Fresh back from Moscow, Jeremy Shaw, head of trade services for Europe, Middle East & Africa, at JP Morgan is fairly upbeat about the viability of the Russian banking sector, and the potential for working on trade finance transactions with them.
“The Russian banks have handled this crisis far better than the crisis in the late 1990s, and the general feeling is that the central bank has acted in a much more coordinated fashion,” he argues.
“From my conversations with the banks, when liquidity was tight earlier in the year, they had clear action plans on how to preserve existing business. Many pre-paid loans outstanding early and kept significantly amounts of cash on their own balance sheet.”
The Russian government has been frantically pumping money into its economy and financial system since the crisis hit, and state financial aid is equal to 14% of GDP, one of the highest rates in the world, according to statistics from UralSib Bank.
Half of the pledged money, equal to around Rb3tn (US$104bn), has already been placed, with Rb750bn (US$26bn) pumped into certain banks, the most prominent recipients being Sberbank and VTB Bank.
Following this large-scale support programme, JP Morgan’s Shaw observes some tentative signs of recovery in the banking sector, and the Russian banks echo this observation. “In the first half of the year, we were not actively looking for new risks. But now with liquidity restored, we are looking for new opportunities,” comments Dmitri Lebedev, head of trade finance at UralSib.
Remarking on the wider banking sector, Oleg Viyugin, chairman of the board of directors at MDM Bank, tells GTR: “I believe we will see positive improvements in Q2 2010.”
Olga Strekalova, director, trade finance and forfaiting at VTB Bank, sees foreign banks dipping their toes back into the Russian market.
“In the last couple of months the risk departments of foreign banks have been unfreezing their lines and looking at bigger tenors,” she observes.
Evidence of a revival in foreign banks’ appetite for Russian bank risk was perhaps demonstrated by MDM’s recent syndicated trade-related loan closed in October. The facility was well-received by the market, with the US$175mn portion of the dual-tranche loan being oversubscribed and closed at US$250mn. It was priced at 4%.
The loan potentially heralded the reopening of the international bank market to Russian banks as it was the first of its kind to be launched by a private Russian bank since the crisis hit. However, this loan was part of an A/B loan with the IFC, which perhaps made it a safer deal to participate in.
Although the banking sector is now far more liquid, Russia is far from full-scale recovery. Banks are now facing another problem in the shape of deterioriating asset quality, and the potentially rising number of non-performing loans (NPLs) hidden in banks’ balance sheets.
“Currently the banks continue to struggle with bad loans. Many try to hide this problem by restructuring and refinancing these bad loans,” oberves Olga Arsentieva, CEO of First Czech-Russian Bank (FCRB), a private Russian bank.
Lebedev at UralSib adds: “Liquidity is now not so much a problem, but the new challenge is the deteriorating quality of loan portfolios on balance sheets.
The Russian real economy is still struggling, and it is the mid-caps and small businesses that are suffering the brunt of the crisis, and either defaulting or showing signs of potential default on loans.
Garegin Tosunyan, president of the Association of Russian Banks (ARB), observes these trends in the real economy, and suggests that banks’ current unwillingness to lend is doing little to fuel recovery.
“Banks have become very strict with their risk assessment, almost overly cautious with their lending. This has had a knock-on effect, with not enough credit being available,” he explains to GTR.
“As a result businesses are shrinking and banks continue accumulating bad debts.”
And, the worse may be yet to come, as UniCredit’s Roberto Lorenzon, executive director, head of global transaction banking, speculates: “Of course the crisis will continue to have an impact in terms of credit quality. We forecast the peak in impaired loans next year.”
These bad debts or NPLs pose a problem for Russian banks, particularly the private banks, looking to do new business, including trade.
As UralSib’s Lebedev explains: “Our new strategy is a half and double strategy, we issue half the number of new loans we would usually, and double the rate or security taken.”
However, some Russian trade finance divisions are finding new means of doing trade business, finding new partners or offering different products.
Crisis grips sector
The financial crisis really hit Russia’s banks in the final quarter of 2008, up until then markets looked buoyant. “2008 was a record year for trade finance at UralSib. The active phase for the bank was last summer, where we had a strong appetite for risk,” comments UralSib’s Lebedev.
