Research Alert

Banks Kazakhstan

Company update Fixed Income Research 3 November 2011

Mikhail Nikitin +7 (495) 258-7789 MNikitin@rencap.com

Research Alert

BTA Bank What’s keeping it solvent (and for how long)?
1H11 results: How can it be worse? Yesterday (2 November), BTA held a conference call to present its 1H11 IFRS
financials, this time without a Q&A follow-up. The presentation contained a technical overview of the bank’s financials. No details on strategy were provided during the call, other than management’s statement that it is committed to business recovery. We struggle to find a viable recovery scenario for a loss-making bank with disproportionately high administrative expenses and no positive track record in dealing with bad loans. An equity deficit of $1.5bn might not be the best solvency measure in this case; however, we think it is a fairly conservative estimate of the potential recapitalisation needs of the bank that are unlikely to be covered by BTA’s own earnings, and there is no way to verify the feasibility of the bank’s plan to recover $500-800mn from its legacy portfolio in 2012. Given that BTA’s senior debt is trading at half par, the market also seems to be sceptical about BTA’s ability to restore capital without external (i.e. state) involvement. 

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Operating costs funded by deposit growth – hardly a sustainable model. BTA’s revenues from new
lending and loan recoveries are too weak to offset its cost base. Imbalanced cash flows have resulted in a situation where the bank’s debt repayments and operating expenses are financed by its inflow of deposits (Figure 1). A slowdown in deposit growth without substantial cash recoveries would restrict BTA’s liquidity to only that available under the National Bank of Kazakhstan’s (NBK) short-term repo facility, with the Samruk-Kazyna bonds used as collateral. Based on the unutilised portion (about 40%, or $1.5bn at end-1H11) of the Samruk-Kazyna portfolio, we think it would be sufficient to cover the bank’s liquidity needs for about 1.5 years, assuming there is no further increase in lending and no material reduction in operating expenses. However, this scenario logically ends with the NBK as BTA’s largest secured creditor, essentially leaving no liquid assets for unsecured creditors, including Samruk-Kazyna.

The NBK’s repo rate: An issue, but only a minor one. Under the NBK repo, the share of payables as a
percentage of BTA’s total funding is 22%, and this facility costs about $200mn pa, based on the existing refinancing rate (7.5% for the tenge-denominated facility; 3% for the dollar-denominated facility). All else being equal, a cut in the repo rate to zero would result in annual net interest income of about $130mn. This would be much better than running a negative NIM, but is still only one-third of the bank’s administrative expenses – and even less when adjusted for accruals. BTA’s trading profit is negligible, while its fee and commission income is lower than its commission paid. We think the bottom line is that BTA must radically decrease its operating costs in order to break even in terms of profitability (Figures 2-7).

Termination of the repo scheme would not significantly impact BTA’s profitability. Theoretically,
Samruk-Kazyna can repurchase its own bonds, providing BTA with cash equal to the notional amount of the bonds and eliminating the costly repo scheme. Such a repurchase would certainly transform BTA’s balance sheet into a more straightforward one (Figure 8 illustrates a simplified balance sheet we have constructed based on this assumption). Our model only confirms that BTA’s actual cash position would not exceed $2bn, which roughly equals the amount of deposits SamrukKazyna holds with BTA. On the other hand, completely terminating the repo would not have a significant positive effect on BTA’s interest margin, as it would also eliminate the carry received by the bank on the bond portfolio.

Pricing BTA’s risk is just guesswork, at least until there is clarification from the state. Even though
we believe deposit growth could support BTA as a going concern for another couple of years, we think it would make sense for Samruk-Kazyna to intervene now, as the more time it takes to find a solution, the more funds will be spent on BTA’s inefficient operations, and the greater the recapitalisation costs the Kazakh state will have to bear if it ultimately decides to restructure. Until Samruk-Kazyna suggests a realistic path for BTA to return to profitability, we think market valuations of any class of BTA debt will remain nothing but guesswork based on different restructuring scenarios, levels of state involvement and the nature of lawsuits against the former owner. At the same time, we are not convinced that repetition of the debt restructuring at BTA would have any economic or reputational benefits for the state when compared with outright liquidation. In a liquidation scenario, assumptions about creditor priority and subordination are almost irrelevant, in our view, as unsecured creditors would be without recourse to any assets, other than increasingly uncertain loan recoveries. For these reasons, we continue to recommend avoiding BTA’s debt, even at current price levels (Figure 9).

