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Central & eastern EuropeSeptember 2 2007

The quiet success story

Under the oversight of the central bank, Armenia has boomed and now foreign banks are circling for a piece of the action. Ben Aris reports.
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Over the past six years, Armenia’s economy has been booming. It sports one of the best legislative bases in the Commonwealth of Independent States, and enjoys a regular stream of money sent home by an army of Armenians working abroad. Largely ignored by foreign investors until now, Russia’s VTB Bank made the first in what could be a set of acquisitions by taking 100% control of CJSC Armsberbank, now CJSC VTB Bank (Armenia), in the last week of July.

Several big foreign banks are circling the republic, tempted by the dirt cheap prices for acquisitions. VTB was among the first in when it bought a 70% plus one share in CJSC Armsberbank in 2004 and now plans to double the bank’s charter capital from the current $21.9m.

Tucked in between the Caspian and Black Sea under mount Ararat – where legend has it Noah landed after the Biblical floods receded – the Caucuses are politically unstable, but after the charismatic president Robert Kocharian was elected in 1998, Armenia has pushed through some of the most comprehensive reforms in the CIS.

The Central Bank of Armenia (CBA) has been among the most progressive of the state organs and bank sector reform is running well ahead of the rest of the economy, although the banking sector remains small and underdeveloped.

There are 21 banks in Armenia, all privately owned, accounting for 94% of total financial assets in the country at the end of 2006, according to Fitch.

Total banking sector assets are 20% of gross domestic product (GDP), low by even CIS standards, and four banks dominate the sector, accounting for just under half of all the assets at the end of 2006. The local branch of HSBC alone has 15% of the total assets and 22% of the deposits.

Thanks to the reforms the Armenian banking system has begun to grow strongly, albeit from a very low base. Bank credit to the private sector grew 33% in 2006, the same pace as in 2005. However, the stock of private-sector bank credit to GDP was just 8.7% at end-2006, up from 7.8% and end-2005 – also the lowest private-sector credit/GDP ratio of any country in eastern Europe.

Easy profits

The problem is that although the banking sector is well regulated, owners have become lazy thanks to the lack of competition; as the spreads between deposits and credits are large, Armenia’s banks may be small, but they are very profitable, returning 15.9% on equity in 2006.

As a result, all the country’s banks are in pretty robust health, well capitalised and with a high capital adequacy ratio of 35% as of the end of 2006 – some three-times the CIS norm. And as the credit frenzy that has gripped many of the countries of eastern Europe has yet to arrive in the capital Yerevan, the non-performing loan ratio is a low 2.5% of total loans.

Most of the credit for the good health of the bank system can be laid at the door of the CBA. It has been tough on banks but now the sector is starting to grow it has begun to ease its stance and is switching to promoting the broadening of the sector and opening new sectors such as insurance and investment businesses, says Emmanuil Mkrtchyan, chairman of AmRatings, the local bank rating agency and part of Global Ratings, the leading bank rating agency in the CIS.

“Armenia’s banking system functions far more smoothly than the economy as a whole, which makes banks unusually attractive partners for foreign investors. Most current investors in the market for banking services are members of the Armenian diaspora [both pre- and post-Soviet waves] and carry little weight in political circles,” says Mr Mkrtchyan.

The CBA has been an engine for change and introduced new corporate governance regulations for banks in mid-2006. The new rules were targeted at clarifying ownership structures and preventing excessive lending to connected entities.

Minimum capital requirements were also raised in March: banks had to have a minimum of 5bn dram (€11m) in capital by the start of 2009 and maintain a minimum of 2.4bn dram in the meantime. Any new banks that open between now and 2009 must use the higher number.

“The government and especially the CBA get very high marks for their commitment and consistency when it comes to reform. It has only been in the past few years that the benefits are starting to come through in terms of investment,” says David Heslam, in charge of Sovereign ratings for emerging Europe at Fitch.

Economy booms

Armenia has successfully transformed to a market-based economy and privatisation is largely over. The European Bank for Reconstruction and Development (EBRD) estimates that by mid-2006 some 75% of economic activity in Armenia occurred in the private sector, the same as in EU members Bulgaria and Poland, and well above the 65% figure for its nearest peer Ukraine.

Since 2000, the country’s GDP has more than tripled in dollar terms, and maintained an average growth rate of 11.5%, before finishing with a sprint in 2006, when the economy grew by an explosive 13.3% – more than double the start-of-year prediction of 6%. Armenia had a GDP of $4.9bn for a population of three million in 2005, and that reached $6.6bn by the end of 2006.

Construction is the fastest-growing sector of the economy and now accounts for just over one-fifth of GDP, with industrial construction growing even faster. However, agricultural growth stagnated in 2006, due to bad weather, and industrial output contracted as sectors such as textiles were affected by the 19% appreciation of the currency last year.