“By September 2008, UralSib’s trade finance book reached a record US$2bn,” he adds.
VTB’s Strekalova also reports a successful 2008, with the bank’s trade finance portfolio exceeding US$3bn, marking a 68.5% increase compared to 2007.
But then commodity prices tumbled, foreign banks cut or reduced their credit lines, and the rouble devalued, bringing trade finance markets to a halt.
By the end of 2008, the range of trade instruments being granted was changing. There were no more loosely trade-related loans being closed and letters of credit (LCs) proved more popular due to the lack of working capital financing for corporate customers.
Market difficulties have persisted in 2009, particularly for the non-state-owned banks. For instance, UralSib has closed US$300mn in trade finance business to date (mid-October) for 2009, which is perhaps an average quarterly volume of the pre-crisis era, according to Lebedev.
However, the lower business volumes of the Russian private banks haven’t been shared by the big state-owned banks such as VTB, which are now picking up a lot of the business in Russia, and other CIS countries, that the private and foreign banks can no longer do.
“When the crisis struck, foreign banks became reluctant to take on emerging market risk. Some of them even closed all their trade finance activities in Russia and the CIS,” Strekalova explains.
However, the trade flows within Russia and the CIS persisted, meaning there was still business there to finance. Much of this remaining business has been taken up by VTB, as the bank’s risk was still acceptable to the majority of financial institutions worldwide.
New risk environments
VTB has been able to further capitalise on the increasingly risk averse mindset of foreign banks and secure more business through the use of irrevocable reimbursement undertakings (IRU). The IRUs have not only allowed VTB to support trade finance transactions within Russia, but also those in the CIS.
Through the use of an IRU from VTB, foreign banks, which may have reached capacity on certain country limits or cut lines, were able to continue financing trade flows in the CIS region.
According to Strekalova, the volumes of IRUs VTB is doing is rapidly increasing. The rate of increase in the second quarter of 2009 compared to the first quarter was 34%, and the increase between the second and third quarter was 56.5%.
IRUs are essentially a means for banks to avoid taking risk they don’t want or don’t have limits for. Rather than taking on a more risky bank in Russia or the CIS, they take on the more acceptable VTB risk.
Of course, this IRU option comes at a price, with the transaction now having three banks involved in financing the trade transaction.
But as Strekalova notes: “However during the hard times, an additional 30-40bp can not be an issue”, if the alternative is that the original deal would not actually materialise in the first place, due to lack of risk appetite.
The pricing on such IRU deals works whereby the risk margin on the risky issuing bank is, for example, 350bp, but for various reasons the foreign bank or the confirming bank does not want to do the deal. Under an IRU, the foreign bank takes 80bp, for example, on VTB risk, and VTB takes 300bp on the risk of the riskier bank. The price difference between this method and directly dealing with the CIS bank is matter of tens of basis points – which is perhaps neglible when looking to secure a trade contract.
Other risk mitigating tactics are being used by Russia’s banks. For instance UralSib has been closely working with export credit agencies (ECAs) signing various risk guarantee agreements. This year the bank signed an umbrella US$500mn two-year loan agreement with Korea’s Export Import Bank, Kexim. Under this agreement, Kexim will confirm LCs from UralSib, provide advance payments and other finance instruments in support of exports to Korea.
Additionally, the bank has signed a US$10mn facility with Taiwan’s ECA, is in talks with Chinese agencies, and hopes to close a deal with the Malaysian export-import bank.
Russian banks are beginning to look at opportunities to work with European ECAs as these agencies launch new temporary programmes covering short-term trade risks.
Shifts in pricing
Russian trade finance pricing is still far higher now than compared to pre-crisis days, and one source says it is unlikely to return to the low pricing seen in 2007 and early 2008, rather it will eventually level out at a slightly higher level.
Strekalova at VTB observes that a one-year trade deal a year or so ago would be priced at 30 to 40 basis points, sometimes up to 50bp. “But now pricing on trade deals stands closer to 80-100bp,” she explains.
