David Nangle of Renaissance Capital -
In this note, we formally put on paper what we have been debating rigorously with clients over the past few weeks while marketing. We reduce our growth, earnings and TPs for Russian banks while, with our crisis hats firmly back on, we stress everything in the system that can and did go wrong back in 2008 to see where we stand today. Russian banks are a bit late to the crisis party and it remains to be seen if they can just squeeze in last orders or really get involved.
We stress test the banks, focusing on the following:
1. Sector liquidity. We see signs of tightening, and while banks and authorities are on guard and better equipped, we assume the endgame will be fine but getting there could be messy.
2. Currency risk. As a key risk, the recent rouble weakness has the potential to affect depositor confidence, to the detriment of banking sector stability.
3. Wholesale funding. Once again, a scarce commodity, and it has negative implications for growth, but much lower risk of default as Russian banks are less leveraged now than they were in 2008. System LDR is 90%.
4. Slowdown of loan growth. This is now our logical base-case, in line with a falling GDP outlook and confidence on both the demand and supply side. Credit growth of 12% is now forecast for 2012 (previously 20%).
5. Asset quality. Step one, we assume write backs stop, step two banks start to accumulate provisions again in 2012. NPLs are unlikely to return to 2009-2010 peaks, but we have to start stress testing the restructured loan books.
6. Trading losses. In our view the most obvious, yet least quantifiable, effect of the 3Q11 market turmoil is on the banks' P&Ls.
EPS forecast cuts, but margins a positive buffer. In our forecasts for 2012E, we cut loan growth from 16-22% to 10-13% and we up the cost of risk, moving from a write-back scenario to one with normalised provisioning at 1-1.5% of gross loans. Rising NIMs (predominantly) and some cost control, as was the case in 2009, should mitigate this. This results in 2012E EPS cuts of 2-11% for the banks under our coverage. To sanity check, it is important to note that in 2H08-YE09, pre-provision profit actually rose in Russian banks - it was asset quality which killed the bottom line.
We remain underweight banks and short-term Russian banks can underperform. We cut our TPs and ratings across the board on EPS cuts and upped cost of equity. Russian banks are no place to hide in a crisis and, at best, our lower growth scenario plays out or, at worst, we get some real sector instability. We stick to fundamentals with our TPs and ratings and in that world, Sberbank of the liquids and Nomos from the mid-cap space are our picks. Two additional points: 1) owning Sberbank DR over the common share is entirely logical while we noticed that in the last crisis, VTB outperformed Sberbank on the way down, irrespective if the difference in fundamentals. We intend to remain fluid with our views in this environment.
Stress test summary
In this note, we formally put on paper what we have been debating rigorously with clients over the past few weeks whilst marketing. We reduce our growth, earnings and TPs for Russian banks while, with our crisis hats firmly back on, we stress everything in the system that can and did go wrong back in 2008 to see where we stand today. Russian banks are a bit late to the crisis party and it remains to be seen if they can just squeeze in last orders or really get involved. Our aim is to be realistic, balanced and not dramatic in what is becoming a very real situation, again. In this note we compare and contrast the current positioning of Russian banks with their situation in 2H08, and we also stress test the banks for the key downside risks that we are currently seeing. Specifically, we focus on the following aspects:
1. Liquidity: The 2008 crisis in Russia started with a liquidity crisis in the interbank market in September 2008, which caused several small and medium-sized banks to fail and called for government intervention to provide liquidity to the system. This August-September we also see signs of liquidity tightening, although the good news is that authorities are now better prepared to deal with the situation. We expect a bumpy road to a positive end game.
2. Currency risk: With Russian banks generally holding no or small open currency positions, the worst-case scenario is that we see some instability in the local banking market via the local proxy for risk, the Russian rouble. Instability in general and retail deposit instability in particular, is clearly the biggest risk for Russian banking stocks.