Fitch expects growth to slow moderately to 9% in 2007 and 8% in 2008, as the dinar’s appreciation in 2006 works through the economy and as the construction boom moderates.

Wealth divide

Meanwhile, the government still has to cope with severe problems. Chief among them is the poor distribution of wealth. Per capita income tripled between 2000 and 2005 but was still only $2200 by the end of 2006 – a quarter of the level in the Baltic states and half that of its neighbours Georgia and Azerbaijan.

Poverty stands at 35% of the population and unemployment is running at 20%-30%, according to unofficial estimates. Wealth is still very concentrated in the hands of a few, most of whom live in the capital Yerevan.

“You have to remember that 40% of the population are still employed in agriculture and are seeing little of the benefits of the fast pace of economic growth,” says Mr Heslam.

On top of the heavy wage distribution pyramid is endemic corruption. The booming economy is persuading firms to join the formal economy that allows them to tap the banks for investment capital. However, there are still many businessmen among the country’s elite who are resisting change. The problem is highlighted by the relatively low 16% of GDP that the government receives as tax revenues, while that of its more progressive neighbour Georgia is just under 30% of GDP.

Armenia is unusual in that foreign banks are well represented in the local market, largely due to the government’s policy to push its banks to compete and the local branch of HSBC dominates the sector.

“There was a concerted effort by the government to attract foreign banks into the system as competition was lacking. The idea was to give the local banks a boot as they are very profitable, thanks to the relatively big spread between deposit and credit interest rates,” says Fitch’s Mr Heslam.

HSBC has a big advantage over its local competition because of its access to cheap funding from its parent bank and as it also holds the most local deposits.

Just behind HSBC, a battle is developing between the foreign-owned subsidiaries Raiffeisenbank Armenia and the microcredit specialist ProCredit. ProCredit operates in 19 countries and specialises in providing small business and agricultural loans, especially in eastern Europe. Raiffeisenbank has been aggressively snapping up local banks in each of the eastern European markets and bought AreximBank from companies controlled by Russian oligarch Boris Ivanishvili, who is an ethnic Georgian.

Mr Ivanishvili sold his Russian retail bank Impexbank to Raiffeisen in 2006 for $550m, which also held his shares in AreximBank. AreximBank has solid market positions in both Armenia’s corporate and retail banking as well as being the leader in car loans.

Raiffeisen will merge its local operations with its new acquisition as it did in Russia with Impexbank and go head to head with the domestic market leaders ArdshininvestBank, Armekonombank and HSBC Bank Armenia.

However, the local game is being shaken up by the imminent arrival of some new players. VTB was an early entrant and is being followed by the banking arm of the state-owned Russian gas monopolist Gazprombank, which says it will set up an Armenian subsidiary sometime this year. Both banks are huge by local standards and will make the locals work hard to maintain their market shares.

Further down the food chain, some smaller deals will introduce specialisations. Leading Russia investment bank Troika Dialog, controlled by Ruben Vardanyan, an ethnic Armenian, is in talks to take over ArmimpexBank, one of Armenia’s largest banks, to create the country’s first dedicated investment bank. ArmimpexBank is currently owned by British citizen Vache Manukian but has been doing little more than treading water for most of the past five years.

ArmimpexBank is second choice for Mr Vardanyan, who was eyeing ConversBank, which was eventually sold for $45m-$50m to Eduard Eurnekian, an Argentine businessman who operates the Yerevan airport.

Currently the only bank offering anything like investment bank services is Armsvisbank.

And Lebanon’s Byblos Bank is already in intensive negotiations with ITB, a smaller local bank, on an acquisition deal worth an estimated $11m. ITB has a capital of $8.4m as of March, making it the smallest-but-one bank in the country.

A group of Dutch investors, who manage Armenia’s post office, were interested in ITB, but are being outbid by Byblos Bank, according to Global Rating. The Dutch group was hoping to use ITB as the basis of a post bank, which is still on the cards. Analysts say that Armenia’s Prometei Bank is the most likely other acquisition target available.

Georgian trailblazing

All this interest is being fuelled by the huge potential upsides in Armenia’s bank valuations. The success of Bank of Georgia next door has whet everyone’s appetite for small banks in small countries. The population and macroeconomics of Georgia and Armenia are very similar, but the divide between valuations of their respective banks is huge. The sale of ConversBank was the biggest deal to date and netted about $50m whereas Bank of Georgia floated on the London Stock Exchange at the start of 2006 and its market capitalisation passed $1bn in June. The question is only, when will Armenian valuations start their catch up?

“It will probably take a bit longer as despite all the progress it remains at a low stage of development. There is not much in the way of a capital market. The government bond market is not very liquid. The banking sector is small and mostly self-reliant and remains small and fragmented,” says Mr Heslam.TABLE: ARMENIA'S ECONOMIC INDICATORS

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