Uncritical Instability

Despite the vacation season, summer was a hot period for those, monitoring the situation in the banking sector. It was essential that all attention was paid to the debt restructuring of the two strategic banks of the country – nationalized BTA Bank and state-controlled Alliance Bank.

Three cents per dollar

Today, we already know the major parameters of BTA and Alliance liabilities restructuring, proposed by their management. BTA debt discount could reach 55-97% while the debt burden could go down by $5.7-8.3 billion. At the same time, the bank needs capital inflow in the volume of $10-12.6 billion, even considering the $4.3 billion, invested by Samruk-Kazyna national wealth foundation. BTA Bank offers three options for its creditors in the preliminary restructuring plan. The first option is to repurchase the debt for a cash equivalent with discount. For this purpose, the bank is planning to spend $1 billion and involve 50% of its credit base. The second option is medium and long-term prolongation of the debt under a lower interest rate. BTA management believes that 35% of its credit base will be involved in this alternative. The third option is to convert the debt into bank’s stocks. It is expected that this option will involve about 20% of loans. Ad notam, total debt of the bank is about $13 billion.

BTA is at the preliminary phase of negotiations with debt holders and the Financial Supervision Agency instructed to sign the agreement on restructuring parameters with them by September 18. Alliance Bank already signed the appropriate document with foreign investors, already approved by FSA. In accordance with the memorandum, the bank’s creditors will be offered five restructuring options. The first one is to repurchase debt for cash with 77.5% discount. At the same time, the minimum debt, to be paid off by the bank, will be $1.85 billion.

The second option assumes a 7-year prolongation of debt with 50% discount on lowered interest rate in the size of 5.8% per year and depreciation of the principal amount after the end of a 4-year grace period. The third option is 10-year prolongation without discount and with depreciation of principal amount after a 7-year grace period. A lower 4.7% interest rate per year will be applied during grace period: 2% per year will be paid by cash and 2.7% per year will be capitalized until the end of seventh year.

The fourth option covers the entire subordinated debt of the bank. It assumes a 13-year prolongation without discount, including depreciation of principal amount after a 10-year grace period. A lower 5% interest rate per year will be applied in the first 10 years. Principal debt and capitalization amount will be paid during the next three years at 10% per year.

The last fifth option assumes the allocation of 33% of preference and common stocks among the creditors, which selected 2-5 options. The conversion into preference stocks on "senior" borrowings will be processed with 75% discount while the conversion on Eurobonds will be processed with 80% discount. At the same time, the dividend rate on preference stocks will reach 4% per year.

Expecting new default

After the announcement of the major restructuring parameters of BTA Bank and Alliance Bank liabilities Standard & Poor’s and Moody’s international rating agencies published updated reports on the banking sector of Kazakhstan. Unlike in the previous reports, they gave much less optimistic overviews. Thus, S&P changed the estimate of the countries risk of the Kazakhstani banking system (BICRA) and moved the republic from group 8 to group 9.

According to Ekaterina Trofimova, the Deputy Director of the Financial institutions group, the Paris office of S&P, the change of BICRA value reflects fundamental, "chronic" (not temporary, but purely cyclical) character of the banking system indicators’ deterioration as well as insufficiency of applied measures on banks’ recapitalization. "Given the world financial crisis and the poor regulation and supervision system, these negative factors have become evident since August of 2007. The problems became even more evident after the recent default of these two strategic banks in Kazakhstan".

S&P forecasts that the restoration of the domestic banking sector will be "long and painful", especially where there is a need for further alleviation of the debt burden of banks, corporations and individuals".

According to Ms. Trofimova, "in the next 12 months the level of problem loans may approach a range bordering our long term estimate of gross problem assets that reaches 35-50% (in the percentage of gross volume of private sector loans)". Moreover, the agency also assumes that in the next few months the number of banks, facing default or forced to restructure debt, may increase in Kazakhstan.

It has to be mentioned that, according to Standard & Poor’s, the BICRA estimate reflects the strong and weak sides of the domestic banking system in comparison to the banking systems of other states while the strongest are listed in group 1 and weakest form group 10. Today, such countries as Belarus, Azerbaijan and Georgia are listed in group 9 along with Kazakhstan.

Moody’s rating agency also has a negative forecast on the banking system development in Kazakhstan. Its analysts say that negative figures reflect the deteriorating quality of assets, lower income and weak capitalization of second-tier banks. At the same time, they forecast that funding conditions for Kazakhstani banks in short and medium terms will remain "unfavorable because refinancing in the international capital markets is unlikely".

According to the report, the negative forecast also reflects expectations of Moody’s with regards to fundamental credit conditions in the industrial sector of the republic in the next 12-18 months. The agency believes that the banking system will remain one of the sectors of economy, very exposed to crisis. Among the weakest sides of our banking system Moody’s points out its dependence on international capital markets, excessive participation in the construction sector, weak corporate governance and weak control by the regulating authority in the conditions of a non-diversified economy.