3. Funding. 2008 saw an effective closure of international capital markets for Russian banks, calling into question their ability to meet/refinance their debt. Once again, we expect that it will be very difficult to source funding internally or externally for most Russian banks, ex. the state champions. Hence debt rollovers will likely have to be funded from existing resources. On a positive note sector LDR is below 100% and there are no serious maturities coming up for listed banks.
4. Slowdown of growth. The previous crisis was marked by quite a sharp slowdown of both the Russian economic and lending growth. This time around, slower lending growth also appears to be a logical outcome: 1) the global economy should see a slowdown (with read-across for Russia); 2) market turbulence results in lower business confidence (and hence loan demand); 3) funding (both debt and equity) becomes less easily available for banks and affects credit supply; 4) as liquidity becomes scarce, banks get less willing to lend. We downgrade our loan growth forecasts for 2012E from 16-22% to 10- 13%.
5. Asset quality: The 2008-2009 crisis was marked by significant asset quality deterioration, driving banks' annual cost of risk as high as 5-7%. We do not currently forecast such a dramatic meltdown of asset quality this time around since, in the past two years, loan growth has been slower and lending standards generally tighter than in 2005-2007. Our base-case scenario factors in a logical halt to write backs and an immediate return to normalised provisioning charges of 1-1.5% in 2012E - up from our abnormally low assumption of 0.4-1% before. This is a top up scenario to an already left-over aggressive buffer from the last crisis.
6. Securities portfolios and trading losses: These factors hit the banks' P&Ls severely in 2H08, and clearly represent the most obvious near-term downside risk to our 2011 forecasts, which is not straightforward to quantify. We expect banks to post losses from trading securities in 2H11 and FY11, while continuing to earn positive profits on FX and precious metals.
In September-October 2008 the banking crisis officially started in Russia with a liquidity squeeze in the interbank market around the Lehmans failure. Once again we have started to see liquidity in the system somewhat deteriorate over the past few weeks. We are not yet alarmist about it, moreover, we think the Russian banking system is now better positioned to sustain the stress, with the Central Bank of Russia's (CBR's) policy being supportive and preventive (as opposed to reactive as in 2008). Hence our current view is that end game will be fine but getting there could be rocky. Liquidity indicators are sending negative signals, in our view: _ Balances on the banks' correspondent accounts and deposits with the CBR are on a downward track and are now at YtD lows. This is partly a seasonal phenomenon (September-October tend to be tight in terms of liquidity because of tax payments), but it also means that at this time of the year banks are particularly vulnerable (remember 2008?).
- The banking system's liquidity position net of borrowing from the CBR and Minfin is around zero.
- Interbank rates are on the rise: The Mosprime rate (3M) has inched up from 4- 4.5% to 5%+ - a negative trend from a very low base; not yet anywhere near the 2008-highs (a near 28% peak). _ MinFin deposits auctions: Demand exceeds supply (i.e. banks queue up for MinFin money), and in mid-September the rate touched 6.17% (vs below 5% for most of 2011).
- Anecdotal evidence suggests that smaller banks (number 50+) are having some difficulty accessing liquidity from the interbank market. They are not cut off, but have to pay up for funds and therefore increasingly turn to the CBR, instead of commercial banks, for liquidity.
• What are the key downside risks, should the liquidity situation deteriorate - recent history is the guide for the worst-case scenario
If the view in the system is that the rouble is going to weaken further, this can place more pressure on bank liquidity, as banks seeking to take net long positions in the foreign currency queue up for rouble liquidity, with a view towards buying dollars or euros for roubles.
- Pressure on fixed income asset prices, as Russian banks unwind positions, some of which are leveraged (anecdotal evidence from our fixed income traders suggests that some [smaller] banks may have significant leverage via repo 'pyramids' [buy OFZ bonds - repo them at 3%, or even 0% at times, discount - buy OFZ bonds again - repo them again etc.]). Either way Russian banks are large holders of Russian local currency and dollar debt.
