Kazakh banks still queasy after a borrowing binge

Elliot Wilson

Friday, May 02, 2008

Kazakhstan’s banks have built up onerous debt repayments after a splurge of Eurobond issuance. Are they facing a liquidity crunch?

The biggest face onerous debt repayments in unpropitious domestic circumstances after a splurge of Eurobond issuance. With little activity about, only Halyk seems to be flourishing. Elliot Wilson reports from Almaty.

ON THE SURFACE at least, rumours about the demise of Kazakhstan’s debt capital markets appear to have been greatly exaggerated. In early April, Halyk Bank, the country’s third-largest lender by market capitalization, surprised many by launching the first Eurobond issuance by a Kazakh lender since July 10 2007.

The $500 million five-and-a-half-year bond, underwritten by JPMorgan and UBS, came at a hefty premium, with a 9.5% yield. It attracted strong ratings – a BB+ by Standard & Poor’s and a Baa3 investment grade by Moody’s – and showed that Halyk Bank at least has access to global debt markets. It was also the first Eurobond issuance by a CIS region lender in 2008.

Dauren Karabayev, deputy chairman of the board at Halyk, tells Euromoney that the bank "wanted to leave something on the table" for investors. "The premium over the secondary curve that we paid was higher than in previous deals," he says. "Still, the transaction was very good in terms of price and tenor, and demonstrated our ability to raise financing in the international capital markets. This marks a point where we should see if the market has turned and become favourable to Kazakh banks."

Halyk’s exuberance isn’t wholly shared with the rest of Kazakhstan’s banking market. Global market turbulence and the credit crunch have not helped, but Kazakhstan’s leading banks are now paying the price for a debt-raising binge that lasted for most of the past three years, and came to a head in January 2007, when local lenders issued five investment-grade Eurobonds worth a combined $2.6 billion. The following month, Kazkommertsbank (KKB) issued a whopping $1.656 billion investment-grade Eurobond underwritten by ABN Amro, Dresdner Kleinwort and JPMorgan.

It was heady stuff, but such binges are often followed by starvation diets. By April 15 2007, Kazakh lenders had sucked in $5.81 billion from global investors, just from Eurobond sales. In the same period this year, Halyk Bank’s $500 million bond is flying solo.

Those Kazakh lenders with the greatest exposure to foreign debt – KKB, BTA Bank (formerly Bank TuranAlem) and Alliance Bank – face a daunting repayment plan. The first two are probably worst off. KKB started 2008 owing $2.3 billion, about $600 million of which it paid out in the first quarter, according to bank executives. BTA Bank is in hock to the tune of $1.2 billion, although it repaid $530 million of that total in the first three months of the year, with the remaining $670 million set to be repaid in October and November 2008. Analysts reckon that Kazakh banks owe $13 billion in foreign debt repayments this year alone.

Jason Hurwitz, the director of financial sector research at Visor Capital, Kazakhstan’s leading investment bank, says KKB, BTA and Alliance are the banks facing the biggest liquidity concerns. Repayments are forcing them to trim existing loans or cut new and existing clients altogether. "Most of the banks are sacrificing the size of their loan books in order to repay their debts," he says. "BTA and KKB targeted loan growth of 20% to 25% this year, and we think that that is unachievable. Any expansion of their credit portfolios in 2008 could prove challenging." Analysts say the two banks are most likely to see their loan books expand at a rate in the low single digits. The worst-case outlook is that loan growth at the two will remain flat this year, or even negative.

Lost traction

Executives at the banks in question agree that banking sector growth will lose traction in 2008, although they are convinced that the slowdown can be contained.

George Iosifyan, managing director at BTA Bank, predicts that his company’s loan book will grow in 2008 at about double the rate of GDP – about 10% to 14%, adding that "under no assumption will growth turn negative". But as a warning to any investor expecting the bank to return to its former freewheeling days, Iosifyan admits that "the growth rates that we have seen in the past will be reduced significantly and won’t be repeated".

Maral Amrina, head of financial institutions at KKB, says the bank’s total balance sheet will "decline by 5% to 10%" in 2008, with the loan portfolio shrinking at a commensurate rate. KKB has also ruled out raising any further capital in 2008, says Amrina, who notes that marginal growth in the bank’s domestic deposit base will "only partially replace the international borrowings coming due this year".

Rising non-performing loan rates are another serious cause for concern, particularly with Kazakhstan’s economy set to grow at just 5% to 7% a year between now and 2013, down from 9%-plus earlier this decade. NPLs are expected to rise by about 4% this year across the banking sector, and analysts fear that default rates could be particularly damaging for BTA and KKB, both of which are highly exposed to the construction sector.

KKB’s Amrina is also fearful of rising default rates, admitting that failed loans as a percentage of total lending will "continue to grow in 2008, reflecting the sharp slowdown in loan growth, and potential troubles in several industries like construction, which has already affected the level of NPLs". Yet Amrina insists that rising default levels are "manageable". KKB’s NPL ratio stood at 3.3% at end-2007.

