Many of Azerbaijan's banks were hit by economic slowdown and falling real estate valuations in 2010, and there are signs that a significant shake-up of the sector is beginning.
In Azerbaijan, the financial crisis arrived late. Unlike Russia, Kazakhstan or Ukraine, Azerbaijani banks had barely touched the Eurobond market, so the global liquidity squeeze did not feed through directly via bond spreads.
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But the crisis arrived all the same. According to Central Bank of Azerbaijan (CBA) data, the banking sector’s aggregate pre-tax profits halved to 140m manat ($178m) in 2010, and were flat year on year in the first five months of 2011. Overdue loans reached 6.3% of total loans in May 2011 (the most recent data available), compared with 3.9% at the start of 2010, and foreign bankers in Azerbaijan suggest that banks are recognising loan losses rather gradually. Total loan portfolios are stagnant, growing less than 0.2% in the year to May 2011, compared with 17% in 2009 and a soaring 54% in 2008.
Real estate valuations, which climbed by more than 50% per year in 2006 to 2007, reversed sharply in 2009 and 2010. Construction starts were down more than 30% in 2010 compared with 2007, with commercial real estate the main victim. The surge in real estate had encouraged private individuals to borrow from banks (often in the guise of small business loans), to buy and quickly resell houses. That tactic unravelled after 2007.
On the slide
Bank Respublika has slipped out of the top five banks in Azerbaijan, recording a loss (of 2.2m manat) for the first time in its 18-year history in 2010. Its total loan portfolio has shrunk significantly, to 150m manat, compared with 260m manat in 2008. Deputy CEO Aslan Abasov says the decline in real estate and resulting provisions for non-performing loans (NPLs) played a significant part, with large corporate clients either repaying loans without further refinancing, or defaulting.
“NPLs are concentrated among a few corporate clients, first of all in the construction sector. We did not have direct exposure to construction companies, but we had related exposure such as cement and brick production companies,” says Mr Abasov.
Faig Huseynov, CEO of Unibank, where roughly 60% of lending is to retail customers, says NPLs at his bank have now peaked, after hitting 17% and pushing the bank into losses in 2010. The 2009 and 2010 vintages that were issued with tougher underwriting standards are proving resilient, while problems with older vintages are evenly spread between retail and corporate segments.
Healthy funding profile
On the positive side, the decline in real estate markets has prompted fresh inflows of deposits to Azerbaijan’s banks. This boosted liquidity from local sources at a time when international markets remain highly uncertain.
“We are observing growing appetite for deposits. Real estate was an investment tool for the public, but now people are more cautious about it. And although inflation is still quite high, real interest rates are positive,” says Mr Huseynov.
Prior to the crisis, banks had just begun to ramp up international borrowings to fund expansion, especially through bilateral and syndicated loans. Mr Huseynov estimates that total foreign debt in the banking sector had reached $2bn. But part of this funding came from multilateral institutions such as the European Bank for Reconstruction and Development (EBRD).
We are observing growing appetite for deposits. Real estate was an investment tool for the public, but now people are more cautious about it. And although inflation is still quite high, real interest rates are positive
The EBRD and German development bank KfW between them hold stakes totalling more than 23% in Unibank, while KfW also owns 16.7% of Bank Respublika. Mr Abasov says multilateral and bilateral official lenders have provided about half of Bank Respublika’s funding, with the other half coming from deposits. And microfinance specialist Access Bank is entirely foreign-owned, by four development banks and a microfinance fund that is itself multilateral-backed.
Small companies, big business
While multilaterals should continue to provide funding where necessary, the rise in NPLs and decline in real estate and construction sectors suppresses future lending opportunities. Most of Azerbaijan’s second-tier banks, and even some within its top-tier, appear to be reaching the same conclusion – to focus on microfinance and small and medium-sized enterprises (SMEs).
Mr Abasov says Respublika has begun to switch its entire strategy away from larger corporates, while Mr Huseynov says Unibank is expecting its fastest growth in small business loans, which the bank classifies as anything up to 2m manat. Over the past 18 months, the Azeri government has passed legislation designed to clamp down on corruption and bureaucracy and simplify the taxation system for small businesses.
“If these measures to support the private sector are well implemented, there will be significant progress in the SME market, and banks will be a lot busier. But that is not going to happen in one day,” says Mr Huseynov.
Denied by Access?
