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Asia-PacificAugust 3 2008

Kazakhstan Searches for pain relief

When the credit crunch struck, Kazakhstan was first hit and worst hit among emerging markets. Philip Alexander looks for signs of recovery.
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Georgy Iosifyan, the newest member of the management board at BTA Bank (formerly Bank TuranAlem) after joining from Russia’s Alfa-Bank in February, is ­hobbling after an accident in the gym. It might almost be a metaphor for Kazakh­stan’s banking sector. Previously pumped up by the anticipation of oil and gas revenues, even some of the country’s largest banks are now struggling to refinance international debts after global liquidity dried up last year, and are beset by rumours and fears about asset quality.

Merely a correction

But despite the pain, Mr Iosifyan is in combative mood. “There is no banking crisis in Kazakhstan, let alone a collapse – people should use big words with great responsibility. We would call it a slowdown or a correction,” he says. Unfortunately for Kazakh banks, the people using big words appear to constitute a large proportion of the market. Single-name credit default swap spreads on some Kazakh financial institutions blew out more than 700 basis points (bps) during the second half of 2007, and although they have narrowed since then, in many cases they are still about 400bps wider than before the credit crunch.

Meanwhile, ratings agency downgrades and negative outlook revisions have continued unabated. Most recently, Standard & Poor’s (S&P) cut the outlook on the sovereign’s BBB- long-term foreign currency rating to negative from stable in April, just six months after downgrading the rating by one notch, citing possible contingent liabilities if the government is obliged to bail out the banking sector. Most of the country’s banks are also on ­negative outlook and in a report ­published in June, S&P indicated that its focus was shifting beyond the ­financing difficulties, onto the asset quality of the banks’ loan books. ­Ratings analyst ­Ekaterina Trofimova warned: “Since the onset of the global and domestic liquidity crunch almost a year ago now, Kazakh banks’ financing to the domestic economy has slowed to a trickle, triggering an economic ­slowdown and debt service problems for many ­borrowers.”

The real estate sector is in the eye of the storm, with estimates for the fall in prices since the credit crunch ranging between 30% and 60%. Victoria Miles, head of emerging markets corporate credit research at JPMorgan, told a recent forum of the Emerging Markets Trade Association, that, in addition to direct bank exposure through mortgages and lending to construction firms and developers, “half of all retail lending added since late 2006 has used real estate as collateral”. She warned that banks were reporting collateral values with a significant time lag to the property market itself, implying that unreported losses are still to be disclosed.

Ms Trofimova of S&P has echoed these concerns, estimating construction exposure at 19% of total assets, and she believes non-performing loans (NPLs) for the sector as a whole could be as high as 15% to 20%. This is more in line with the Kazakh financial regulator AFN’s estimate for impaired loans (16.4% in May 2008), compared to average NPL ranges of 2% to 4% reported by the banks themselves.

The long view

Mr Iosifyan does not deny having a different stance on problem loans from the ratings agencies and foreign investors. His own bank, rated speculative grade BB with a negative outlook by S&P, has declared NPLs at 1.75% of the total portfolio, which he expects to rise to 2.3% to 2.5% by the end of this year, easily covered by provisions of 6.3%. He says BTA is holding about 40 residential units whose owners simply handed back the keys, but is happy to keep them on the books until they can be sold into a more favourable market, which he anticipates will emerge within the next two years.

Meanwhile, he says that construction sector lending was undertaken at very conservative loan-to-value ratios of no more than 60%, so he argues that BTA would still be in the money on the collateral if it foreclosed on most of these projects. “But that would kill the ­customer, a healthy customer overall that is just experiencing difficulties at this time, and it would cause a domino effect if you dump real estate onto the market, it will hurt the economy and the consumers,” he explains. “We have not only a professional responsibility, but also a social responsibility, and we understand that it is better to help the customer survive and repay their debts. We are not a charitable institution, we are in the risk-calculating business.”

