Russian Banks: Autumn Might Not Be That Bad

Dmitry Dmitriev, Head of Financial Institutions, Consumer Goods and Services / VTB Capital

Mikhail Shlemov, Analyst, Financials, Banking Sector / VTB Capital

The Russian banking sector is seeing significant growth in NPLs, but at only 4.6 percent, we think that they are still far from their peak (which we expect in 2010, as loan books keep maturing). We expect NPLs under IFRS to peak at 15 percent in 2010, although ultimate credit losses are likely to be much less, at around 9 percent of loan books. With a number of loans falling due in the second half of this year, the market consensus is that a second wave of the crisis will hit banks this autumn. However, we argue that the second wave could be significantly smoothed as aggressive restructuring and falling interest rates will enable companies to service their debts. Moreover, government efforts to restart lending might begin to bear fruit in the autumn, as the state guarantees scheme is re-launched with 500 billion rubles of new lending to be distributed by state banks under the program. Even on the statistics front, we are starting to see some glimmers of hope for the sector: recent statistics have suggested that assets have stopped shrinking as the banks are returning expensive CBR funding ahead of schedule (while loan books seem to be stabilizing). At the same time, following the CBR’s moves to cut the refinancing rate, interest rates have started to drop. This, coupled with the huge wave of restructuring (15 percent of loan books have already been restructured and we expect this to reach 25 percent by the end of the year), might in our view partially smooth the effect of the second wave of the crisis, allowing companies to refinance at lower rates, and provide the conditions for the economy to bottom out. Bad debts, with the seizure of collateral, currently represent a great challenge to the sector. As a result of borrowers defaulting on loans, banks are taking a lot of non-core assets on to their balance sheets, threatening capital adequacy ratios and requiring fresh capital.

Under our 20 percent provisions scenario, we anticipate that the sector will require RUB 1tn of recapitalization (which is only 2.4 percent of GDP). Based on the government’s proposed recapitalization plan via preferred shares and OFZs for the top 60 banks (60 percent of banking sector assets) in addition to funds readily available for Sberbank, in case of need, and VTB’s recapitalization, we consider the funds allocated by the government to be adequate under this scenario. At the same time, we are reiterating our view that a mechanism needs to be provided to banks for them to dispose of the bad and non-core assets that are currently accumulating on their balance sheets, i.e. the so-called “bad bank.” As non-core assets and bad debts require a higher capital reservation allocation than core banking balance sheet items such as current loans and securities, the mounting number of such assets will pressure capital adequacy ratios back to earth.

That said, we are more constructive (though still cautious) on Russian banks as we now believe that the catastrophic scenario has been avoided and that the second wave of the crisis will be smoothened. And while it is certainly too early to claim that banks are out of the woods, they are definitely doing their homework with both operational changes and close work with clients to collect debt and/or work on restructuring.