Credit Turnaround: the Much-Needed Catalyst for Russian Banks

Cristina Marzea
Co-Head of EEMEA Financials Research
BofA Merrill Lynch

Following less-than-stellar performance in the first half of 2010, Russian banks seemed to have lost the appeal they had in the second half of 2009, being mostly a story of provision releases in 2011-12. This case still stands — in our view — that Russian banks are more than adequately provisioned at the moment with upward of 100 percent nonperforming loan coverage. Gradual provision releases would be a major driver for earnings in the coming two years. However, in the shorter term there is more reason to be enthusiastic about the sector, as we are finally seeing a firm recovery in lending volumes along with signs of rates on new lending stabilizing. According to the Central Bank, in May, Russian corporate lending increased by 1.9 percent month on month, followed by retail at 1.2 percent month on month. While some growth was already delivered in April, even March for the retail sector, it is only now that we see credit to real economy turning positive in the year-to-date. In June, growth continued, so we believe that we are seeing a sustainable trend, making us more optimistic on our 10 percent lending forecast for 2010. The Central Bank sees total lending growth at 10 percent to 15 percent.

Margin deterioration has been another factor strongly weighing on profitability. Unfortunately, we are due to see declining margins at least until the third quarter of 2010, but the rates on new lending seem to have stabilized, according to banks’ management and anecdotal evidence. With lending rates at 9 percent to 10 percent for the top-tier corporates and as low as 6 percent to 7 percent for regional administrations, banks would struggle to cover their funding costs. Retail deposit rates could serve as a leading indicator — already in June we recorded the average maximum deposit rate for the top-10 banks up for the first time since July 2009. Since then the deposit rate has declined from 15 percent to 9.2 percent.

Ivan Bokhmat
EEMEA Financials Analyst
BofA Merrill Lynch

Another reason to be positive about Russia is the situation on Central and East European (CEE) markets. While the region’s economies are among the most exposed to EU fiscal tightening risks, the banks may suffer from regulation and tax uncertainty — Hungary, Poland and Romania are considering special bank taxes. In addition, Poland’s two biggest banks, PKO BP and Pekao, are involved in merger and acquisition domestic consolidation talks that may lead to share overhang because of the need to issue additional capital. Finally, CEE valuations have been extremely resilient to correction in the second quarter of 2010, leaving stocks at a 10 percent premium to Emerging Europe, Middle East and Africa peers on 2011 price/book value.

All these factors make Russian banks our preferred region in our EEMEA coverage, benefiting from both improvement in fundamentals and relative valuations. Sberbank remains our top pick — a unique combination of strong margins and operating profitability, rapidly improving return on equity (more than 20 percent delivered in the first quarter already) and, we believe, sustainable performance on the back of an exceptionally strong franchise.