BTA Bank predicts that its NPL ratio will rise by nearly two percentage points this year, albeit from a low base of just 0.7% at end-2007, reaching 2.5% by the end of 2008. The bank’s Iosifyan says pointedly: "The situation with bad loans is very fluid, and they can snowball at any given time, so we are keeping a close eye on the situation and managing it accordingly."

Both lenders are denied access to the one obvious financial channel they crave to get themselves leveraged up and running again: the overseas debt market. Meanwhile, the country’s plan to prop up failing construction and industrial projects and firms with a $4 billion fund is also in jeopardy: Hurwitz noted in a March 6 report that what is known as the Kazyna Fund might now not receive much more than the initial $1 billion allocated in Kazakhstan’s 2007 budget.

A market insider notes that the strategies of KKB and BTA have been based, to a large extent, on funding their operations via the international capital markets, yet those markets had become saturated with their offerings by the start of the second half of 2007. "It’s hard for them to grow their business lines further, as they have to focus on repaying foreign obligations rather than focusing on any new funding activities," he says. KKB and BTA admit that any overseas capital-raising in 2008 is unlikely, although they vehemently deny suggestions of a funding crisis. BTA’s Iosifyan notes that his bank is the best capitalized in Kazakhstan, with a capital adequacy ratio of 16.9%, while KKB’s Amrina insists that capitalization is "more than adequate for a no-growth environment". He adds: "We expect capital to grow by 20% in 2008 as a result of retained earnings in 2007. There are no plans currently to issue any additional shares."

Declining source of capital
Kazakhstan Eurobond issuance – yearly volume
Deal pricing date	Deal value ($mln)	No.
2006	5,773	22
2007	7,691	15
2008	495	1
Source: Dealogic

Yet despite this stout defence, analysts are downbeat about the market’s overall prospects. Hurwitz notes: "Because of its high dependence on foreign borrowing, Kazakhstan’s banking market is probably not going to take a big turn for the better before foreign markets in general start settling down. Until then, the banks’ potential is very limited as they have limited local funding sources. That in turn is hurting the economy, as the ability of banks to fund growth abroad was pushing everything along."

Property prices

Plummeting property prices are also likely to dog banks with significant exposure to the real estate market. High-end real estate prices in Almaty are off around 12% to 13% this year, and at the lower end of the spectrum, property prices have plunged by more than 30% from their peaks in the summer of 2007. That’s hardly a doomsday situation: after all, property prices in general are still 400% to 450% higher than they were at the start of 2005. But during a time of global market turmoil, the last thing any country wants is a bunch of over-leveraged, under-capitalized lenders heavily exposed to industries that spook at the first sign of a recession.

Hurwitz adds that Visor Capital’s outlook on the sector has been cautious since July 2007, when the investment bank and brokerage placed more sell ratings than buys on the banking sector.

He says: "We saw some good results in 2007 but that shouldn’t provide investors with too much comfort. In the middle of the year we could start to see some actual defaults in the construction sector." In fact, Visor Capital has sell or hold ratings on all of the country’s leading lenders with the exception of Halyk Bank and Bank CenterCredit. Standard & Poor’s concurs with the generally gloomy outlook: in April, S&P credit analyst Ekaterina Trofimova noted that the Kazakh banking system had "reached a decisive point in its development" and was being constrained by rapidly built, unseasoned loan portfolios, tight capitalization and untested risk management. And in April, Fitch noted that asset quality at Kazakh banks had fallen significantly since the third quarter of 2007, most notably at Alliance Bank. Direct questions about funding difficulties placed to senior executives at Alliance Bank by Euromoney went unanswered.

The main beneficiary of this industry negativity has been Halyk Bank, which investors see as a safe port in a storm. Karabayev at Halyk notes that during the bank’s March Eurobond roadshow, which took officials through London, the US, Europe and finally Hong Kong and Singapore, investors noted its "strong liquidity, low exposure to foreign debt and its perception as the best bank in Kazakhstan". Sixty percent of the Eurobond was parcelled out to US investors, with 25% snapped up in London.

Halyk’s 670 branches were inundated with clients begging for new loans – particularly in the third and fourth quarters of 2007 – after their credit lines were shortened or cut completely by rival banks racked with internal liquidity problems. First-hand experience shows that Halyk’s branches continue to thrum with new customers, while BTA’s and KKB’s branches are quiet. "People know about the issues with foreign markets being closed to Kazakh banks and have seen that our peers are lending less," says Karabayev. "By contrast, we continued to lend, and in fact we are lending even more."

Halyk’s books certainly appear strong. According to data from the Financial Market Supervision Authority (FMSA), Kazakhstan’s banking regulator, Halyk’s share of the domestic retail banking market rose to 24% in December 2007 from 19% six months before, with KKB’s share falling to 21% from 23% and BTA’s down 1% to 18%. Total deposits grew 21.4% at Halyk in the fourth quarter of 2007, compared with just 8.8% at KKB, with growth either flat or slightly negative at Alliance Bank and BTA Bank.

