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Armenian banks braced for difficult year

Stringent capital requirements set by the Central Bank of Armenia will test many of the country's banks, which are already struggling in a slowing economy. But for those that already meet the new standards, the opportunities arising from possible consolidation could provide a much-needed avenue to growth.
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Armenian banks braced for difficult year

Change is on the horizon for Armenia’s banking sector. The 21 banks in the smallest Caucasus country are faced with an ambiguous future thanks to challenges such as the country's economic difficulties, asset deterioration and a volatile currency. However, there are also opportunities for growth through consolidation.

When looking at the macroeconomic facts, the outlook for Armenia’s banks is not rosy. The country, which joined the Eurasian Economic Union led by Russia in 2015, is heavily reliant on the Russian economy and, as the forecast for gross domestic product (GDP) growth  dwindles, Armenia must brace itself. 

“Although there are signs that we could exceed expectations, Armenia would do very well to exceed 2% [growth in GDP] this year, given the forecast for negative growth in Russia, and [Armenia's] dependence on the economy in Russia. It is reasonable to forecast growth [to be] flat at best,” says Henry G R Kerali, regional director for the south Caucasus at the World Bank.

Latest forecasts by the World Bank’s global economic prospects database are for 0.8% growth in Armenia in 2015, 2.7% in 2016 and 3% in 2017. This follows 2014’s 3.4% GDP growth to 4843bn dram ($10.23bn) from 4556bn dram and a 3.5% growth in 2013. 

Difficult conditions

Another problem for the Armenian economy is its reliance on remittances to earn foreign exchange, according to Mr Kerali, as it does not have enough tradables to export. This dependence on remittances threatens to become even more problematic with the slowdown of the Russian economy, as about 80% of all transfers from abroad come from Russia, according to Nerses Karamanukyan, CEO at Yerevan-based Anelik Bank. He adds that remittances fell by 30% to 35% in the first few months of 2015 because of the deterioration of the Russian rouble.

In addition to this unfavourable backdrop, Armenia’s banks have already seen their asset quality deteriorate in 2014. Sector-wide non-performing loans (NPLs) rose from 4.5% at the end of 2013 to 7% in 2014, according to figures from the Central Bank of Armenia.

After experiencing growth in 2014, new credit extension in Armenia has already slowed in 2015, thanks, say bankers, to economic uncertainties. But it is the further deterioration of asset quality that will be the main challenge for the banking sector in 2015, according to Artak Hanesyan, chairman of the management board and CEO at Ameriabank, a universal Armenian lender. “We already see a deterioration of NPLs across the banking system to about 9%,” he says.

“A second issue will be capital adequacy, because with the devaluation [of the Armenian dram] against the US dollar and worsening loan quality, banks need more capital to grow," says Mr Hanesyan. The banking sector’s aggregate capital adequacy ratio decreased from 16.7% to 14.5% year on year in 2014, although it remains just above the minimum requirement of 12%, according to figures from the central bank. 

To improve levels of capital among banks, Armenia's central bank introduced a new requirement for institutions to hold a minimum of $60m of capital, which will come into effect in January 2017.

Currency concerns

Armenia’s domestic currency is highly volatile, the main factor behind the economy’s high dollarisation. In the past year, the Armenian dram suffered in line with the devaluation of the Russian rouble, falling from 441.26 dram per $1 on November 1, to 490.34 dram on November 17, before stabilising at less than 480 dram in February.

“Currently the Armenian banking sector meets minimum capital adequacy requirements and responds to the central bank's monetary requirements and prudential measures,” says Mr Kerali. "However, vulnerabilities in the sector remain considerable due to the high dollarisation of banks’ balance sheets, significant reliance on external finance, especially remittances, and risks of NPLs due to growing currency and credit risks in the backdrop of lower economic growth."

Armenia’s banks are exposed to the risks linked to the currency, although most make sure that any assets and liabilities in different currencies match, as there are no hedging products in the market. Still, in a country where about 80% of all deposits are made in foreign currencies, a run on the currency would pose a threat to lenders. There also is the currency risk, which banks are passing on to clients who borrow in foreign currencies.

“Yet, even if all your assets and liabilities are in US dollars, your capital is in Armenian drams and, even if your business is going really well, there is still some hypothetical level where you could be short of capital,” says Taron Ganjalyan, CEO at Yerevan-based InecoBank. “We do stress test all of those levels and try to understand how much bandwidth we can take, how much liquidity we should keep and how we should manage the credit risk.”

To lessen foreign exchange risk, the Central Bank of Armenia has introduced a higher mandatory reserve requirement for banks’ foreign currency exposures, obliging banks to keep 24% – compared with the previous 12% of local currency – with the central bank for funds attracted in foreign currency.

This, however, has led to another issue for banks, as it has exposed a lack of dram liquidity. With only about 20% of deposits in local currency, the most common way to attract dram funding is through repos in the interbank market or through Lombard loans from the central bank, according to Mr Hanesyan. Local capital markets are still in their infancy, however, and the central bank is working with the European Bank for Reconstruction and Development to develop local currency financing.

