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Asia-PacificJuly 31 2007

New strength attracts interest

Kazakhstan’s economic growth story is attracting foreign investors, especially in the booming banking sector. Ben Aris reports.
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Kazakhstan is on fire as foreign investors begin to flood into the big country with a small population in central Asia’s steppe. Oil revenues have primed the pump but after per capita income broke through the $5000 mark, a virtuous circle of spending and investment has resulted in the economy starting to diversify. The first big beneficiary of the change has been the banking sector.

Just how far things have progressed was thrown into stark relief in June when Austria’s Bank Austria Creditanstalt (BA-CA) announced the first ever acquisition of a Kazakh bank by a foreign investor. BA-CA bought leading second-tier institution ATF Bank for €1.6bn – the second biggest acquisition in the former Soviet bloc, beaten only by Erste Bank’s takeover of Banca Commerciale Romana last year.

BA-CA is part of the UniCredit group and spearheads its drive into central and eastern Europe. The Austrian bank followed up with the purchase of Ukrainian bank Ukrsotsbank two weeks later, also a new favourite destination for foreign investors. The relatively high multiple of the ATF Bank deal of five times book value underscores the growing enthusiasm for Kazakh banks, which are already comparable to their central and western European peers on some counts.

“It was a good price for an excellent bank,” says Hubert Pandza, a former European Bank for Reconstruction and Development senior banker who now sits on the ATF board of directors. “Kazakhstan has always had the best banking sector in the CIS [Commonwealth of Independent States] in all respects. Both the quality of management and the standard of the banks’ operations are higher than those of Russia and the other countries of the CIS. This deal was an important milestone in the progress of the Kazakh banking sector.”

Foreign interest

Foreign banks have been looking around the Kazakh commercial capital of Almaty for a couple of years now, but baulked at buying into the sector. Raiffeisen International bought a 15% stake of top-three player Bank TuranAlem, but sold it last year when it became clear that the management was not ready to sell out. And Grigoriy Marchenko, CEO of Kazakhstan’s biggest retail bank, Halyk Bank, has been trying to interest a strategic investor in a stake without success and so decided to launch an initial public offering (IPO) in London earlier this year instead. Mr Marchenko said that foreigners thought Kazakhstan was “too small” to justify spending hundreds of millions of dollars.

Investors’ interest has perked up, however, after banking sector assets almost doubled in 2006 and the fastest growing banks, including ATF, almost tripled their assets,

That kind of growth is possible because the Kazakh economy has reached a critical mass. Years of relatively liberal reforms have started to pay dividends: Kazakhstan’s gross domestic product (GDP) grew 10.6% in 2006. Economists believe it will grow another 10% this year, bringing the value of the economy to more than $100bn. Kazakh president Nursultan Nazarbayev told a group of investors in June that the former Soviet state has set a goal of achieving a GDP figure of $300bn by 2015, and few doubt it.

Oil is the foundation of the economy, which accounts for a third of GDP and half of the country’s exports. However, in its latest report on the country, the IMF cites “impressive” growth in the non-oil sector that could help avoid oil-related growth problems. Locals say that what has changed is that consumers are now rich enough to fuel a virtuous circle of consumption and investment.

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“Kazakhstan is going through a very positive transition. It continues to be a natural resources-based economy, but as the per capita income has broken through the $5000 level, there is enough money now to fuel consumption-driven growth that will allow the development of a more balanced economy,” says Mikhail Derkavski, the CEO of Compass Assets Management, one of the first domestic funds to be set up, in 2004.

Gold rush Kazakhstan is suddenly hot as investors want to diversify out of Russia and at the same time are tempted by the ballooning Kazakh economy. A slew of funds have launched this year to allow investors to get some exposure to central Asia and more sophisticated products are in the works.

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“A gold rush has started,” says Michael Sauer, CEO of Visor Capital, Kazkhstan’s first domestic investment bank, which was set up in 2005. “Every week we are seeing two or four [international] clients coming down to take a look around. We take them out to meetings and I am sure the volume on the [Kazakh Stock Exchange] has doubled in just the past three months. At the same time there is more private equity action and more mergers and acquisitions.”

 

Sweden-based East Capital got the ball rolling in February when it raised $100m with its Central Asia and the Caucasus Fund, which closed almost as soon as it started accepting investments. “We closed the fund almost immediately because demand was so great,” says Aivaras Abromavicius, partner of East Capital and manager of the East Capital Bering Central Asia Fund, which is up 8% since its inception at the end of February. “Those who made good money in the Baltics and Ukraine are looking for the next big thing.”

Likewise, Visor Capital’s asset management arm, Compass Capital, quickly raised about $350m with the launch of two offshore funds, one of which was floated on London’s Alternative Investment Market in April. Compass hopes to raise another $300m, with a third fund targeting European investors that is due to close in December.

And Russia’s leading investment bank, Renaissance Capital, is in the middle of setting up a full service investment bank to cater to the growing international demand for exposure to the region and plans to offer investors “the entire gamut of services”, says its new CEO, Alexander Pertsovsky.