Sympathetic approach

He says that this stance has been ­justified by a 20% rise in net income even in the first quarter of 2008. As evidence that the sympathetic approach to customers pays off, he points to the fall in NPLs in January, from 0.75% to 0.55%, after two loans from a single customer that had originally been classified as impaired were unexpectedly repaid.

On this basis, BTA would have little use for the government’s tentative proposal announced in November, to set up a distressed debt fund for banks to transfer troubled assets into – modelled on the recovery funds used in Asia after the 1997 financial crisis. “We have few projects in negative equity, only some of those deals signed less than a year ago, and they are a minuscule part of the overall portfolio,” he says.

If Kazakh bankers such as Mr ­Iosifyan are right, then an accommodating stance toward troubled borrowers could cushion contagion from the banking sector into the real economy, as well as helping sustain market share. But if the problems among debtors are more fundamental, then this approach will merely prolong the downturn in new lending, as banks postpone write-offs and subsequent recapitalisation. Mr Iosifyan acknowledges: “Only time will show whether I am right or wrong, but based just on fundamentals, especially the high commodity prices and commodity shortages in the world economy, I think Kazakhstan is well placed for long-run success. It is just the next seven or eight months that are crucial, the banking industry needs to regroup and pull itself out of this.”

In practice, even some foreign ­strategic investors have been more ­sanguine than the credit markets about the country’s prospects. Sweden’s ­specialist eastern Europe investment fund East Capital owns a 3.1% stake in BTA, and its chairman Peter Håkansson sees Kazakhstan’s difficulties as transient. “It was really a problem of timing, banks borrowed too early on the international markets, before enough oil and gas revenues had started to flow through,” says Mr Håkansson. He believes the systemically important banks are sound and points out that the state has more than enough funds to intervene if conditions deteriorate too far.

Investors circling

Mr Håkansson’s confidence in the banking system is reinforced by signs that many foreign institutions have seen the downturn as the chance to make a cheap entry into a sector that has good long-term prospects. ATF Bank is one of the few that retains a stable outlook from the ratings ­agencies, after Italy’s Unicredit bought a 91.8% stake for $2.1bn towards the end of last year. ­Raiffeisen, which sold its stake in BTA to East Capital in 2006 after being refused majority ­control, announced in July that it was applying to set up its own ­subsidiary in Kazakhstan. Korea’s Kookmin bought 30% of Center­Credit for $634m in March, and Abu Dhabi private equity fund Alnair increased its stake in Kazkommertsbank (KKB) from 8% to more than 25% in June.

New opportunities

One of the advisors to Alnair for the KKB purchase was Russian-­headquartered investment bank Renaissance Capital (RenCap), about a year after it opened the doors of its central Asian office in Almaty. Adel Kambar, who left Merrill Lynch to become CEO of RenCap’s new central Asian business, is keen to emphasise that 2008 will not be a fallow year for the bank. The downturn is forcing companies to consolidate or seek foreign investment, creating immediate advisory opportunities for bankers on the ground who can react more quickly than the occasional visitors from the US and western Europe.

“As there is deleveraging going on, this means there is going to be a lot of re-equitisation by local companies. For the smaller companies, there is no reason why they should not list on the local exchange, it is cheaper and less onerous than listing in London, which is a better home for larger companies and banks,” he says. Mr Kambar expects financial institutions in the country to be at a standstill or in decline this year, followed by a rebuilding phase from 2009. But even before then, more cash-rich Kazakh corporate clients in the resou­rces sectors are already looking to begin making acquisitions outside the country.

Mr Kambar also notes that the downturn in residential property is not mirrored elsewhere in the economy, with growth still strong enough for net job creation. Commercial real estate prices have been far less affected because there is still a shortage of quality office and retail space, which could become more acute as funding for new projects dries up. And even on the residential side, BTA estimates that, at current construction rates, it would still take another 15 years for housing stock in Kazakhstan to reach similar per capita levels to central Europe.

