Research Alert

Fixed Income Kazakhstan

Credit update Fixed Income Research 13 April 2012

Mikhail Nikitin +7 (495) 258-7789

Research Alert

Alliance Bank An alternative history

Two years after debt restructuring, Alliance Bank has reported positive equity. Alliance’s balance
sheet capital is now above zero ($7mn at YE11), based on its consolidated results released on 11 April. Even though this achievement is largely of psychological importance, we think it is also credit-supportive evidence of the progress that Alliance has made in terms of financial and operational restructuring.

Alliance’s performance in 2011 is far from a success story; still, we think ‘not being like BTA’ qualifies as an achievement in itself. In our view, Alliance clearly looks favourable in comparison with BTA Bank –
an entity that completed its initial debt restructuring in 2010 (several months later than Alliance) and defaulted again in January on essentially all its debt. To be sure, Alliance and BTA are not entirely comparable given the difference in size and nature of their legacy non-performing assets. However, we see a number of reasons to consider Alliance’s credit as at least not having too much in common with that of BTA and the recovery process at Alliance as more consistent and potentially successful. 1. The good/bad bank segregation shows business is alive: Alliance’s loan portfolio was split between the “good” and the “bad” parts roughly in 45/55 proportion at YE11. According to management data, the difference in loan loss provisions between the two parts is enormous – 6% for “good bank” loans and 76% for the “bad bank” loans. IFRS-based consolidation only gives us the combined picture: 55% of total loans reported as 90+ day NPLs at YE11. This is an improvement compared with 67% at YE10, but we think it was driven by de-recognition of about $320mn of “bad bank” consumer loans sold to collector agencies in 2H11. More important, in our view, is the 70% YoY growth in the retail segment, mostly in consumer loans that exceeded $500mn (about one-third of the “good bank” assets) at YE11. The bottom line can be misleading but the bank’s operating performance certainly has improved: High effective margins (around 18%) of the consumer lending segment support Alliance’s margins on a consolidated basis. Net interest income increased 135%, NIM increased from 1.1% to 2.3% in 2011, and – in contrast with BTA – accrued interest revenues are adequately matched with cash flows. Non-interest operating profit was significantly distorted by non-cash and one-off items, however. After adjustments for the reversal of dividends on preferred shares, gains from repurchases of its own bonds and recovery of impairment losses related to the loans sold, Alliance would report a pre-tax loss for 2011. Breakeven in terms of capital is mostly due to technical factors: The same items that affected the bank’s P&L helped pull its capital back to positive values. In fact, the combined effect of the disposal of non-performing consumer loans, recovery of provisions, decrease in the liability component of preferred shares (as a result of a reduction in the minimum guaranteed dividend) and deferred tax benefit almost equals the YE10 equity deficit. None of these factors are sustainable, in our view, and it does not add much in terms of Alliance’s recovery potential. Liquidity depends on repo, but at least the carry is not as destructive for margins as in BTA: Alliance received about $380mn under repo agreements collateralised by Samruk-Kazyna and MinFin bonds. Repo has been required to cover the bank’s liquidity needs despite the healthy 47% deposit growth during 2011. Alliance’s loan-to-deposit ratio was above 2x at YE11, so the bank remains dependent on repo funding and we think this dependence is unlikely to decrease should loan origination volumes increase as planned in 2012. At the same time, interest expense on the repo ($27mn for 2011) was only 8% of interest income for 2011 vs. 20% at BTA. Alliance’s cash position was sufficient for bond repurchases in 2011, but it could be less comfortable for debt redemptions starting in 2014: The bank used available cash to repurchase its own bonds from the market – again, unlike BTA. The amount of debt that Alliance repurchased during 2011 is about $90mn; the resulting gain is about $25mn. Significant debt redemptions will begin for Alliance in 2014 with amortisation of the senior bonds. There is no pressure from the repayment schedule over the next 1.5-2.0 years, but beyond this period it becomes less favourable, assuming $104mn in redemptions of principal only in 2014, then $207mn in 2015 and 2016. Given the bank’s still relatively weak cash-generation capacity to date, we do not see how Alliance would solve the refinancing issue without external support.

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In the medium term, we think the risk of Alliance defaulting again will remain a function of state involvement; however, we see no reason or incentive for Kazakh financial authorities to make it another failure. On the
contrary, Alliance could be a counter-example to the perceived weakness of post-crisis governance in the Kazakh banking sector, particularly if and when Alliance merges with Temirbank and/or sells out to an external investor. From a risk-return perspective, Alliance’s senior bond trading at 16% YtM and above (duration 3.8) looks attractive, in our view.

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Renaissance Capital

Alliance Bank

13 April 2012

Figure 1: Alliance Bank consolidated balance sheet data, KZTbn Cash and cash equivalents Trading securities Gross loans - Provisions Available-for-sale securities incl Samruk-Kazyna bonds Property, equipment, and intangible assets Deferred tax asset Other assets TOTAL ASSETS Current accounts and deposits from customers Retail deposits Corporate deposits incl Samruk-Kazyna Loans from the Government of Kazakhstan Amounts subject to Restructuring Plan Debt securities issued Subordinated debt Amounts payable under repo agreements Other liabilities TOTAL LIABILITIES EQUITY TOTAL LIABILITIES AND DEFICIT 2009 18.1 17.9 697.9 -454.2 97.7 96.2 25.0 0.0 18.2 419.1 153.8 51.6 102.2 70.4 22.6 734.2 0.0 0.0 5.0 29.2 944.9 -525.8 419.1 2010 19.7 33.2 622.2 -370.4 102.2 90.7 23.1 0.0 9.0 427.6 208.8 76.9 131.9 60.6 18.7 0.0 149.6 84.4 59.6 11.5 532.6 -105.0 427.6 2011 16.7 20.1 622.8 -294.0 115.8 97.1 22.2 17.9 8.4 529.9 294.2 112.9 181.4 69.3 22.4 0.0 128.0 20.7 56.9 6.6 528.9 1.0 529.9

Source: Company data, Renaissance Capital estimates

Figure 2: Alliance Bank consolidated P&L statement, KZTbn Interest income Interest expense NET INTEREST INCOME Fee and commission income Fee and commission expense Net gain/(loss) on trading securities Net FX gains/(losses) Gain from restructuring Net gain from recovery notes Net gain on repurchase of liabilities Other operating gain/loss OPERATING INCOME (LOSS) Reversals of (provision for) impairment losses General administrative expenses Profit/(loss) before income tax Income tax expense NET PROFIT 2009 85.2 -81.5 3.6 7.5 -0.5 -64.4 -51.8 0.0 0.0 4.0 -1.0 -102.7 -174.8 -20.9 -298.4 0.0 -298.4 2010 44.4 -40.0 4.4 4.5 -0.4 2.3 16.4 324.7 2.1 0.0 -1.3 352.7 4.5 -22.7 334.4 0.0 334.4 2011 49.6 -39.2 10.3 4.6 -0.3 0.8 -0.3 0.0 1.7 3.8 7.1 27.7 13.6 -20.2 21.0 18.8 39.9

Source: Company data, Renaissance Capital estimates

Figure 3: Alliance Bank Senior Eurobond 2017 price/yield performance, % Price, LHS YtM, RHS 105 100 95 90 85 80 75 70 65 60 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12

25 23 21 19 17 15 13 11 9 7 5

Source: Bloomberg, Renaissance Capital estimates