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Renaissance Capital

BTA Bank

3 November 2011

Figure 1: Balance sheet structure, $mn Cash and amounts due from banks Samruk-Kazyna bonds, unpledged Samruk-Kazyna bonds, pledged to NBK Other securities Investments in associates Loans to customers Gross loans (Provisions) Deferred tax asset Other assets TOTAL ASSETS Repo with NBK Due to banks Samruk Kazyna deposits Other customer deposits Debt incl. RCTFF incl. recovery notes Other liabilities TOTAL LIABILITIES EQUITY DEFICIT YE10 855 963 2,639 751 613 5,343 18,698 -13,354 1,084 613 12,861 3,051 426 2,009 2,626 5,193 629 813 264 13,570 -709 1H11 727 1,253 2,396 647 622 5,291 15,798 -10,507 667 612 12,216 2,757 367 2,057 3,178 5,108 482 848 231 13,698 -1,482 BTA had about $1.5bn in cash and liquid assets (ex. cash on-hand and Samruk-Kazyna bonds pledged with the NBK) at end-1H11. Supported by the inflow of customer deposits, the bank’s cash position is sufficient to maintain its ability to repay debt in 2012-2013 (about $1bn). Cash has primarily been spent to finance debt payments and operating expenses, rather than to originate new loans. Revenues from lending (both current interest income and loan recoveries) remain too weak to compensate for interest expenses and/or operating costs, in our view. Deferred tax assets are hardly a reliable source of ‘hidden’ accounting capital: in 1H11, BTA reported a significant increase in ‘unrecognised’ deferred tax assets as a result of less certainty with regard to recovery of loan loss provisions, with a negative effect on P&L and capital. Deposit growth (both in corporate and retail – around $250mn in each segment) is the key driver of liquidity. However, such a balance of cash sources and uses is unlikely to be sustainable in the longer term, as it implies the direct use of deposit funding to service debt and opex.

Source: Company data, Renaissance Capital estimates

Figure 2: Structure of interest-bearing liabilities (end-1H11) Debt (ex. RCTFF and RNs) 30% NBK repo 22% Banks (incl RCTFF) 7% Corporate deposits 9%

Figure 3: Structure of interest-bearing assets (end-1H11) Debt securities Placements other than with banks Samruk- Kazyn Samruk-Kazyn 4% a bonds a bonds 37% 5%

Deposits of NWF SamrukKazyna 16%

Retail deposits 16%

Loans to customers, net of provisions 54%
Source: Company data, Renaissance Capital estimates

Source: Company data, Renaissance Capital estimates

One year after the completion of the debt restructuring, BTA is still wholesale-funded: borrowings account for about one-third of non-equity funding, and debt remains the most expensive funding source for the bank. Samruk-Kazyna bonds (about one-third of BTA’s interest-bearing assets) are an important source of liquidity, but their contribution to NIM is next to zero due to the high interest rate on the NBK repo. NIM could break even once there is a recovery in interest income from loans and/or a significant decrease in interest expenses on the repo. However, we do not think a positive interest spread is enough to offset BTA’s massive operating expenses. Figure 4: Net interest income structure 2H10 vs 1H11, $mn 2H10 Interest income 670.7 Loans 510.2 Samruk-Kazyna bonds 113.3 Other debt securities 23.9 Due from banks 23.3 Interest expense -632.1 Due to the government and NBK -100.3 Due to banks -41.7 Due to customers -170.2 Incl. retail deposits n/a Debt securities issued -319.9 Net interest income 38.6 1H11 534.2 399.8 106.2 21.3 6.8 -566.8 -96.0 -44.4 -191.6 -97.6 -234.8 -32.6

No improvement at the interest margin level, and it looks even worse if adjusted for the non-cash component: cash interest revenue was only 58% of accrued. Assuming that all uncollected interest revenue relates to loans, BTA only collected $234mn on its loan book in 1H11. NBK charges an official refinancing rate (currently 7.5%) on the repo against the Samruk-Kazyna bonds owned by BTA, implying a negative rate differential or ‘negative carry’, as this rate is greater than the coupon paid on these bonds (of 6.8%). An immediate cut of the repo rate to zero would, obviously, push BTA’s NIM into positive territory, but it is not a final solution: repo expenses are less than 20% of total interest expenses. What BTA is earning on loans would still be insufficient to cover interest on deposits and debt, in our view.