However, both Mr Kambar and Mr Iosifyan acknowledge that property and construction will not be the key drivers of growth that they were before 2007, and other sectors will therefore need to take up the slack. Given the country’s huge surface area and Soviet-era legacy of underinvestment, its infrastructure needs are vast, including road, rail, water and power generation and distribution. Mr Kambar says: “The government is very keen to have public-­­ private partnership concessions put in place, it is changing the law to make that more attractive for international investors – Kazakhstan has a lot of money, but the government realises that, for the kind of money that is needed over 20 years or more, it will require international investors.”

In addition, as global food prices spiral, agriculture and agroindustry are obvious candidates for investment, and Mr Kambar observes that Kazakhstan is one of the few countries in the world to enjoy large exportable surpluses of all three commodity groups – energy, metals and softs. Mr Iosifyan notes that grain sold to Russia can now generate up to $300 a ton, compared with previous prices of $100 to $120, and production costs of $80 to $90 a ton. Larger investment in agricultural output should also stimulate greater activity in the Kazakh fertiliser and chemicals sectors, which the BTA director speaks of as a new “booster rocket” for the economy, to work alongside commodities.

Looking for funds

To achieve lift-off, however, local banks will need to reopen funding on affordable terms. Mr Iosifyan is very reluctant to borrow from international investors at current costs, which he feels are out of line with BTA’s fundamentals. Deposits could be difficult to attract, given that real interest rates have turned negative as inflation reaches 20%.

But here at least, the fall in the property market could play to the banks’ advantage, as real estate is no longer a viable alternative to bank savings for retail investors. The deposit-to-GDP ratio in Kazakhstan has traditionally lagged behind that of Russia by about two years (see chart), and on this basis, Mr Iosifyan calculates that there could be an extra $4bn in Kazakh deposits to pick up in the next two years.

ALMATY AMBITIONS AS REGIONAL HUB

When adel kambar took charge of Renaissance Capital’s office in Almaty in May 2007, his remit included developing a presence right across the central Asian and Caucasus regions. It is, he acknowledges, a long-term objective in countries where RenCap must effectively “invent” the market for investment banking. Still, founded on his confidence that the Kazakhstan Stock Exchange will witness “enormous growth” during the next three to five years, he believes it can act as the exchange of choice for companies from across the region to begin listing.

Mr Kambar says: “Everyone realises Turkmenistan is a massive oil and gas play, it is a question of getting access, there is only one stock you can get exposure to at present.” But he believes the government of President Gurbanguly Berdymukhamedov, in power since February 2007, is sending positive signals on allowing greater foreign investor access. ­Uzbekistan has the region’s largest population, at almost 28 million, alongside a nascent automotive industry, agricultural commodities and some gas reserves. “The population is enough to sustain an industrial base, and once the financial sector is liberalised, it will be a good financial institutions market given the population and the low absolute starting point of the local banks,” Mr Kambar explains. Finally, ­Kyrgyzstan has a much smaller population, but great potential to generate and export hydroelectric power.

Domestic banks in ­Kazakhstan are also looking beyond the country’s borders as the slowdown bites, and BTA had already aimed to become a pan-CIS bank for some years. Its subsidiary in Russia – consolidated onto its main balance sheet for the first time this financial year – has enjoyed annual asset growth of 100%, while its assets in Ukraine have risen by more than 200%.

Mr Iosifyan says that non-Kazakh loans account for 10% of the total portfolio, which he would ultimately like to see ­rising to 50%. Armenia could be his next target, due to a benign combination of 10% gross domestic product growth and inflation of less than 7% – low by regional standards.

However, the Kazakh regulators may have unintentionally created a perverse disincentive among local banks to seek geographic diversification. They require investments in Russia to carry a capital reserve 50% higher than that for assets in Kazakhstan. “This is illogical given that Russia has a higher sovereign rating, more liquidity in the banking sector, a better economic performance and lower interest rates for funding,” says Mr Iosifyan.

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