Financing of the Kazakh Mining Iindustry by Banks
Asyl Khamitov, Head of Risk Management, Kazkommertsbank
Valery Nalobin, Head of Project Collateral Security, Kazkommertsbank
The country is facing a need to enhance its processing capacities, in order to reduce dependence on the trends of international raw materials markets. The authors believe that the state should provide an impetus for this sector of the economy. Mining companies themselves are starting to recognise the advantage of having a developed processing capacity.
Today, the involvement of most Kazakh banks in the national mining industry is limited to the provision of credit to companies which are operating in already explored fields. Usually, banks provide them with working capital, whereas capital investment accounts for a negligible proportion of the loan structure.
According to the National Bank of Kazakhstan, working capital makes up 63-64% of commercial banks’ credit portfolio. Thus, from January to July 2001, this item totalled 244.5 billion tenge. Credit for buying capital assets accounted only for 8-9% during the same period.
The short-term nature of liabilities (that is, funds at bank’s disposal) prevents banks from going for long-term capital investment programmes even in priority sectors, such as mining. Investment in capital assets, development of new fields or building of new facilities will require extended loan terms (7 to 10 years). After that, replacement of fixed assets will be required again.
The above principally applies to medium-size and small mining companies. Large ventures, which usually involve foreign capital, have no problems with credit, being financed either by their parent companies or Western banks, whose interest rates are much lower than those of Kazakh banks.
Kazkommertsbank, which has been financing mining operations since 1995, is providing 1 to 3-year loans to the sector. Mining companies occupy up to 18% of the bank’s credit portfolio. In 2000, Kazkommertsbank’s investment in the mining industry, metallurgy and oil and gas totalled 11.84 million tenge, exceeding the 1999 level (4.426 million) by 167.5%.
Mining projects in Kazakhstan may be loosely divided into three categories:
• functional companies which are operating old Soviet fields, at the peak of production or declining;
• newly explored fields;
• projects which were launched in the Soviet times but mothballed afterwards, or whose ownership is uncertain.
What kind of investment proposals are banks facing most often? Mostly new fields, which imply considerable allocations for supplementary exploration, technology testing and infrastructure. All these, naturally, are associated with a high degree of risk. Today, such projects can be handled only by transnational giants, which can make up for the risks with profit from other projects.
Large exporters prefer borrowing working capital from Kazakh banks for 2-3 years, whereas their main financial backing comes through offshore zones.
As for the second and the third categories of projects, support from one or two banks appears to be insufficient. Investment in companies at the stage of field development should be a long-term arrangement. For example, building of gold producing facilities is a costly venture, which only starts to be repaid after many years. Thus, according to experts, construction of an average-sized plant costs $45-50 million, which is 50% of the biggest Kazakh bank’s capital, or 20% of the total capital of the national banking system. No Kazakh bank is in a position to handle such investment programmes alone, especially given the National Bank’s limit on risk per borrower which must not exceed 25% of a bank’s own capital.
Most new mining sites are located in underpopulated areas with poor infrastructure and a harsh climate, which implies lack of qualified manpower. All these factors drastically complicate field development. However, it is understood that the advance of the mining sector largely relies on new fields, technology and infrastructure development.
For the latter case, an interesting option would be to share risks and pull financial resources together within the frameworks of a syndicate. An example of such arrangement initiated by Kazkommertsbank was a syndicated loan to ABC-Balkhash, a gold producing company, provided jointly by Kazkommertsbank, Halyk Bank, CenterCredit Bank and TuranAlem Bank. The National Bank provided the consortium with credit resources under a six-month LIBOR plus 7.25% per annum. Therefore, the resulting interest rate for ABC-Balkhash, inclusive of the banks’ margin, was 11.13%.
Experience in Risk Assessment
The basic criteria for a bank are the company’s financial transparency and stability, good credit history, adherence to international performance standards and prospects of long-term operation in Kazakhstan.
Only 2 to 4 proposals out of every 10 are normally accepted by banks. This conservative approach towards credit is dictated by the need to minimise risks, especially while dealing with small to medium-size projects for developing new sites.
For example, when a bank delivers credit to an operational company with known financial and production trends, fairly accurate forecasts can be made as to the company’s output and costs. In the case of a new field, little or no information is available to the crediting bank, which represents an investment risk.
To minimise risks, banks employ their own experts and analysts. Kazkommertsbank has a special department for assessing mining projects, which comprises highly professional geologists, lawyers and economists. Their efforts enable the Bank to judge risks confidently and demand appropriate security.
