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Expert Opinion

04.01.2013

What is making foreigners to sell Ukrainian banks for $1?

Ukrainian banks had a rough year in 2012. With the year coming to a close, it is an opportune time to look back at the main causes and examine the prospects in 2013 and beyond.

High macroeconomic uncertainties,devaluation expectations, and administrative regulation, as well as a lack of creditworthyborrowers are the complex of factors that characterized the Ukrainian banking sector in 2012. In addition, unfavorable external markets,an inability to attract cheap external financing due tothe European debt crisis and tight domestic monetary policy made Ukrainian banks rely solely on the local, highly-competitive financial market, which pushed funding costs to extremely high levels in 2012.

As a result, the cost of credit to the economy has skyrocketed 30-35% (at zero inflation), totally depressingbanking system lending in 2H12.In 11M12, banks’ total combined loan booksgrew just 2.9% YTD,mainly thanks to corporate lending in hryvniasby state and Russian owned banks, and the few local banks affiliated with large Ukrainian financial groups.Meanwhile,local Western-ownedbankscontinued to clean up their balancesheets, shrinkingassets and searching for potential buyers to exit the Ukrainian market. The large supply of banks of different sizes and portfolios compared to demand led to a considerable decline in the pricesfor banks, which dropped to 0.5x equity – 10x less than in pre-crisis 2006-2007.

However, evenat this level, all ‘for sale’foreign banks have not been able to find a buyer and only five Western banks managed to leave the Ukrainian marketin 2012.

Undoubtedly, the biggest deal in the Ukrainian banking sector in 2012was the sale of Bank Forum from Commerzbank to Ukraine’s Smart-Holding. The volume of the deal was not disclosed, but considering Forum’s distressed assets, I believe, it did not exceed USD 100-200 million, whereasCommerzbank has invested USD 1.0 billion in its Ukrainian daughter over the last five years. The second most important, in my opinion, is the sale of Kreditprompank (owned by a pool of foreign investors) in late December. This transaction is due to be closed within the next month. The buyer turned out to be another Ukrainian businessman,NikolayLagun (the owner of Delta Bank), for the symbolic amount of $1. Sweden’sSEB bank and Austria’sErste have also managed to sell their daughters to AlexandrAdarych who plans to mergethesetwo banksnext year.

Other banks that have announced plans to leave the Ukrainian market have been Swedbank (a member ofSwedbank Group) and Universal Bank (of Greece’sEuroBank). The main suitors, according to Ukrainian media, are still the aforementioned NikolayLagun andAlexandrAdarych, as well as Russia’s Alfa Bank. The list of potential banks for sale is definitely longer than the list of potential bidders, which, in my view, is evidence consolidation in the banking sector is far from complete. Thus, 2013 is likely to be anotheryear of large buyouts and foreign bank exits.

Looking at this situation,for me, the main question is: what is scaring foreign investors in Ukraine so much that they are running away, literally at any cost?

Let’s look back at the situation a few years ago. The rapid growth in the global economy in 2004-2006 led many foreign investors to look at new growth markets. At the same time, the triumph of democracy in Ukraine’s Orange Revolution and declaration of Europe’sdevelopmentinitiative considerably increased the attractiveness of Ukraine as a large and unpenetrated market. The mass entrance of foreign banks into Ukraine and the injection of cheap external funding stimulated an unprecedented credit boom in 2006-2008 viacheap FX loans.

However, the global financial crisis and the more than 60% devaluation of Ukraine’s national currency in 2008 resulted in dramatic growth in non-performing loans and the needfor additional capital. At the same time, there remained weak protection of creditor rights due to inadequate legislation and completely different ‘rules of the game’ comparedto matured markets. The escalation of the European debt crisis in 2011-2012 and limited ability of European banks to support their unprofitable foreign subsidiaries have forced manyof them to review their international strategies. In short, the situation has completely changed. At a same time, high macroeconomic uncertainties, the faded prospects for the Ukrainian banking sector and the recent deterioration in Ukrainian democracy have put Ukraine atop many of their lists for exit.

Here is another question: is the decision to leave the Ukraine at any cost right or wrong?

In my opinion, credit activity in Ukraine will remain muted at least for the next few years,whilethe Ukrainian economy will continue to deleverage, followingthe rapid growth in loan portfolios of 2006-2008. The lending boom of 2006-2008definitelymade a material impact on theUkrainian economy but perhaps it was a case of too fast, too soon.

Ukraine’s loans-to-GDP ratio (reflecting the level of credit penetration in the economy) rose from 35% to 75% within just three years (2006-2008), slightly declining to 60% by the end of 2011. As an example, the loans-to-GDP ratioof our closest peers in the CISare 43% for Russia, 28% for Azerbaijan and 33% for Kazakhstan. In my view, this is evidence that Ukraine needs at least another couple of years to restore the relative balance, while Ukrainian banks can able to rely only on very modest growth in core revenuesto just cover increases in their operating expenses.

In 10M12, Ukrainian banks’ combined bottom line amounted to UAH 4.0bln. However, the improvement in sector profitability was achieved mainly due to a decrease in the cost of risk rather than growth in core revenues, which looks very sensitive in the current economic environment. The share of FX loansin banks’total loan portfolios is still over 35%, while open short positionsin FX amounts to USD 7.5 bln. Thus, UAH devaluation even by 10% will cause new losses, puttingadditional capital increaseson the agendas of bank shareholders.High administrative pressure and ad hoc monetary regulation are two more obstacles for Ukrainian banks, making the operating environmentextremely difficult and unpredictable, even for local players, and completely non-transparent and not-understandable for foreigners. So we can hardly blame them for getting out as soon as they get an opportunity chance – any reasonable opportunity.

Svetlana Rekrut
Начальник отдела финансовых проектов

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