is necessary: the alternative would be to have “zombie banks” a la Japan in the 1990s, with enormous portfolios of loans that everyone knows to be rotten but that, at least on the financial statements, appear to be in the rudest of health. There’s still work to be done, but the first-quarter results do suggest progress in tackling some of VTB’s well-publicized problems.

On the other hand, however, there are questions about VTB’s longer-term trajectory that the first quarter results can’t hope to answer. Even with recent improvements, the bank’s interest margins remain about 20% lower than they were in 2012, suggesting that a lot of the recent growth in loan volume has come at the expense of quality. And staff costs continue to march upwards, growing by 11% year over year.

So give VTB credit for improving, but the real key will be to sustain this progress moving forward. Unfortunately, there are good reasons to be skeptical about that.

Mark Adomanis is a Wharton MBA student by day, Russian analyst by night. Follow him on @MarkAdomanis