Risk analysis passes through two stages. At the first and main stage, the company’s human, financial and technical resources are overviewed, along with the prospects of the project itself, i.e. the field’s reserves, as presented by the borrower or concluded by geological exploration companies and the State Reserve Committee (SRC).
While assessing field deposits, the Bank applies a common technique, which is different in some basic parameters from those used by the SRC or foreign investors. Whereas SRC’s judgement is entirely based on world prices of raw materials, with no regard for domestic factors (quality, transport costs, etc.), foreign investors tend to incorporate the maximum possible costs in their assessment, hence the striking difference between the two calculations.
At the second stage of risk analysis, the actual financial and production parameters are assessed against the business plan and forecasts drawn up. Therefore, the Bank, based on ongoing monitoring, has a means of reducing regulatory risks, in case the borrower fails to comply with the agreement.
Following the Bank’s acceptance of a proposal regarding the development of a new field, a working group is formed including a mining specialist, a lawyer and a Bank’s collateral specialist. The working group visits the site to perform an assessment, which covers all aspects of mining and compliance with the minimal working programme, including the scope of geological surveys, assessment and taking stock of deposits, working project, observance of the contract and licence terms, breaches of legislation, etc.
Kazkommertsbank has generally adequate expertise in crediting mining projects, which enables it to select viable proposals. Virtually, the Bank’s practice of dealing with mining companies reduces the risk of borrower’s non-compliance with field development contract to zero.
Contracts are being concluded and fulfilled in accordance with the Act On Mineral Resources And Their Use, and the Oil Act. Article 70 of the former Act governs the timing of field exploration and development, as well as maintaining certain production levels, based on geological features of the site.
The Bank will be exposed to risk in the event that a Competent Body (authorised public body) suspends exploration or production for a period up to 6 months or terminates the contract with the borrower (Act On Mineral Resources And Their Use, Articles 45-1 and 45-2). In addition, the Competent Body may terminate the contract if the borrower fails to fulfil his obligations or working programme (ibid., Article 45-2).
The Bank will also encounter risks if the borrower violates technical provisions in the contract (for example, regarding percentage of element extraction from ore). In the case the borrower appears insolvent after termination of the contract, the Bank will resort to covering the debt with collateral, which may be represented by the right to mining or other company’s property.
Currently, the Bank cannot employ hedging instruments, due simply to their absence from the market. On the other hand, using the services of Western insurance companies, which are involved in major projects in Kazakhstan and have vast experience in risk assessment, would be too costly and have a bearing on the borrower’s financial status.
The Problem of Collateral
As a rule, Kazakh companies are reluctant to pledge their right to mining, which is regarded as the most valuable asset, and offer other property, such as infrastructure, shares, etc., as collateral.
On the contrary, banks are interested in controlling the whole of the property chain. Owning infrastructure without the right to mining will inevitably result in a conflict of interests if the collateral has to be sold.
Kazkommertsbank has set the precedent of selling the right to mining which had been pledged by a bankrupt gold producer. In the course of the bankruptcy proceedings, the Bank managed to sell both the production facilities and the right to mining to a licensed Kazakh company which has experience in the gold industry, while preserving all investment obligations and a minimal working programme. However, this case is rather exceptional, since the market in «second-hand» rights to mining is not yet functional.
In reality, it is extremely difficult for a bank to make up for losses in the event of default on the part of a small or medium-size mining company. Domestic businesses generally lack resources and expertise in mining and, therefore, collateral is more likely to be bought by a large market player. There are one or two big companies in the mining sector which are able to purchase such collateral – at an inadequate price, however.
Priorities
Kazakh mining companies, such as the Donskoy Ore Mining and Processing Works, Kazzinc and Sokolovsko-Sarbayskoye GPO, are large exporters of raw materials. Regrettably, the global integration which came to Kazakhstan appears to have embraced only the mining sector.
The country is facing a need to enhance its processing capacities, in order to reduce dependence on the trends of international raw materials markets. The authors believe that the state should provide an impetus for this sector of the economy. Mining companies themselves are starting to recognise the advantage of having a developed processing capacity.
The Development Bank of Kazakhstan was founded to assist large-scale ventures, including those in the mining industry. Commercial banks also tend to pay more attention to this sector. To Kazkommertsbank, particularly, the mining sector is an attractive area in its investment policy, representing new clients and long-term projects which the Bank will support readily.
Table of contents
The Corporate Bonds Market in Kazakhstan Damir Karassayev
Moscow Almaty Kiev Minsk Where Next? Alexandr Dilbazi
Financing of the Kazakh Mining Iindustry by Banks Asyl Khamitov, Valery Nalobin
