Halyk Bank announced on Wednesday it had paid KZT185bn (US$560mn) for 96.8% of the shares in Kazkommertsbank (KKB), the country’s second-largest lender. The news is particularly encouraging amid the ongoing debt restructuring of defaulted state-owned lender International Bank of Azerbaijan and growing concerns about the banking sectors’ health across the region.
The new combined bank’s total assets will be equal to US$30bn, which, according to ING, puts it in 7th place among CIS bank ranked by assets, and to 3rd among privately-owned banks in CIS. The new entity will control nearly 38% of Kazakh’s banking sector assets, 29.1% of the sector’s customer loans, 37.7% of retail deposits and 34% of corporate deposits. The closing of the transaction is currently expected to take place in 3Q17.
The general outlook on Kazakhstan’s economy remains positive. The European Bank for Reconstruction and Development (EBRD) has forecast the country’s economy to grow 2.4% in 2017, a significant improvement from the modest 1% growth recorded last year. But its troubled financial system could prove to be a hindrance on the country’s positive economic momentum.
The deal is also expected to boost the country’s debt markets. ING analyst Dmitry Polevoy wrote in a brief that the announced merger will bring fundamental reasons for improving the credit quality of KKB and its outstanding Eurobonds.
“We think that the spread between KKB 5 1/2 12/21/22 and HSBKKZ 7 1/4 01/28/21 will decline to around 50bp, as was in the case with Bank of Moscow and VTB. The current spread at 175bp looks attractive,” the analyst noted.
Bad Loans Rising
Kazakh banks have been struggling since the 2008 financial crisis, mostly due to weak balance sheets and surging non-performing loans, coupled with years of low oil prices, the country’s main export. The situation has become so delicate that policymakers fear the collapse of the country’s largest financial institutions could trigger a chain reaction that could precipitate a full-blown financial crisis.
According to official data, around 12% of the US$80bn assets held by Kazakh banks are non-performing loans, while Moody’s research suggests up to one-third of the loans on banks’ balance sheets are “distressed.”
KKB has suffered in recent years after overextending its balance sheet to troubled corporates and other financial institutions including BTA, a former bank turned distressed asset manager, where half of the lender's assets are tied up – approximately US$15.7bn. Today, around 50% of KKB’s loan portfolio is made up of toxic loans.
A possible failure at KKB could cause havoc in the country’s financial system, which the government seems determined to avoid.
Under the terms of the deal, a state-linked Fund of Problem Loans will back repayments of the loan by BTA Bank to Kazkommertsbank at an amount of up to KZT2.4tn, while a stabilisation loan provided by the National Bank of the Republic of Kazakhstan to KKB will be partly repaid due to proceeds.
Furthermore, Halyk Bank will recapitalise Kazkommertsbank by KZT185bn using own sources, and NPL coverage ratio of KKB will be increased to adequate levels, with the bank’s CET1 ratio planned to exceed 19.9% as at the end of May 2017.
Earlier the Kazakh government announced it will allocate more than KZT500bn (US$1.52bn) to support the nation's banking system.
For Clemente Capello, Chief Investment Officer at Sturgeon Capital, this deal should not be mistaken for a full-blown bailout.
“State money has played a role as a backer rather than as an actor, which is probably for the best,” Capello said.
The marriage of KKB and Halyk may be the most significant deal yet, but there may be more in the pipeline. A merger between Tsesnabank and BankCenterCredit, said to be in the works, would create the country’s second-largest lender after Halyk-Kazkommertsbank. Capital Bank and Tengri Bank, two smaller banks, also signed a memorandum of intention to merge, with a deal likely to be finalised next year.
A Long-term Solution?
The government, following the advice of the IMF, believes that solidifying the country’s financial system is the best way to avert a possible crisis, although some analysts warn that more government involvement may be needed to maintain stability in the banking system.
“We consider the announced transaction as a crucial step for the rehabilitation of Kazakhstan’s banking sector, which is mitigated by the “too-big-to-fail” risk of Kazkommertsbank and it removes a huge system risk in Kazakh’s banking sector,” wrote Polevoy.
But another analyst, Egor Fedorov, earlier warned that the longer-term outlook is still unclear.
“The mergers will help stabilize the economy, for now, however in the long run, it will depend on different factors,” Fedorov explained.
The government will need to accompany these mergers with new regulatory measures aimed at deepening monitoring of the financial system and improving the health of banks’ capital, if it is to succeed in stabilizing the financial system in the long run.
Still, the ING note further indicated that Kazakhstan’s state support makes an important statement to international investors amid growing concerns over other major banks in the region, namely the International Bank of Azerbaijan (IBA), which announced debt restructuring in May.
The IBA intends to write down the principal on some senior notes by 20% and swap debt for sovereign bonds following a painful currency crisis. Creditors holding more than 87% of the Azeri state-lender’s debt affected by the proposal have voted in favour of a restructuring, a day before the deadline, in what Baku would consider a major win.
Another neighbour, Uzbekistan, recently received a boost from Fitch ratings agency, which reaffirmed the IDRs of four of the country’s major banks, including of Uzbek Industrial and Construction Bank Joint-Stock Commercial Bank (Uzpromstroybank), Asaka Bank, OJSC Agrobank and Microcreditbank's at 'B+', with a stable outlook. The agency praised the state's “currently solid” ability to provide support, due to the moderate size of the banking sector relative to the Uzbek economy.
But Fitch also warned that banking sector remains concentrated and support-dependent and pointed to the economy's structural weaknesses, as Uzbek exports are commodities-driven and concentrated on a few countries, and external finances are heavily supported by remittances.
And these anxieties to a greater or lesser extent can be applied to other CIS states, bound by strong economic and financial ties with each other and with Russia, which is carrying out its own banking sector consolidation, and has seen a number of major lenders, including the recent case of Yugra Bank, go into administration.
Until deeper, more structural reforms of the banking sector are carried out across the region to secure a long-term solution for the financial system, the industry will continue to rely on state support – and as such remain vulnerable to spikes in volatility traditionally impacting these economies, such as swings in commodity prices and political uncertainty.