By any measure, 2009 was a poor year for Russia’s banks. Put simply, nothing went right. While the global banking system tottered, Russia’s financial structure threatened to collapse entirely.
Savers switched from the rouble to the dollar, heaping stress on the Central Bank of the Russian Federation (CBR), an institution already undermined by plummeting energy and mineral prices.
Domestic conglomerates, grown fat in the good years from cheap loans and high stock prices, wobbled. Many, particularly in the first half of the year, defaulted on debts, further imperilling Russia’s embattled lenders. In May 2009, Standard & Poor’s tipped problem loans to rise to between 35% and 50%. The following month, Moody’s twisted the knife, warning Moscow that its lenders would need to be recapitalized to the tune of R1.3 trillion ($45 billion).
So, barely a year on, it comes as something of a surprise to find Russia’s banks – and the country’s entire economic structure – approaching, if not quite yet matching, their old rude health.
After contracting by nearly 8% last year, Russia’s economy is on track to grow by between 3% and 5% in 2010. On April 26 finance minister Alexei Kudrin provided a balanced view of the economy, warning that while a route out of the lingering crisis “will be long”, economic growth of around 4% was realistic. Kudrin’s comments came on the same day that premier Vladimir Putin unveiled solid first quarter figures, with Russian industrial production expanding year-on-year by 5.8% and disposable income up 7.4%.
A rising number of Russians believe their government handled a perilous crisis with remarkable élan. They are probably right. A series of key measures taken during the middle months of 2009 helped recapitalize and restructure shaky Russian corporates and lenders.
Last July, Sberbank restructured 6.5% of its corporate loan book. In September VTB Bank raised nearly $6 billion selling new shares to investors. Later that month, the local head of Austrian banking group Raiffeisen praised Moscow for successfully restructuring the “lion’s share” of Russian corporate debt.
Little wonder Russian politicians are feeling pleased with themselves. In late April Putin praised the government’s “vital” efforts in managing and allocating anti-crisis funds, saying: “We needed prompt decisions and the prompt allocation of funds.”
Local banking leaders agree. “The second half of 2009 saw a very slow recovery supported by some growth of external demand and inventory accumulation,” Sergey Vasiliev, deputy chairman of Vnesheconombank (VEB), tells Emerging Markets. Vasiliev says lags in domestic demand still exist but these could be filled by faster recovery across the global economy.
Yaroslav Lissovolik, head of research Russia and the CIS at Deutsche Bank, is equally upbeat on the country’s economic prospects: “While there are still challenges ahead, there are signs that the economy is on track to recover quite strongly this year, and we see lending increasing over the coming months, driven by rising household consumption and corporate investment.
“We may see some cooling off in the third quarter of the year due to global factors such as withdrawal of capital from global stimulus packages, but overall the picture is positive,” he says. “Some of the macroeconomic factors are also favourable: declining interest rates, falling inflation and a relatively good fiscal position.”
That latter factor – the country boasts a fiscal deficit of just 6%, which should fall to less than 4% by end-2010 – is another reason why Russia has managed to bounce back relatively quickly from last year’s crisis.
EUROBOND concerns
But in recent weeks, signs of global economic turmoil have come back – the prospect of Greece’s turmoil spreading to the eurozone has spooked financial markets. Russia is not immune: its much anticipated $5.5 billion sovereign bond issue last month was broadly welcomed after pricing on April 22, but the deal sank in secondary markets days later as heavy selling of Greek debt infected other sovereign credits.
The Eurobond was meant to have quelled lingering doubts about Russia’s economic future, but as deputy finance minister Dmitry Pankin notes, the Greek fiscal crisis and its fallout across Europe could have significant knock-on effects in Russia and beyond. “It’s a serious question for us in terms of macroeconomic stability. It’s very difficult for us to make any projections, to make budget projections, if we have such an unstable market with huge volatility in the exchange rate and in the bond markets.”
Nevertheless, many investors still see Russia as a markedly better bet in coming years than slower growing nations in the west. Richard Luddington, head of CEMEA debt capital markets notes: “[Russia’s] debt-to-GDP ratio is very low by any criteria. But Russia also has huge capital reserves and its budget situation is also very positive, helped by a generally positive global economic outlook.”
Confidence in the country’s leading corporate institutions and, in particular, its banks remains high. Take the February 8 report by Deutsche Bank titled Russian Banks: high expectations. Quite apart from the bullish strap-line, the report notes an improving outlook for Russian banks “as non-performing loan [NPL] growth decelerates and liquidity returns”.
Indeed, the main challenge Deutsche foresees is that of overheating, as money growth and capital inflows accelerate. The German investment house is particularly bullish on Sberbank, which it rates a “buy”, noting net profit forecasts of 35% in 2010 and 12–14% in 2011.
Deutsche is not alone in singling out the underlying strength of many local lenders. They benefit from the backing of a strong, solvent sovereign state: Russia is largely debt free, with foreign exchange reserves of more than $400 billion. The banks themselves have cash in reserve – tier-one capital adequacy ratios are rarely less than 10%, while high net profit margins provide a generous buffer against write-offs.
