Credit where it’s due
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Emerging Markets

Credit where it’s due

The collapse that many had predicted for Russia’s banking sector has been averted. But access to credit remains key to a full-fledged recovery

Talk of the sudden collapse of Russia’s banking system has receded – for now. More than a year on from a crash that many believed would wreak untold havoc on the sector, operating conditions for banks are tough, as access to credit remains scarce. But signs of an economic revival and a thawing in international credit markets are helping to ease the country’s bad-debt crisis.

Russian banks are still struggling with losses as provisions for bad loans rise, consuming profits and capital. But fears of a second wave in the autumn and of non-performing loans (NPLs) hitting levels of 20–30% have largely been replaced by a resurgent optimism and increasing confidence in the government’s economic policies.

Despite the financial turmoil since last year, no major Russian bank has gone bust, and there have been minimal signs of depositor panic. This is in sharp contrast to the country’s sovereign default in 1998 when many Russians had their savings wiped out and many of the leading banks disappeared.

Fawzi Kyriakos-Saad, chief executive officer for Credit Suisse in Russia, the CIS and Turkey, says Russians are benefiting from an unwritten contract with the state, whereby citizens do not interfere in politics as long as the Kremlin ensures social stability and increasing wealth.

 The public reaction to the government’s handling of the crisis has borne out this theory. Russians haven’t taken to the streets in protests in any significant numbers, and the state has repaid them by defending the rouble, protecting their deposits and preventing any large banks or industrial giants from collapsing.

“Banking systems in emerging markets like Russia, Turkey and Lebanon are doing relatively well, and Turkey does not have a problem with non-performing loans,” says Kyriakos-Saad. “Russia has had issues surrounding NPLs, but the banks – at their own initiative  and with encouragement from the economic ministry – have been working with clients to get them through a difficult time. The central bank and the regulators have done a good job working with the banks and preventing any large collapses.”

Large and small

The latest official data put non-performing loans at 5.4% of nationwide lending portfolios, although bankers and investors say the figure is much larger. Based on IFRS (International Financial Reporting Standards principles, Russian bank UralSib believes that non-performing loans have already exceeded 10%.

These numbers are still far off pessimistic – or perhaps deliberately conservative – predictions made by Alfa Bank chairman Pyotr Aven and Sberbank chief executive German Gref that overdue loans could account for up to 20–30% of all loans in the system by the end of the year.

Slava Rabinovich, managing partner of Moscow-based hedge fund Diamond Age Capital Advisors, says warnings about bad loans are overblown. “Russian NPL growth has already peaked at 11% versus prior 15% estimates and will stand at 8–9% by year end versus 12% previously forecast,” he says. “Loan loss provision charges are anticipated to fall from 6–7% to 2–3% in 2011. Russian banks were surprisingly decisive and resilient; bad loans are now fully provisioned.”

Russia’s central bank had previously forecast 10–12% of the total portfolio would be classified as non-performing by the end of 2009 under what it called a conservative scenario. Raiffeisen, the biggest foreign bank in Russia, recently reported that its NPLs had risen to 7% while state-owned VTB sees its bad loans reaching a possible 10% by the end of the year.

Holding up

The Russian banking system has held up well compared to countries like the US and the UK, says Mattias Westman, chief executive of Prosperity Capital Management. The firm he founded is the largest portfolio manager operating in Russia.

“The system may be enhanced by the crisis as there has been no case of Russian banks losing their money,” he says. “This may be partly attributable to the low sophistication of the banking sector, which did not get involved in the sub-prime sector.”

Russia’s exposure to US sub-prime mortgage and complex derivatives was low – but the resulting credit crunch has been felt across the board. The closure of international credit markets translated into a liquidity squeeze, which was due to massive growth in leverage of Russia’s banking and non-financial sectors in the years preceding the crisis.

Russia’s economy contracted by 10% in the first half of 2009 as the lending drive by state-controlled banks proved inadequate to offset the contraction in loan portfolios at private institutions. Stock markets tumbled by 80% as companies struggled to refinance their debt.

Higher-than-expected world oil prices have allowed the government to trim the size of next year’s deficit and predict that by 2012 Russia’s economy will return to pre-crisis size. The economy ministry believes Russia is pulling out of recession, but analysts agree that access to credit is crucial to that turnaround.

Credit activity

Central bank chairman Sergei Ignatiev recently pointed out that Russian banks have not significantly stepped up lending to the real economy this year, despite official requests to do so. “The credit activity of Russian banks remains low. According to preliminary estimates, the volume of the loan portfolio to non-financial organizations and the population has barely changed in the first eight months of the year,” he told the Duma, lower house of parliament in September.

While this may be true of state-controlled banks, such as the country’s biggest lenders Sberbank and VTB, lending activity is nevertheless picking up among Russian private banks that were too scared to issue new loans earlier this year.