In the opinion of Moody’s, this has resulted in the default of three large Kazakhstani financial institutions: BTA Bank, Alliance Bank and Astana-Finance. At the same time, the agency analysts suppose that Kazakhstan still expects the worst case scenario in the future and, therefore, there might be other default bankruptcy cases. There is also a probability that the role of banks with foreign participation will intensify in the financial system of Kazakhstan.

In concern with losses and the absence of the opportunity of systematic support, Moody’s lowered the ratings of senior unsecured debt from Ca to C for three Kazakhstani second-tier banks – BTA Bank, Alliance Bank and Temirbank. At the same time, the agency confirmed their deposit ranking in the local and foreign currencies at Caa3. The rating of financial sustainability and the rating of subordinated debt remained unaltered at E and C respectively. The Moody’s press-release informs that "the forecast on banks’ deposit rating is under consideration while the forecast on other ratings is stable".

According to analysts, the downgrade of the BTA and Alliance rating is reasoned by the losses, incurred by banks, as well as the debt restructuring process. "Moody’s decision to downgrade BTA Bank’s credit surveillance and lower its senior unsecured debt rating from Ca to C reflects big losses and the negative capital of the bank. BTA Bank is planning to restructure its market debt. As per BTA management estimates, the losses, to be incurred by the investors in this case, will reach over 50% of their investment in the bank".

Speaking of Alliance Bank, the downgrade of the credit surveillance of this bank as well as the lowered rating of senior unsecured debt were reasoned by the agency due to significant losses, incurred last year, that led to the negative owned capital of the bank at $2.9 billion (at the end of May, 2009). "The bank is restructuring its debt. Based on the options, offered to the creditors, the investors’ losses may exceed 50% of their investment volume", the analysts say.

Regarding Temirbank Moody’s says that the downgrade of its rating is related to a weaker financial strength rating in E category as well as the downgrade of parent BTA Bank’s ranks. As in the case with BTA, the rating of senior unsecured debt of Temirbank does not assume the possibility of systematic support through the BTA Bank. At the same time, the agency expects that "in order to support the stability of the banking sector the Kazakhstani government may offer some support to bank’s depositors".

Risks are growing

The domestic experts are no less pessimistic about the situation in the banking sector. In the opinion of Kanat Berentayev, the Chief Research fellow of the Institute of world economy and politics under the Foundation of the first President, the problems, faced by BTA Bank today, became the consequence of a number of negative factors and, first of all, selective policy of monetary authorities in relation to second-tier banks. "Thus, BTA used to be considered as one of the best private banks in the post-Soviet area that ran operations in a few countries of CIS, including Russia. It was one of the strategic banks that, according to Mukhtar Ablyazov, could independently manage the repayment of its external debt and did not need governmental assistance". Nonetheless, National Bank and FSA decided that bank’s operations do not meet the requirements of the regulating bodies and they forced the nationalization of the bank. At the same time, "unreasoned loyalty" was demonstrated in relation to other banks that faced similar or worse problems. In this concern, the expert says, "one can assume that governmental actions had other motivating factors, for instance, basic reallocation of property to the benefit of certain groups or powerhouses".

Mr. Berentayev underlines that these actions seriously affected the business reputation of the bank. Immediately after the nationalization we have witnessed a mass outflow of depositors, both in Kazakhstan and abroad. This substantially weakened the position of the bank.

The expert notes that another negative factor not always considered and expressed by the intentions of decision-makers. "Thus, the statement of Kayrat Kelimbetov, the Head of Samryk-Kazyna NWF, saying that the government starts negotiation on restructuring the external debt of the banking sector, immediately brought into challenge the capability of our banks to meet their liabilities on servicing external debt".

Therefore, Kanat Berentayev is affirmed that the demand of two creditors on early repayment of debt can be interpreted as "the first Portent" and there is a possibility that other debt holders will also try to follow their example. "In this case the bankruptcy of BTA Bank is not the solution since it is a de facto state owned bank. Hence, the government must pay its debts as the owner. It is essential that the repayment of debt will be carried out at our expense since it will mandatorily use either state budget funds or National foundation funds". The expert also believes that in case the court’s decision is not executed, the debt holders will attempt to arrest governmental accounts abroad or National Foundation funds. "Considering that the total volume of BTA Bank’s external debt reaches about $13 billion and the debt holder may demand its early repayment with the consideration of foregone earnings (and this is 20 or more billion US dollars), we face a threatening situation", he emphasized.

However, the Bank’s management is full of optimism and does not exclude the possibility of selling BTA to Sberbank of Russia. Thus, at the meeting with journalists on July 25, 2009 Anvar Saydenov, the President of JSC BTA Bank, expressed a high possibility for signing a deal that would enable Sberbank to buy a stake in BTA. "We have a normal situation around the negotiations. We have established a working group, representing both BTA Bank and Sberbank and are exchanging information".