Local lenders are also backed by a government unafraid of making tough decisions when called upon – note Moscow’s decision to inject liquidity and capital directly into banks and the banking system in the first half of 2009. “Russian bank assets and credit portfolios have been quite stable during the crisis,” says Vnesheconombank’s Vasiliev. “There was no slump in bank credit like in many other foreign markets, but further growth is yet to come.
“There are some positive signs such as restored bank profitability, constrained non-performing loans and increased household deposits,” he says. “If all of the above persists, credit growth will definitely continue in 2010, as many observers and officials predict.”
Russia’s banks are also enjoying a paradoxical but somewhat inevitable variation on an Indian summer. At the tail end of every modern financial crisis, Russia’s fickle consumers suddenly flip their savings back from the US dollar to the rouble. The switch to the dollar did much to undermine local lenders in late 2008 and 2009. Now the reverse switch is happening, granting grateful Russian banks a de facto second capital injection just when it’s needed.
“Banks are benefiting enormously from the ‘de-dollarization’ of savings, with savings taken out from under mattresses and put back into the banking system,” says Deutsche’s Lissovolik. “The biggest banks have another competitive advantage, which is that they have diversified well and developed deposit bases. That will be increasingly important in the post-crisis landscape as earnings recover on a personal and corporate level.”
That process is further boosting bottom lines. Sberbank on April 15 posted quarterly earnings of R43.2 billion ($1.41 billion), against just R0.3 billion a year ago, and predicted full-year 2010 net profit of not less than R100 billion. Meanwhile Alfa Bank, owned by billionaire Mikhail Fridman, said on April 26 that it expected assets to increase by 11% in 2010 to $24 billion.
Russia’s banks look set to expand regionally and, eventually, on a more global footing. Sberbank has long been at the forefront of a more aggressive expansionist strategy, with interests across the CIS, notably in Belarus and Kazakhstan. But it is to VTB that most look, and a bank that is widely seen as the key future banking representative of Russia Inc on the world stage.
NOT PLAIN SAILING
But Russia is not yet entirely out of the woods.
Industrial production softened slightly in February after a strong start to 2010, while fixed income also weakened in the second month of the year, contracting by 7.4% year-on-year. The key real estate sector also showed signs of deceleration in February and March.
Moreover, some believe that Russia’s economy should be growing at a faster lick, given its wealth of natural resources and with oil prices steadying, in April 2010, around $80–90 a barrel. Bill Browder, the founder and chief executive officer of London-based Hermitage Capital Management – a leading investor and corporate governance activist, who was stripped of his Russian visa in 2005 after falling foul of corrupt local officials – believes Moscow has been underperforming for months.
“The Russian economy is a function of oil, aluminium and steel, and the price of all of those commodities has gone up,” he says. “That is how the economy works. It’s remarkable how Russia has not bounced back more strongly given what they sell.”
But perhaps the greatest scourge still facing local lenders is one they thought they had already slain: the non-performing loan. The extent of this problem remains to be seen. Many independent observers believe that the greatest long-term legacy of the recent economic crisis is that of poor credit quality.
In its February 8 report, Deutsche noted that a recent reported slowdown in non-performing loans was due largely to a rise in restructured loans. So the real size of the troubled loan book may be masked by rising loan growth as well as a greater portfolio of “restructured” – and, possibly, equally troubled – loans. By end-2009, for instance, Sberbank managed to restructure 16% of its corporate loan portfolio. But adding this to a failed-loan ratio of 9% at end-2009 would give the largest bank in Russia and eastern Europe a total NPL ratio of 22%.
Then there is the issue of Russia’s notorious financial opacity. Few investors truly believe the financial statements released by leading state-controlled lenders – much of it tends to be guesswork at best.
Hermitage Capital’s Browder says: “Because fraud is so prevalent in Russia ...financial institutions are a particularly insecure long-term investment. When you analyze Russian bank income statements and balance sheets, you have no idea what you are buying and when the next piece of bad news will emerge.”
Others have a more positive view: “An NPL problem is likely to be avoided,” says Lissovolik. “What we do expect is that while credit quality improves, we will see a revitalized drive on the part of Russian banks to lend, and this will continue as the health of the economy improves.”
Another issue that continues to divide Russia’s authorities, neatly cleaving the reform-minded president Dmitry Medvedev and the country’s old-guard premier Vladimir Putin, is the make-up of the economy as a whole. Long dependent on revenue streams from carbon and commodities, Russia profited immensely in the 2000s as a result of Putin’s energy-geared economic initiatives.
President Medvedev by contrast sees Russia’s future in services, with Moscow and St Petersburg acting as a financial hub for the region and, increasingly, the world, ranking the Russian capital alongside the likes of London, New York, Hong Kong and Dubai. “There is still a need in Russia to diversify away from energy and commodities, and we could see a push to do this next year,” says UBS’ Luddington.
Yet despite credit quality and opacity fears, the overall financials augur well for a country that suffered more than most in the global downturn – and emerged potentially stronger than ever, with a robust, restructured, realigned banking system.
If 2009 was a year Russia’s banks will not care to remember, all the evidence suggests that 2010 will be a year few will be quick to forget.