Ben Aris in London -
Kazakhstan's banking sector stumbled after international credit markets effectively shut down last summer and local banks, which were funding triple-digit asset growth via heavy international borrowing, have been forced to take stock of their strategies. Although real risks remain, fears of a systemic banking crisis are overblown and the sector is unlikely to fail.
Some analysts say the credit crunch even has a sliver lining; concerns were growing that the sector, gorging itself on cheap and easy international credit, and had gotten ahead of itself. Kazakh bankers came to believe that 200% asset growth a year was normal. Observers point out that controlling the quality of assets at this pace of growth was impossible, so the stinging slap in the face the sector has just received is probably timely and will head off a much nastier crisis further down the road.
After several years of sector-wide growth of over 60%, the total assets of Kazakh banks are expected to grow by 10% this year. The crisis triggered by the collapse of the US sub-prime market has hurt almost everyone in the sector. The former savings bank Halyk is the only real winner, which didn't borrow abroad, and came out of the debacle reversing its loss of market share. But even the losers, like Kazkommerzbank, will still manage to stand still this year in terms of asset growth.
"The Kazakh banking sector is tentatively recovering from the sudden and sharp shock that it received last autumn from the fallout of the global credit market freeze. This assault highlighted that the business model used by some banks of aggressive growth reliant on foreign funding was unsustainable, and came as a much needed cold shower for overheating credit and asset price growth," says Andrew Keeley, a bank analyst with Troika Dialog. "While there have been short-term winners and losers, the medium-term slowdown in the sector's growth that we expect to see - 2008-10 CAGR [compound annual growth rate] of loans of 21% - should allow for sector-wide refocusing on better risk management and sustainable growth."
Redemptions: so far so good
The main fear has been a massive default on all the loans taken out in recent years. However, the banks have been largely sensible in their borrowing policies and much of the debt is of a relatively long maturity. Kazakh banks have enough to cover the roughly $5bn in debt that must be repaid this year even if the edge has been knocked off the blistering pace of growth.
While Russian banks and companies are already returning to the international capital markets to raise money, albeit at higher costs, these markets are expected to remain closed to Kazakh banks for the rest of 2008, say local bankers. "Many Kazakh banks will have an uphill battle on their hands to deliver growth in 2008," reckon analysts at Renaissance Capital.
Kazkomerzbank, the biggest bank in the country, was amongst the hardest hit, as more than half of its balance sheet was funded by international borrowing. However, the bank has a strong balance sheet and with only a 20% cost/income ratio, the bank is extremely efficient. Kazkomerzbank was able to comfortably pay off a $700m syndicated loan in December. Likewise, second-tier Bank CentreCredit redeemed its $200m debut Eurobond in February in the first of two big redemptions due since the onslaught of the crisis.
The undisputed winner from the liquidity crunch is Halyk bank, which unlike all its peers hadn't borrowed heavily on international capital markets and saw an inflow of customers in the last nine months as fears of a possible systemic collapse of the system grew: the bank's share of retail deposit went up from 18% to 24% over the second half of 2007.
Kazakh banks are in trouble because they became overdependent on international wholesale borrowing to fund their rapid growth. "Asset growth has been rampant, but has been heavily funded by foreign liquidity. Banking-sector assets virtually tripled in 2005-07 from $34bn to $97bn, with loans trebling from $22bn to $71bn, increasing at a CAGR of 71%, compared with 51% in Russia," says Keeley. "This phenomenal growth has been founded for many banks on foreign debt; at 45% of assets, $4bn, its share of funding is almost twice that in Russia."
Long-term external financing accounted for just over a third of the funding of Kazakh banks in the first half of 2007 and external short-term debt another 13%, according to the Kazakh bank regulator. The closing of the international credit markets has cut them off from the sources of capital they were using to fuel their rapid growth.
This year, banks will be forced back to domestic borrowing and increasing deposits to finance their growth. Both will take time to organize.
Deposit growth stalled in September as the crisis broke, but according to the latest information, deposit growth had begun to pick up again in January. Even so, everyone is still nervous. "The outlook for retail deposits in 2008 is unclear," say analysts at Renaissance Capital. "Despite recent positive trends, most market participants feel retail depositor confidence is not yet fully restored, and we believe growth in this segment will depend on economic, banking sector and currency stability throughout the year."
However, corporate clients are already more confident of continued growth, as the resource-based business in hydrocarbons and minerals are still making money hand over fist, report bankers.