- Failure of small-to medium-sized banks most leveraged to the repo market facing margin calls (a la KIT Finance, Svyazbank in 2008). _ A deposit run on a smaller bank being blown out of proportion by local media and turned into a crisis that it isn't.
• What is different/better versus 2008 is policy response
The CBR's actions (both in terms of FX and rates policy) immediately prior to the 2008 (Lehman) crisis were counterproductive in our view, exacerbating the impact of the global credit crisis: the CBR was still increasing the policy rates in August 2008, with a focus on curbing inflation. It was only after the liquidity crunch happened that the CBR reacted - with what was, in fairness, a very quick and efficient intervention (see Appendix for details). Now the situation is different in that the CBR is trying to take preventive steps (e.g. it cut the one-day direct repo rate from 5.5% to 5.25% in mid-September), its FX policy is much more flexible, it is equipped with the entire set of liquidity enhancement measures first introduced in 2008 (uncollateralised lending, extended Lombard list etc), and the system overall looks to us much better prepared for any turmoil.
• Feedback from our economists' recent meeting with the CBR- the regulator is alert and on guard
Banking system liquidity issues have recently come to the fore as liquidity has been steadily declining since the beginning of 2011 from a peak of RUB1.7trn at the start of the year to around RUB800bn at the end of August and . The situation has been exacerbated by recent declines in oil prices, which have led to more limited inflows into the Russian market. Consequently, interbank rates have spiked, raising concerns about the stability of the Russian banking sector. _ The CBR is well aware of the situation. It indicated that two main factors have contributed to the decline in liquidity: 1) larger-than-expected budget surpluses so far in the year; and 2) the discontinuation of FX interventions to prevent the rouble from strengthening too much. According to the CBR, it is the latter that has served as the main avenue for providing liquidity in the system and since the rouble has been under depreciation pressure recently, the CBR has almost stopped buying dollars and euros with roubles.
The CBR thinks that the expected intensification of budget spending in November/December 2011 will significantly alleviate liquidity issues, although this leaves September/October as two months where interbank rates could still remain at elevated levels. The CBR also feels comfortable with interbank rates that move within the boundary set by the overnight deposit rate (3.75%) and the repo rate (5.25%), as long as market rates fluctuate within this range the CBR is unlikely to get too worried about the situation. Still, the CBR argued that it will defend the 5.25% rate, implying that it stands ready to provide enough liquidity to the banks at the current repo rate. We also understand that having cut the direct REPO once the CBR will probably cut even further, should global economic conditions continue to disappoint. This also implies, as the CBR argued, that we are very unlikely to see a repeat of the 2008 crisis, when interbank rates rose by a considerable amount as the CBR is now much more concerned about smoothing interest rate volatility than it was back then.
Feedback from banks' management: We are not seeing deposit outflows, but some nervousness is being felt as the rouble starts to move. With that in mind banks have become more conservative in preparation for volatile markets and are thinking of the possible conversion of rouble deposits into FX, therefore they have started increasing their rouble-liquidity positions. Bottom line: The authorities do seem very aware of the risks and liquidity is being supplied directly to the system as currently being seen. We expect a volatile month on this front, while we have yet to see much negative impact from the weakening rouble. Although the authorities are far better placed to handle the situation vs 2008 and we are comfortable about the end game from here, the path to that end game is what concerns us. We expect volatility of banking sector newsflow around liquidity, funding availability and deposit stability. All of which is negative for Russian banks asset prices, in our opinion.
With the rouble having come under intensifying pressure in August-September, further currency weakness is clearly a focus for investors at the moment, as Russian banks are effectively a pure(ish) rouble play. To recap, late 2008-early 2009 saw a 36% depreciation of the rouble against the dollar, despite an aggressive defence by the CBR. This time around, the CBR is being openly more flexible in its FX rate policy, with the rouble weakening within a broader band and allowed to move more with market forces than before.
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