However, compared to pure corporate lending, Russian trade finance still offers better pricing to the customer.
Working capital loans from Russian banks to corporates are usually charged at 15% interest if financed in dollars and 20% if financed in roubles, according to estimates provided by UralSib’s Lebedev.. These figures compare to 9-13% interest on dollar deals and 14-16% interest on rouble deals before the crisis hit.
Now, despite rising costs, trade finance remains comparatively well-priced, with margins around the 3-4% mark. Pricing on LC discounting is around 3% plus Libor on one-year deals, while it was closer to 1% over Libor in pre-crisis years.
Still in danger zone
Despite some positive noises, headlines in Moscow and around the world continue to highlight the level of bad loans on Russian balance sheets. In October, Moody’s issued a negative outlook for Russian banks, highlighting risks of further instability in the banking system, increased pressure on capitalisation, and deteriorating asset quality.
Yet, on the ground in Moscow, some of the leading Russian names such as MDM note a stabilisation in the level of NPLs on their own books. MDM’s chairman, Viyugin comments: “In the third quarter, there was a very minor increase in NLP volumes and no further deterioration of MDM’s books. The NLP level is starting to stabilise.”
Richard Hainsworth, president of GlobalRating (the parent company of RusRating), sees problem loans on the rise in the final quarter of 2009, but nothing yet beyond “a manageable level of risk”.
He believes that there is no “loan crisis” as such and a rise in problem loans is “expected and natural” during an economic downturn.
“There is stress in the economy that can be seen in the increasing levels of distressed loans held by banks. Turning around the economy is essential for the whole country, not just the banking system,” he explains.
“How long distressed loans will increase is directly related to the length of the economic recession.”
It is also difficult to get a real grasp of the actual level of bad loans afflicting the market, and the extent of the damage done. Whether or banks are being completely clear about the state of their balance sheets is also up for debate.
Arsentieva at FCRB argues: “Traditional methods for assessing banks’ condition are inadequate for outlining their position in the current market.
“It is impossible to determine the actual volume of toxic assets on balance sheets since different banks use different methods for solving their bad loan problems. Some use the active approach and are fast in disclosing the true volume of bad loans whereas others try to hide the real state of affairs.”
She adds: “It is necessary to rethink the way a bank’s condition is analysed because the indicators used before the crisis by the rating agencies have proved to be ineffective.”
She argues that the main indicator should be capital adequacy as it reflects the bank’s ability to cover potential losses, citing that in the current climate, 10%-12% is not enough.
Roman Popov, chairman of FCRB, reports that capital adequacy of FCRB and its Czech subsidiary European-Russian Bank is over 30%.
“We have no irrecoverable loans on our books and for the problem assets we expect to recover 80%-90% of the value by negotiation with the lenders, restructuring or sale of available security,” he says.
Fresh hopes for trade
However, from a trade finance perspective, there is reason to be relatively more optimistic than those in other financial sectors. UniCredit’s Lorenzon remains upbeat: “Trade finance is a business to leverage on quite strongly.
“I do not think that banks will be blocked by the NPL problem in doing business. True, some will be constrained, but for some of the players, with better risk profiles and good access to funding, this will not be an issue.”
Although previously airing concerns over NPLs, UralSib’s Lebedev says that presently his bank’s NPL level is not yet cause for concern.
“The capital adequacy of the bank is 14-15%, which is sufficient for now but the bank will look to take further capital enforcement measures so as to be able to absorb further deterioration of loan quality.”
He adds that UralSib’s loan book did deteriorate, but not as badly compared to banks with aggressive retail express loan services. The bank’s NLP rate was 3.5-3.7% in June 2009 and increased to 5-6% by the end of 2008.
“It now stands at 8-9% which is not critical, but a matter for concern.”
What will be important to watch is whether banks will generate enough revenue to create adequate provisions to cover a potentially rising level of NPLs. Trade finance business could be a way of securing those revenues.
As JP Morgan’s Shaw remarks: “Generally [trade finance] volumes are down, without a doubt – but we have to position ourselves for growth. Russia will start to grow again in 2010, and we have to be ready for that.”