Debt restructuring


The signs are that debt restructurings are proceeding, and western banks are becoming more receptive to new loan requests. Rusal, the world’s largest aluminum maker, has broadly agreed restructuring terms with as many as 70 banks, promising to repay $5 billion by the end of 2013 and to refinance its remaining debt for an additional three years.

Foreign bankers view the successful conclusion to Rusal’s debt negotiations as a gauge of Russia’s ability to manage the $475 billion in foreign debt accrued before markets crashed in the second half of 2008.

MDM Bank is raising a $175 million international loan from a syndicate of lenders. It is the first time in more than a year that one of Russia’s privately-owned banks has been able to obtain foreign financing. Without international loans, private banks have been reluctant to lend to local corporate clients.

Staying away

The 87% rally in Russian stocks since yearly lows in February has been driven largely by domestic money, according to bankers. Despite the rare combination of spectacular gains, and continued attractive valuations, global investors – with some notable exceptions – still aren’t yet buying into the Russia story.

There are many reasons for this – including corporate governance, concerns about liquidity, Russia’s weak market infrastructure and political risk. “Russia trades at a significant discount to fundamentals in both fixed income and equities”, says Yuri Soloviev, chief executive of VTB Capital, the investment banking subsidiary of state-owned VTB bank.

“While some of this can be attributed to issues surrounding corporate governance, there is still a lot of misunderstanding and misapprehension by international investors which need to be allayed. We want to facilitate this by creating a dialogue between them and the business elite and the senior political establishment.”

Retail banking and consumer lending still represent a huge opportunity for domestic and foreign players, says James Cook, chairman of Kreditmart, Russia’s largest mortgage and consumer finance brokerage. “There is still a lot of growth ahead in consumer lending because consumer credit in Russia is minuscule at 10% of GDP, while mortgages only represent 3% of GDP.”

Russia’s government is optimistic that the country’s mortgage market will return to pre-crisis levels within two years. Minimal mortgage interest rates have  risen to 14% while the rate of mortgage defaults has shot up to 5% from 0.5%.

HSBC has said it will aggressively pursue an expansion programme, three months after opening its first four Russian branches in Moscow and St Petersburg. The bank’s local unit, which had a charter capital of $224.6 million in 2008, has said it is not actively pursuing acquisitions.


Barclays in Russia

Hans-Joerg Rudloff, chairman of Barclays Capital, says the UK bank will expand into investment and private banking in Russia following its deal to acquire local lender Expobank for $745 million last year. Barclays has since rebranded Expobank’s 36 branches and hired Nikolai Tsekhomsky as chief executive from Russian state bank VTB to head up its retail and commercial banking in Russia. Rudloff says: “This is an important step in the strategic development of Barclays in Russia and integral to Barclays’ ambitions to diversify internationally. We are optimistic about the growth opportunities in Russia and remain committed to the market.”

The investment banking story

While commercial and retail bankers continue to plough through bad debt, their investment banking counterparts are building up their businesses to profit from a recovery in capital markets.

Soloviev says VTB Capital has recently hired several teams of bankers from Dresdner Kleinwort, Troika Dialog, Morgan Stanley and ING. VTB Capital, which has hired over 500 bankers in the past year, has soared into second position for arranging Russian and CIS loans.

Merrill Lynch and Credit Suisse’s operations in Moscow have made senior hires while Russian brokerages Troika and Renaissance Capital are expanding again after personnel cuts of 40%.

Ed Kaufman, co-head of corporate and investment banking at privately held Alfa Bank, says Alfa’s investment banking team has recorded its best six months on record. “Alfa’s investment bank has generated about $200 million in revenue for the first half of 2009 while costs are down over 30%,” says Kaufman. “Fixed income and equities have been great, but the pipeline for corporate finance deals is growing rapidly, and we expect a good flow in the second half as well.”

Big ticket deals involving Russian firms expanding abroad may be back on the cards for bankers following Sberbank’s and Canadian auto-parts group Magna’s deal to take a 55% stake in German-based car maker Opel. Russian prime minister Vladimir Putin said the agreement will be the first substantial step in integrating the economies of Russia and western Europe.

Domestic M&A has been quiet this year, with the much-anticipated boom in the financial sector’s deal-making yet to materialize. Regulators, politicians and central bank officials have said that consolidation of the country’s 1,100-plus banks is inevitable, and that hundreds of small banks cannot withstand rising bad loans and funding shortages.

In fact, the state news agency Prime Tass reported that the number of operating credit institutions in Russia had decreased only marginally to 1,078 in the eight months to September 1. The biggest deal in terms of value was the merger of MDM-Bank and URSA Bank, which closed in August and was worth an estimated $1 billion.

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