Banks moving into the SME segment will face a tough task competing with Access Bank, the well-entrenched largest player in microfinance and agricultural lending in Azerbaijan. Thanks to its development bank owners, Access has brought best practice to the country from its inception in 2002.
During the boom years, says CEO Andrew Pospielovsky, competitors had little interest in the Access Bank model, with its very conservative underwriting standards. The bank’s success during the financial crisis has transformed those attitudes. Some rivals have apparently sought to obtain client lists for Access and target them offering lower borrowing rates, because they know that Access has done proper due diligence on all of its borrowers.
Mr Pospielovsky says he will not compromise underwriting standards, even if it means growing the bank more slowly. And Access is rigorous in immediately recognising any loan with arrears of more than 30 days – currently just 1.3% of the portfolio. This market-leading credit quality had a dramatic effect in attracting deposits, which tripled in 2009 and rose by 85% in 2010.
As its funding is plentiful and management time is not being swallowed up tackling NPLs, Access has had the field almost to itself. Loans grew 45% in 2009 and 80% in 2010, while many competitors exited the market for new loans altogether until 2011.
A safe option
“Reliability is our selling-point. We used to be the more conservative bank, but in the past two years we were sometimes the only bank making new loans. Good-quality clients know that we will not turn them down, the money is there if they can prove they are not just going to take it and run,” says Mr Pospielovsky.
While larger banks concentrated on hydrocarbons, petrochemicals and real estate, Mr Pospielovsky says there are many opportunities in other neglected sectors of Azerbaijan's economy. Leisure and tourism sectors have hardly begun to develop, and around the bank’s core agribusiness clients, there is a whole network of supporting infrastructure that still needs to grow.
Reliability is [Access Bank’s] selling point. We used to be the more conservative bank, but in the past two years we were sometimes the only bank making new loans
“In agriculture and retail, there are big investment needs for warehouses, distribution logistics, food processing and cold storage. Many smallholders are selling crops at the peak of the harvest, when prices are lowest, because they do not have access to storage. Good investments in these areas will boost company margins,” he says.
Shake-up at the top
There is also change at the top of Azerbaijan's banking sector, which used to be dominated by state-owned International Bank of Azerbaijan (IBA). While this bank acted as the distribution agent for government welfare and pension payments, it had limited retail lending activity, with corporate loans accounting for almost 90% of the total.
Ratings agency Fitch placed its BBB- credit rating on IBA on 'negative' rating watch in March 2011, citing risks including the bank’s “inadequate capitalisation, reduced profitability, poor asset quality and corporate governance issues, particularly substantial lending to privately owned related parties”.
According to Fitch analyst Dmitri Abramov, the bank’s exposure to construction and real estate sectors is equivalent to 1.5 times equity, while NPLs stood at 14.4% at the end of 2010. Impairment reserves are only 3.6% of the total loan book, and the bank’s capital adequacy ratio is just 10.7%, which is in breach of the local regulatory minimum of 12%, so the bank has no loss-absorbing capacity.
In mid-2011, the authorities engaged investment bank Rothschild as advisor for a potential privatisation of IBA. But the timeline for this is unclear, and in the meantime, IBA is not in a position to increase lending. Its importance in the economy is diminishing, with its share in total loans falling by more than 10 percentage points since the start of 2010, to 35.6% by May 2011.
New challenge
One bank in particular has been eating into that market share: Pasha Bank, which started operating in 2007 and is already the country’s second largest bank by capital. It takes its name from its owner, Arif Pashayev, the father-in-law of Azerbaijan’s president Ilham Aliyev. Through its conglomerate Pasha Holding, the Pashayev family owns stakes in many sectors including construction, tourism, agribusiness, electronics, communications and insurance, giving Pasha Bank a ready-made client base. The combination of high capitalisation and well-connected owners suggests Pasha Bank could pose a direct challenge to IBA.
“There are five or six banks that we consider competitors, IBA is one of them. The competition is increasing, and is felt in terms of rates, in terms of the knowledge and abilities of the banks, and we welcome that because we strongly believe in the value of the open market to improve the system,” says Pasha Bank CEO Farid Akhundov.
Pasha Bank recorded a profit of $70m in 2010. Mr Akhundov, a former HSBC executive, believes it can gain competitive advantage through the breadth and high-quality execution of corporate services, including treasury and export credit agency-backed trade finance. Non-interest income already amounts to 20% of the total, and the build-out of a ground-breaking private banking franchise as part of its second three-year strategy from 2011 should further diversify its revenues.
