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Kazakh bank valuations

Kazakh banks can be divided into two big groups – those that have just raised capital or found new strategic partners and those that are planning to do so in 2007. Kazkommertsbank and Halyk Bank have issued shares on international markets, while Bank TuranAlem, Alliance and ATF are expected to do so in 2007. A significant stake in Bank Caspian is now controlled by foreign investors who could inject capital. CenterCredit Bank has indicated that an international placement is possible but yet not certain.

We maintain our 'Buy' recommendation on Kazkommertsbank with a $14 target price and 16% upside, expecting the bank to keep its positions on the local market after capital is raised.

We also expect Bank TuranAlem to raise around $1.5bn from the market this year. Given that Bank TuranAlem has less exposure to interest rate declines and that the bank is expanding on the local and CIS markets, we give Bank TuranAlem a 'Buy' recommendation with a target price of $1,600 and 32% upside, more than that of Kazkommertsbank.

We also raise our target price for Alliance, which increased its equity capital at the very end of December. It appears that the bank is still interested in an IPO. Based on these expectations, we give Alliance a 'Buy' recommendation with a target price of $650 and 19% upside.

We rate the other Kazakh banks as 'Hold' for various reasons. ATF has a low return-on-equity (ROE), which is expected to stay at 13% after capital growth. Halyk is expensive as it is traded at 4.8x price/book value. Bank Caspian and CenterCredit could become an attractive buying opportunity if they raise capital. Though we currently rate both banks as 'Hold', we could revise our target prices and valuations higher if they increase equity capital.

Kazakh banking sector outlook for 2007

Kazakh banking assets are expected to reach 88% of GDP by the end of 2007 versus around 80% at the end of 2006. The slowdown in their asset growth rate to 50% was mainly dictated by expectations of additional restrictions on foreign borrowing which could be introduced by the central bank. In 2006, monetary authorities implemented obligatory reserve requirements on foreign borrowing for Kazakh banks and introduced a ratio for foreign currency liquidity to reduce appetites for currency risks. The high likelihood of additional restrictions being introduced in 2007 is the key concern for Kazakh banks.

In 2006, foreign borrowing was the main source of funding in an environment of slow growth of local resources. Increasing in foreign obligations financed 40% of banking asset growth last year. In 2007, banks are likely to keep their eyes on foreign markets as retail deposits are not expected to increase.

Mounting inflation is keeping retail deposits at 10% of GDP, lower even than in Russia. We anticipate that the inflationary environment will stimulate demand for retail lending while also allowing only a modest increase in deposits to 11% of GDP this year.

The Kazakh corporate sector is also unlikely to deliver strong increases in accounts with banks. The appetite for IPOs from the corporate sector in general is still modest despite some placements completed in 2006. As at this time a majority of corporate institutions are not public companies, they are more likely to be aggressive borrowers from local banks rather than holders of large accounts.

The Kazakh banking market will continue to deliver fast growth with retail loans reaching $27.2bn by year-end. We anticipate this market to increase by $10bn for the entirety of 2007, reaching 19% of GDP. In this case, growth will be comparable to the increase of the corporate loans market, targeted at $37bn. We believe that the declining interest rate environment will dictate an increase of the share of loans to total assets.

An important topic for the Kazakh banking sector will be the dynamics of interest rates. The Kazakh banking market is not dominated by one large player, like Sberbank in Russia, but rather by the "Big Three" – Kazkommertsbank, Bank TuranAlem and Halyk Bank – which together controlled 57% of total assets in mid-2006, a fall from 60% in the beginning of the year. Competition in Kazakhstan is strong and intensified in 2006, which should keep pressure on interest rates in 2007. We expect the largest Kazakh banks to increase exposure to small and medium-sized businesses in order to preserve margins.

Kazakh banks are more vulnerable to the global interest trend than Russian and Ukrainian banks. With around 50% of their assets financed with foreign obligations, the increase of US and worldwide interest rates will increase their cost of funding.

Kazakh retail banking outlook

The Kazakh retail lending market totals around 14% of GDP, or approximately $12bn as of year-end 2006. One-third of this market is in mortgages, amounting to $4.0bn, or 5% of GDP. Around 28% of the mortgage market is controlled by Halyk, which increased its market share from 10% a couple of years ago. Some 20% of this market is controlled by the largest Kazakh bank Bank TuranAlem. These two banks are the main players on the local mortgage market.

Together, they also control around 20% of the entire retail lending market.

On the consumer finance side, 40% of the market is controlled by Alliance.

Strong cooperation with Kazpost helps the bank to increase its retail sales. We expect the consumer finance market will deliver the fastest growth rate in coming years.

As in Russia, the segment of personal loans provided for unspecified use by employees of banks’ corporate clients represents a substantial portion of retail lending. As of the end of 2006, this represented 45% of the total retail portfolio of the banking sector.

The poor development of the auto loan market is rather surprising. While 90% of cars sold in Kazakhstan are bought with borrowed money, Kazakh banks have not yet developed specific car lending products. We expect that, as in Russia, this market will emerge with the maturation of the retail market.

New borrowing restrictions: a boost for IPOs

The Kazakh financial regulator has suggested imposing new restrictions on foreign borrowing by Kazakh banks. The new regulations will limit foreign liabilities of Kazakh banks to 3-5x book value, and to 2-4x book value excluding bonds issued, with tougher restrictions applied to smaller banks. The restrictions will come into effect in March; however, the six or seven banks that have yet to comply with the limits will have until 2008 to meet the terms of the new regulations.

In our view, the new regulations will not have any significant impact on the largest Kazakh banks. Both Kazkommertsbank and Halyk Bank recently raised additional capital, bringing their equity to $2.0bn and $1.0bn, respectively, and their debt/equity ratios to 1.8x and 1.4x. ATF, CenterCredit and Bank Caspian have relatively low foreign debt/equity ratios and would hardly be affected by the new regulations. We expect Bank TuranAlem to raise capital from international markets in 2007.

All in all, we believe that the new requirements will prompt more banks to seek to raise their equity capital, particularly by arranging public placements. Unsurprisingly, Bank TuranAlem recently mentioned its intention to conduct and IPO in 2007. As long as the banks would be allowed to increase their borrowing along with capital, the proposed restrictions would hardly limit growth in the Kazakh banking sector.

For second-tier banks, additional restrictions on foreign borrowing could clearly be a reason to consolidate their business or to sell it to larger peers. We believe that the additional restrictions will have a positive impact, reducing banking sector risks and increasing their growth with foreign participation in equity capital.

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