Given the importance of capturing wavering retail customers, analysts say the market is ripe for a deposit war between the leading banks. Interest rates on deposits have already been hiked by about 2 percentage points over the last six months - the headline rate for foreign currency deposits is 9% and 12-13% in tenge. Provided the external situation settles, local banks may start hiking rates on deposit accounts more aggressively to win new retail business. Indeed, Alliance bank is the top-tier bank in the most trouble and has already broken ranks to offer 15% for three-year timed retail deposits in an effort to bring in some badly needed cash.
Needless to say, the central bank is worried about the moral hazard that a deposit war would lead to in this still very volatile situation and there is currently a debate as to whether it would be a good idea to introduce a 13% cap on interest rates, which is supported by most of the bigger banks.
Government to the rescue
Fears of a Kazakh bank crisis have been over done. Quite apart from the fact that Kazakh banks have enough money to cover their obligations, the government has made it clear it will step in and bail out any bank that gets into trouble. The state has already set up a $4bn fund to refinance any real estate loans that go bad - the Achilles'' heel of the sector - and at the start of this year, announced it would buy up residential apartments to prop up that segment of the market where housing prices have dropped by a third in the last six months. "The funds are directed at mitigating potential social aspects of the crisis, rather than providing a free bailout for banks and construction companies," says Renaissance Capital.
Some $1bn of this money has already been distributed and the remaining $3bn is being held in reserve. However, banks complain about the lack of clarity from the government over whom it intends the rest of this money to be made available to.
What perhaps gives locals the most confidence is that the crisis is almost exclusively financial; the raw materials foundation of the economy means that revenue will continue to flow into the country and the strong economic growth ensures a rosy business environment in which the banks will have time to sort out their problems.
As the Kazakh bank sector is arguably the most sophisticated in the CIS and banks play a much more important role in the economy - providing 23% of investment capital against the 10% of Russian banks - banking sector ills will impact the economy. But as the oil and metallurgical companies don't borrow from local banks, Kazakhstan's engine of growth will be largely unaffected. "The Kazakh economy remains in reasonably robust health. Growth is sure to slow down this year, but is still expected at 5-7%, while gross international reserves and the National Fund total over $40bn, providing solid support cushion should it be needed," says Keeley.
Most of the attention for the near future has focused on the deteriorating quality of bank's liabilities and especially of credits to the construction sector. The number of non-performing loans (NPL) has risen and will continue to grow, especially in the construction sector as the real estate market and new developments grind to a halt.
Indeed, analysts say the biggest threat that the banks face is not a lack of funding to cover redemptions or finance growth, but the possibility of a rapid deterioration in the quality of their assets.
Most of the banks are heavily exposed to the construction and real estate sectors, which made up 27% of the sector's loan portfolio as of the start of this year. In general, NPLs have risen by about a percent or two in most sectors, but those in the construction sector have almost doubled in the last six months from 4.7% as of June 2007 to 8.6% as of January 1, 2008.
One of the easiest and most tempting ways to shore up the stability of the Kazakh bank sector would be for international banks to come and buy a few local banks.
The financial M&A wave that has swept through the CIS over the last 18 months was about to break in Kazakhstan when the US sub-prime crisis hit. While several international banks were looking for takeover targets in Kazakhstan prior to the crisis, few deals were done as valuations had risen so high. "The banking sector remains heavily concentrated - the top six have over 85% of assets - and dominated by domestic private ownership, but the arrival of UniCredit Group and Sberbank has thrown down the gauntlet to the big domestic names and the market is now ripe for further consolidation," says Troika's Keeley.
Unicredit was among the first with the purchase of AFT bank in November for $2bn, followed by Russian Sberbank's purchase of Texakabank and Israeli bank Hapoalim's acquisition of Demir Bank. More recently, the South Korean Kookmin Bank was reported to be in talks with Bank CentreCredit. But that is it - and by regional standards this is very little. "There are clearly more negotiations going on behind the scenes, with Almaty known as a hotspot for M&A bankers at the moment. Banks known to be circulating with intent include BNP, SocGen, Raiffeisen International and Intesa," say analysts at Renaissance Capital.
Give the problems that the sector now faces, prices have fallen and international banks must be tempted to pounce on some of the carrion in the sector. Analysts say that other banks like Temirbank and Alliance Bank are likely buyout targets this year.
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