Growing pains for Russian banks
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Emerging Markets

Growing pains for Russian banks

Bad debts from retail lenders threaten to undermine Russia's rapidly growing banking sector

Money is pouring into Russian banks from equity and strategic investors alike. Investment banks that left after the 1998 crisis, including Goldman Sachs and Lehman Brothers, have returned. But analysts are worried about the banks being overstretched – especially in the rapidly swelling retail sector.

Banks’ assets (45% up during 2006), lending activities (49% up) and profits (44% up for the top 100) are expanding at mind-boggling rates. And at the centre of the whirlwind is a growth of consumer credit. Retail lending totalled $78.4 billion in 2006 (91% up year-on-year), of which $12.4 billion was mortgages and $9 billion car loans, according to statistics compiled by Alfa Bank.

The retail loan portfolios of several banks swelled by three or four times last year and that of Vneshtorgbank’s new consumer outlet VTB-24 nearly 10 times over. Even Sberbank’s grew by 47%.

Credit card lending is fast catching up point-of-sale and car loans. The North West Association of Banks, which represents lenders in St Petersburg, reported that during 2006 lending doubled through the region’s credit cards, including 5.4 million Visa/Mastercards.

But there’s a spoonful of tar that could spoil this barrel of honey: bad debts from retail lenders, which tripled during 2006 to 33 billion rubles (about $1.25 billion). Analysts say that under Russian accounting rules it’s possible to mask the seriousness of the problem, and it might be worse.

These bad debts won’t bring the banking system down, but it’s a headache for those that specialize in consumer lending, such as Russian Standard and Home Credit. Retail loans account for 94% and 99% of their loan portfolios respectively, and cautious observers warn that they may live to regret aggressive marketing drives that have made them the second and ninth largest retail lenders.

RusRating, the agency that rates Russian banks, downgraded Russian Standard twice last year. Director Richard Hainsworth, director, says: “Does Russian Standard have too high a level of bad loans? No. These are high-interest products, and they can cover any losses from repayments on the portfolio as a whole. But not everything is in order.

“Russian Standard was first into the consumer market and had the best products. But this business is at an early stage of development: there’s little in the way of credit histories, debt recovery is in its infancy, and these factors have an impact.”

Mortgage rise

Russians are starting to take out mortgages in a big way – and there’s a potential asset-liability mismatch there too. At the end of 2006 the total volume outstanding was about $5.5 billion in ruble mortgages and $3.4 billion in foreign currency mortgages, about three times the volume at the end of 2005.

But Inessa Tolokonnikova, associate director at Fitch in Moscow, cautions: “Mortgages are offered at fixed rates for 15-20 years, but many banks don’t have the long-term funds to cover them, and don’t have sufficiently robust interest rate management.” Market sources observe that high-worth individuals are borrowing to buy real estate, while putting their own money into other businesses.

The Russian retail loans market is so young that no one yet knows how the debt collection business will fare. Interesting, then, that one of Russia’s most respected bankers, Yevgeny Bernshtam, a former first deputy CEO of Alfa Bank, is now running the leading debt collection agency, Sequoia – and that Goldman Sachs bought a significant share in it, in October last year.

 

A senior source at a western investment bank in Moscow comments: “Retail lenders want to get the bad loans off their books, and Sequoia is well-positioned to grow, as the scale of the problem becomes apparent.”

Johann Jonach, CEO of Raiffeisen Bank Russia says: “There is a general shift in the market towards retail lending. It is growing as a proportion of the whole, and the central bank has indicated that it may be happening a little too fast. Non-performing loans will not cause a systemic crisis, but they could cause problems.” Raiffeisen, the longest-standing foreign-owned player in the consumer market, recently announced that its own retail loan portfolio had topped $1 billion. Its combined portfolio with Impexbank, which it bought last year, should make it no. 4 retail lender.

The right thing

Russia’s retail lending pioneers not only need to convince rating agencies about the quality of their portfolio management – they also face a clampdown by regulators who say their commissions and charges are unfair. Advertised interest rates are 20-30%, but many banks add commissions and charges that hike them up to 50-70% – a practice that will be outlawed by a central bank directive, effective from 1 July, that interest rates be disclosed.

The central bank’s move follows a campaign against the banks by Gennady Onishchenko, head of Rospotrebnadzor, the consumer rights supervision agency. In January the Supreme Court upheld Rospotrebnadzor’s case against Home Credit & Finance, whom it had accused of levying illegal fees for loan service, and for early and late repayment.

Onishchenko was back on the warpath in March, claiming that banks had committed a “range of breaches” that “rely on people’s lack of knowledge and abuse their trust” – and backing cases by borrowers demanding the return of fees and commissions.

But Oleg Vyugin, until recently the head of Russia’s Federal Commission for the Securities Markets, warns that if judges and other officials continued to condemn banks’ behaviour so loudly, the problem of bad debts would be aggravated. “People will ask why return the money they’ve borrowed, if judges say that the interest was collected wrongly,” says Vyugin, who resigned to take up a job in the private sector.

Sourcing the funds

No little local difficulty with retail loans is going to put the international capital markets off Russian banking. The mood has changed, and a domestic rights offering by Sberbank closed in March – which raised $8.8 billion, of which an estimated $3 billion was from foreign investors – showed just how much.

An even weightier sign of foreign appetite came on May 11: an initial public offering (IPO) by state-owned VTB, Russia’s second largest bank after Sberbank, which raised $8 billion, the world’s largest global public offering so far this year.

The first IPO by a privately-owned bank, Zenit, is expected to be brought to the international markets towards the end of this year by JP Morgan and UBS. But there is also an appetite for eurobonds and other types of debt issued by Russian banks. Russian Standard is planning an issue of Euro Commercial Paper (ECP) notes worth up to $1 billion.

Recent changes to the rules for subordinated debt have caused analysts to speculate that that source of funds – used in the past only by Sberbank, VTB, Alfa and a few other large names – will bring about $5 billion into the sector by the end of the year.

And then there are strategic investments: last year Societe Generale raised its stake in Rosbank to 20%, Commerzbank bought 15% of Promsviazbank, Unicredit/HVB built on its stake in International Moscow Bank by buying Aton brokerage, and Morgan Stanley bought CityMortgage bank of Moscow, which specializes in mortgages and their securitization. ICICI of India, Santander and Intesa have moved in too.

Jonach at Raiffeisen sees a sea-change towards foreign ownership. “There is a little consolidation domestically – Gazprombank has recently purchased some smaller institutions, for example – but this is not the most significant trend. Many Russian owners of banks see short-term gains in other sectors, and their attention is concentrated there. Many of them are interested in selling their bank interests out to foreign buyers, or taking in foreign partners.”

The big boys are back

Perhaps the best measure of the Russian banking sector’s confidence is the return of Goldman Sachs and Lehman Brothers, who both withdrew after the 1998 meltdown.

Goldman opened a new office in Moscow in January this year, employing about 80 people, headed by Magomed Galaev, who moved from Morgan Stanley last year, and David Schwimmer, who helped arrange the Archipelago-New York Stock Exchange merger.

Lehman Brothers has yet to set up an office in Moscow, but has recruited Nick Jordan, formerly Deutsche Bank’s co-head of investment banking in Russia, to take charge of its investment banking business there. Jordan, whose brother Boris helped to found Renaissance, one of Russia’s foremost brokerages, has strong connections with Gazprom and other state-owned companies. No one, not even the biggest, can afford to stay out of this market.

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