Adel Kambar, who was hired from Morgan Stanley in April to head Renaissance Capital’s central Asian operation, says: “It’s amazing that you have a $100bn economy and total population of about 80 million in central Asia, and yet there is not one proper investment bank in the entire region.”

Part of the interest in the region is the fact that Russia, the traditional focus of international investors in the region, is doing so badly this year. After nearly doubling every year for the past three years, the Russian stock market was up less than 15% by the end of June since the beginning of 2007. And investors are worried by the increasingly belligerent rhetoric flying between Moscow and Washington. Many have decided it is a good time to diversify their portfolios.

Bank sector booms

Oil money underpins the growth but the banking sector is driving it. Total banking sector assets were up 97% in 2006, growing twice as fast as most of the banks were predicting. The sector is starting to look normal as the ratio of gross loans to GDP hit 57% at the end of 2006, on a par with the lower end of central Europe’s banks.

“Kazakhstan’s banks benefited from three real advantages: a stable and well-managed economy; a competent and assured regulator willing to implement Western regulations; and the absence of any banking crisis that would undermine public confidence in the banking system,” says Richard Hainsworth, CEO of leading bank rating agency RusRating, which has set up shop in Kazakhstan under its new Global Ratings brand.

Kazakhstan has always had money; what has changed is that retail banking has reached critical mass. The amount of loans to individuals rose by 130% and comprised 28% of total loans (and 16% of GDP) at end-2006. Growth was a more modest, but still strong, 16% in the first quarter of this year, so retail is now a little less than a third of total sector loans.

The fastest growth is going on among the second-tier banks, which has upset the traditional hierarchy of the sector. Thanks to relatively liberal reforms, Kazakhstan has long sported the best financial sector in the former Soviet Union. The sector has been divided into three tiers with the three big banks – Kazkommertsbank (KKB), Bank TuranAlem and Halyk bank – dominating the top tier.

However, as the big banks, which traditionally catered to the handful of huge corporate customers in the oil and mineral sectors, were slow to spot the potential of the retail banking business, the 15 or so second-tier banks have managed to close some of the distance. Indeed, the two leading second-tier banks, Alliance and ATF Bank, followed aggressive lending strategies that enabled them to almost triple their assets in 2006. By the end of the first quarter of this year, both banks had overtaken Halyk, formerly the third-largest bank in Kazakhstan, although Kazkommertsbank and Bank TuranAlem remain the two largest banks by a comfortable margin (see tables, page 57).

Risks are growing

The fast pace of growth is causing some concern. Visor Capital’s analysts are asking how good risk management can be if banks are tripling their loan portfolio in a year and have already downgraded some of the leading Kazakh banks. “Such rapid growth entails heightened credit and operational risks, and is by far the largest single source of risk for Kazakhstani banks at present,” says Fitch Ratings in its annual report on the Kazakh banking sector, published in July.

One bank has already gone bust. The Kazakh authorities did not bail out Valut-Tranzit Bank, which became insolvent in 2006, but it was a small bank with a 2% share of sector assets and a 5% share of retail deposits at end-2005, and analysts welcomed its collapse as a timely reminder of the dangers associated with fast growth.

A second growing risk is that, despite the floods of oil money, Kazakhstan is too small to finance the growth of the banking sector out of its own pocket; banks have been tapping the international capital markets and are not able to slake their thirst for cheap long-term credits. Banks issued $6.5bn worth of Eurobonds in 2006 and another $7bn through syndicated loans. In just the first three months of this year, banks raised another $6bn in Eurobonds, taking foreign funding to a new high of 46% of bank sector liabilities.

Market conditions for Eurobond issues were very favourable at the beginning of this year, but the ratings agencies warn that the continued growth of the Kazakh banking sector is becoming increasingly dependent on the conditions prevailing on the international capital markets. A downturn of sentiment will cause refinancing problems for many banks.

“The trouble is that the economy cannot absorb all of this new financing. While on an individual basis the foreign financing is easy to justify, when taken together it becomes less clear that the money lent to the entire system can be absorbed by the economy. Evidence of this is the expansion of the Kazakh banks into neighbouring countries and their ability to pay well for their new assets,” says Mr Hainsworth.

Regulators react

The local regulator is aware of these problems and has already moved to nip any potential crises in the bud. A deposit insurance scheme is already in place and a series of new and tough restrictions was placed on the banking sector earlier this year to head off potential trouble.

New limits that are designed to curb excess borrowing were introduced in April, particularly among the higher risk, smaller banks. The limits on borrowing are tied to capital in a staggered system, which maxes out at five times the capital of the biggest banks and limits smaller banks to lending only three times their capital.

The new rules forced almost all of Kazakhstan’s banks to boost their capital and the seven that have failed to meet the new requirements have a year to get their houses in order. Mr Nazarbayev is also taking a personal interest in the health of the banking sector and ensuring that banks stick to the new rules.

“The regulator is very proactive and started on reforms well before anyone else in the CIS,” says Mr Sauer. “There are some concerns over the fast pace of growth but the regulator is watching the situation very closely.”KEY SECTOR ASSET AND LOAN DATAKAZAKHSTAN BANKING MARKET SHARES (%)

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