Yet many in the financial capital Almaty and the political centre of Astana believe that the time is right for local lenders to regroup and perhaps recast their funding and growth strategies. For too long, Kazakh banks have been borrowing too easily and too cheaply, their chief growth strategy seeming often to consist of simply raising an infinite amount of hot money from abroad.

Few believe that any leading Kazakh bank is in serious trouble. "We’re unlikely to see any big fire sales of leading banks," notes a local market source. "The big banks potentially have other sources of funding, and of course the ones that are in trouble have a default source of fresh capital, in that many of them are not renewing or making good on loans. And if things go bad, they have shareholders with very deep pockets."

Many indeed wonder why Halyk Bank forged ahead with its recent issuance. After all, with customer deposits rising at a compound annual rate of 70% between 2005 and 2007, and net income jumping 50% to KT40.5 billion ($336 million), from KT27.16 billion a year ago, Halyk hardly wants for capital. The bank’s capital adequacy ratio stood at 14.2% at the end of January 2008, One market watcher says he believes Halyk did the deal "just to show that they could – to show that they were different, that they could raise capital, unlike everyone else".

Bigger picture

In the broader investment banking markets, life is a little more upbeat. True, there are few initial public offerings on the horizon. Equity capital market activity is subdued – $153 million-worth of Kazakh-related ECM deals were completed in the year to April 15, barely a quarter of the total generated for the same period in 2007 – while debt market activity is also severely diminished. Yet the leading global investment banks focused on Kazakhstan – ABN Amro, Credit Suisse and JPMorgan, plus Citi and Deutsche Bank – are casting around for alternative money-making wheezes to take up the slack.

One target is the surprisingly robust mergers and acquisitions market. Cross-border M&A transactions totalled just shy of $3 billion in the year to April 15, up nearly six-fold from $520 million in the same period a year earlier, according to Dealogic. Notable transactions include the $634 million deal by South Korea’s Kookmin Bank, which in March 2008 announced that it would buy 30% of Kazakhstan’s sixth-largest bank, Bank CenterCredit, and increase its stake to 50.1% later. Visor Capital was acting as an exclusive adviser to Kookmin on the largest-ever cross-border M&A transaction by a Korean financial institution. Other big M&A deals are springing up. The previous month, London-listed miner Kazakhmys snapped up two coal-fired power plants from AES of the US for $1.48 billion.

"We’re now seeing M&A really picking up," says Jurgen Rigterink, the country head at ABN Amro, which is shortly to be renamed RBS Kazakhstan. "We’ll see some consolidation within Kazakhstan, with larger corporates gobbling up smaller ones, as well as increasing interest from foreign strategic and financial investors for Kazakh assets. Energy and resources are the logical sectors, and expect one or two transactions in the financial services space and retail sector."

A few, Kazakh conglomerates are also slowly entering the corporate big leagues, via domestic and overseas consolidation. London-listed miner Eurasian Natural Resources Corporation (ENRC), Kazakhstan’s largest corporation by market capitalization, is certainly on the hunt for foreign acquisitions, sources say. It has made a few minor acquisitions, notably in Russia, but is determined to grow overseas and has the cash to back its aims.

Another aggressive buyer is KazMunayGas (KMG). In April, the state-run Kazakh energy firm tied up a $3.1 billion deal to buy 75% of Romanian oil and gas marketing and refining concern Rompetrol Group. That deal was paid for via a $3.1 billion syndicated bridge loan underwritten equally by ABN Amro, Calyon and Credit Suisse. KMG will refinance that bridge facility in the second half of 2008.

KMG’s ultimate goal is to play a role like Norway’s Statoil, dragging in huge chunks of revenue for the treasury in Kazakhstan’s capital Astana, and building an oil-generated sovereign wealth fund that will power the country’s economy for decades to come. "I wouldn’t be surprised if one or both of ENRC and KMG does one or two more big overseas deals this year," says a banker close to both companies. "They’re both acquisitive and they’re both keen to buy." Likely targets would be mining or energy firms, or power generators, in Russia, central Asia and eastern Europe.

With stock prices now back at reasonable levels after years of soaring valuations, and many Kazakh lenders under pressure to recapitalize or sell, expect more inbound M&A deals this year in the country’s banking sector.

Many of the country’s larger lenders are on the slab. Temirbank, the country’s seventh-largest lender, is being packaged up for sale by its majority controller and market rival, BTA Bank.

BTA desperately needs capital, and believes it can raise $1.6 billion from the sale of Temirbank, although market consensus says $800 million is closer to the mark.

"Temirbank is a good franchise, but it will benefit from being associated with a strategic investor," says Visor Capital’s Hurwitz. "If BTA sells, they can get a huge boost on earnings, and an immediate influx of capital, helping to shore up some of their assets."

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