Source: Company data, Renaissance Capital estimates

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Renaissance Capital

BTA Bank

3 November 2011

Figure 5: Detailed P&L structure – 1H11, $mn Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net fee and commission Net trading gain/loss Translation differences Other income OPERATING INCOME Staff expenses Other administrative and operating expenses Incl. Legal services and consultancy Depreciation and amortisation Taxes other than income Obligatory insurance of deposits Loss on realisation of collateral Other operating expenses OPERATING EXPENSES Total core operating income (before provisions) Loan loss provisions Other provisions Total operating income after provisions Net income from insurance operations Share of income of associates Profit/loss before income tax expense Income tax expense NET PROFIT/LOSS AFTER INCOME TAX 1H11 534.2 -566.8 -32.6 59.8 -62.9 -3.0 3.4 5.0 5.8 -21.4 -68.5 -98.8 -61.3 -10.7 -13.8 -14.9 -4.1 -20.2 -231.0 -252.4 -40.8 -1.1 -294.4 8.3 14.8 -271.3 -427.2 -698.5

Fee and commission income is also too low – not only too low to offset the bank’s negative NIM, but also too low to cover fees and commissions paid. This is further evidence of a deeper issue: the bank’s extremely weak operating performance. BTA’s branch network generates about $140mn in annualised staff expenses only, i.e. before rent and other administrative costs. The question remains whether there is any potential for sales growth potential beyond its purely deposit-taking function. The size of legal and consultancy fees can exceed $100mn pa again, and is comparable with total personnel expenses – reflecting management’s focus on litigation and asset workout procedures, but with no tangible results so far. In spite of the significant write-offs of corporate loans in 1H11 (about $3bn, or 18% of average gross loans), BTA continued to charge loss provisions on loans to individuals – another $128mn in 1H11, implying a very high 15.5% annualised risk cost of retail loans. The net result for 1H11 was affected by the revaluation of deferred tax assets. The capital deficit adjusted for the accounting loss provides a fairly conservative estimate of potential recapitalisation needs, in our view, although the net result is less relevant in terms of BTA’s debt service capacity. Figure 7: Components of weighted-average interest rate on assets/liabilities 0.4% Debt securities (ex. Samruk-Kazyna bonds) Placements with banks Loans to customers (cash-based, net) Samruk-Kazyna bonds -3.7% -2.3% -0.6% -1.4% 0.1% 4.7% 2.2% Debt (ex. RCTFF and RNs) Customer deposits (cash-based) Bank loans and RCTFF NBK repo 0% 2% 4% 6%

Source: Company data, Renaissance Capital estimates

Figure 6: Effective interest rates on assets/liabilities Debt securities (ex. Samruk-Kazyna bonds) Placements with banks Loans to customers (cash-based, net) Samruk-Kazyna bonds -12.5% -5.5% -9.3% -6.6% -15% -10% -5% 8.4% 1.4% 8.8% 5.9% Debt (ex. RCTFF and RNs) Customer deposits (cash-based) Bank loans and RCTFF NBK repo 0% 5% 10%

-6%

-4%

-2%

Source: Company data, Renaissance Capital estimates

Source: Company data, Renaissance Capital estimates

In view of the 40% gap between accrued and collected interest on loans, we apply cash flow-based adjustments to our calculation of the effective rate on loans. Likewise, we adjust interest expense on customer deposits for the accrual component of interest paid on the long-term deposits placed with BTA by SamrukKazyna. Our estimate of the negative interest spread is 73 bpts (170 bpts if accrued interest expense is included). Figure 8: Simplified balance sheet structure adjusted for NBK repo, $mn YE10 1H11 Cash and amounts due from banks 1,406 1,619 Other securities 751 647 Investments in associates 613 622 Loans to customers, net 5,343 5,291 Deferred tax asset 1,084 667 Other assets 613 612 TOTAL ASSETS 9,810 9,458 Due to banks 427 367 Samruk Kazyna deposits 2,009 2,057 Other customer deposits 2,626 3,178 Debt 5,193 5,108 Other liabilities 264 230 TOTAL LIABILITIES 10,519 10,940 EQUITY DEFICIT -709 -1,482
Source: Company data, Renaissance Capital estimates

Figure 9: BTASKZ 18 price vs yield (RHS) performance, ppts 130 120 110 100 90 80 70 60 50 40 30 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

50 40 30 20 10 0

Source: Bloomberg, Renaissance Capital estimates

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