A cause for consolidation

Meanwhile, the central bank's requirements, both for more local currency funding and additional capital, could pose a challenge for smaller banks. For now, only five out of the country's 21 banks are compliant with the minimum capital requirements, according to Mr Hanesyan at Ameriabank, the country’s largest lender by assets. While Ameriabank already fits the criteria, he notes that of those 16 banks not already hitting these targets, only another five have the scope to increase their capital through organic growth.

“The remaining 11 banks need to inject additional capital from new or existing investors. Moreover, those banks have much lower returns on investments, which are not comparable with their risks,” he says. “As a result, additional investments in these banks are not economically justified, while growth potential for current champions [of the capital requirements] is much higher.”

Return on equity in the Armenian banking sector reached an average of 6.4% in 2014, while data from the central bank shows that the banking sector has posted losses in the first quarter of 2015. Experts agree that this makes it likely that some of the smaller banks that do not currently meet the capital requirements will start considering mergers. “We are already seeing some negotiations starting between the banks on possible mergers and acquisitions. This is a process that we are closely looking at and we will seize lucrative opportunities,” says Mr Hanesyan.

Ameriabank, which launched its corporate banking offering in 2007, still sees its business skewed towards corporate banking. However, the bank is keen to grow its retail operations, so that it comprises half of its loan portfolio in the medium term, rather than the current 30%, according to Mr Hanesyan. This, he says, would ideally be done through a merger or acquisition. “Our bank is aiming towards a universal banking model, because we think this model is more sustainable. We started to invest more in technologies and in processes and products that are targeted to retail and small and medium-sized enterprise [SME] clients,” he says.

After an anticipated merger and integration of a retail banking brand, Ameriabank is targeting an initial public offering (IPO), ideally in London. “We started our IPO preparation a year ago by improving our corporate governance, reporting and investor relation practices, but we also need scale for a successful IPO,” says Mr Hanesyan. “The new opportunities for consolidation in the local market bring more opportunities to grow quickly and to be ready for an IPO in the next couple of years.”

Portfolio progress

At the smaller and more specialised end of the spectrum are banks such as InecoBank and Anelik Bank, both of which currently fall short of the 30bn dram capital requirement.

Anelik Bank, which since 2013 has been 100% owned by Lebanese Credit Bank, is seeking to attract further capital injections by its shareholders. “We have $30m of capital at the moment, but are injecting another $5m into the capital of our bank this year,” says Mr Karamanukyan. “Our shareholders will invest more, of course we will also make some money, some of which will go into our capital as well, and we might consider mergers.”

Anelik turned in a profit in 2014, after struggling in previous years, thanks to a change in strategy. This made it the second fastest growing Armenian bank in 2014, behind AmeriaBank.

“The bank was [previously] not doing any retail business, we only had a small gold pawn loan portfolio, but it was not delivering unsecured loans,” says Mr Karamanukyan. “When we started doing that, we quickly grew our portfolio, not only through retail clients but also by incepting new products for microfinance – up to $20,000 loans with a more speedy way of appraisal of the small companies.”

In line with the expansion of its lending business, Anelik is opening another two branches in 2015, which will take its total to 15 branches. It has also improved its risk management capabilities through new hires and software. Apart from retail, Anelik also focuses on micro businesses and SMEs.

Niche angles

InecoBank, meanwhile, had 23bn dram of total regulatory capital as of the end of 2014. It specialises in point-of-sales credits, offering immediate credit to qualifying customers seeking to buy a product with a retailer. Nearly every large or medium-sized Armenian retail outlet has such an agreement with InecoBank, says Mr Ganjalyan. “People actually [visit] shops to see if they can get InecoBank credit,” he says. “And, from the side of the retailers, when they start their business, they establish the brand and decide what they want to import. Then, the second thing they do is get in touch with InecoBank to get the agreement to sell this loan.”

To choose the right customers, Ineco can rely on its own large database as well as data from Armenia’s centralised credit bureau. “We almost have everybody who potentially has credit [on file],” says Mr Ganjalyan. “Our system also stores individuals that have been denied credit.”

While the point-of-sales credit business is InecoBank’s speciality, it only makes up 40% of its portfolio. The remainder comes from the corporate side – across the supply chain.

“Because we have a large market share in that [niche], the retailers want to do business with us,” says Mr Ganjalyan. “Because we deal with the retailers, the wholesalers want to deal with us, and the transport companies want to deal with us. Because we know what is coming, we can manage the risks pretty well.”

InecoBank is looking to transform its business into a fully fledged retail bank, giving out credit cards and accounts. Mr Ganjalyan says that the idea is to blend several aspects of modern technology with standard banking licences, in order to create a product that has a very low hurdle for new customers to open an account. This means offering customers the ability to open an account on its website, with additional services requiring some additional identification or documents, instead of asking for everything at once.

As shown by Anelik Bank, Ameriabank and InecoBank, Armenia’s lenders will have a lot to contend with in the next couple of years. And just how many of the country's 21 banks will still be around in 2017 is a matter of real uncertainty.

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Read more about:  Central & Eastern Europe , Armenia