At the same time, many analysts believe that final decision of Sberbank on the purchase of BTA will mainly depend on the success of bank’s external liabilities restructuring. At the same time, the probability of bankruptcy is estimated as "50/50".

Numbers speak

In her turn, at the press-conference on August 12 Elena Bakhmutova, the Head of FSA, named the situation in the banking sector not critical, but unstable. She made this unfavorable conclusion, based on the aggregated index of financial strength (AIFS), developed by the agency. According to her, the negative influence on the index is majorly caused by the situation in BTA Bank and Alliance Bank.

"Analyzing the situation, on January 1 of this year the AIFS indicator was equal to 2.6. Our methodology says that this characterized the banking industry as satisfactory with an excessively high risk level. Analyzing the situation in the first half of the year, the index fell down to 3.4. This indicator shows the situation in the banking industry as unstable, but not yet critical".

As of July 1, the share of standard loans in the structure of banks’ loan portfolio fell from 43.3% (at the beginning of this year) to 31.7% while the share of bad loans, vice versa, increased from 4.4% to 22.8%. The analysts forecast that this is not the limit and the quality of domestic second-tier banks will continue to deteriorate.

FSA official statistics does not produce optimism either. It properly demonstrates huge losses, incurred by state-controlled banks. Only in June, BTA, largest by the assets size, lost 92.6 billion tenge, as a result of which this indicator dropped by 3.5% to 2,566 billion tenge. Kazkommertsbank is no better-off and in the first month of the summer its size of assets fell by 71.8 billion tenge (2.7%) to 2,546.4 billion tenge. At the same time, the reverse situation is observed at Halyk Bank and ATFBank – their assets grew by 56.9 billion tenge (3%) to 1,976.5 billion tenge and by 42.9 billion tenge (4.2%) to 174.4 billion tenge respectively. Bank CenterCredit, the last one in the top five, demonstrated a growth of assets by 18.2 billion tenge (1.9%) to 966.3 billion tenge.

In June the negative owned capital of BTA and Alliance dropped down by another 105.3 billion tenge and 50.1 billion tenge respectively, reaching minus 890.3 billion tenge and 488.1 billion tenge. One can also consider the capital loss of Temirbank that reduced from 3.8 billion tenge to 21.9 billion tenge. As a result, they also affected the total result of the banking sector, whose aggregated owned capital fell from minus 227 billion tenge to minus 376.6 billion tenge within a month.

Therefore, the positions in the top five leader by the volume of own capital have gone through serious changes. The first place is held by Kazkommertsbank with 254.5 billion tenge, although it lost 2.5% in June. The second place goes to Halyk Bank with 222 billion tenge (+0.3%). Then there is Bank CenterCredit – 91.7 billion tenge (+2.7%), ATFBank – 90.4 billion tenge (-1.1%) and Nurbank – 43.7 billion tenge (-1.4%).

The biggest losses were also incurred by BTA Bank, Alliance Bank and Temirbank – 1,518.4 billion tenge, 645.3 billion tenge and 27.8 billion tenge respectively. Overall, this is 2,191.5 billion tenge or $14.6 billion. At the same time, in June the losses of BTA Bank, Alliance Bank and Temirbank increased by 105.3 billion tenge (7.5%), 50.2 billion tenge (8.4%) and 3.9 billion tenge (16.3%) respectively. Overall, these three banks lost 159.4 billion tenge in June, i.e. over $1 billion. The top five of unprofitable banks also includes Halyk Bank and ATFBank, whose losses reached 13.3 billion tenge and 2 billion tenge respectively.

The profit leaders became Bank CenterCredit (4.4 billion tenge), Citibank Kazakhstan (4.3 billion tenge), Kaspi Bank (2.9 billion tenge) Tsesnabank (1.8 billion tenge) and subsidiary Alfa Bank (1 billion tenge).

Speaking of the retail deposit base of the banks, Halyk Bank still holds a leading position. In June the deposit of individuals in Halyk Bank increased by 0.05% to 369.6 billion tenge. The second place is held by Kazkommertsbank with almost 1% growth to 307.1 billion tenge. Bank CenterCredit came third – plus 2.6% to 234.9 billion tenge. BTA Bank, holding fourth place, faced the reduction of its deposit base by 0.7% to 172 billion tenge. The last of the top five is ATFBank, which faced the increase of deposit base by 4.1% to 156.8 billion tenge.

By the volume of corporate deposits the leader is Kazkommertsbank that demonstrated the reduction by 4.3% to 1,567.4 billion tenge. The corporate clients’ deposits in BTA Bank fell by only 0.1% to 1,297.8 billion tenge. Third place is held by Halyk Bank whose indicator grew by 7.2% to 952 billion tenge within a month. The volume of corporate deposits also increased in Alliance Bank by 0.1% to 479.6 billion tenge. Bank CenterCredit, the last one in the top five, also showed the growth of corporate deposits by 1.4% to 399.5 billion tenge.