EUROMONEY, Kazakhstan - Thu April 25, 2013

Grigoriy Marchenko: Kazakhstan gets serious on bad debt

The Kazakh banking sector is still burdened by a big non-performing-loan problem. Central bank governor Grigoriy Marchenko explains how the country is approaching the issue with more urgency and a more conservative approach to financial management.

Central Asia’s largest economy is tipped by its central bank, the National Bank of Kazakhstan (NBK), to grow by 6% in 2013. But it retains one glaring weakness: its banks.

BTA, still suing its former chairman for mass fraud, remains on life support following last year’s bailout, the second in two years. Another Kazakh bank, ATF Bank, looks set to lose its majority owner, UniCredit – assuming Italy’s largest lender can find a buyer.

Even worse lies beneath. Most lenders across the former Soviet Union have struggled to sell off or carve out a festering mass of bad loans disbursed pre-crisis, often to overleveraged borrowers.

Kazakhstan is no exception. In fact, the country’s vast stock of soured loans might make this one of the very few categories in which Kazakhstan can claim the unfortunate title of world-beater. Ninety-day non-performing loans stood just shy of 33% of the country’s cumulative loan portfolio of T11.2 billion ($73 million) by the end of 2012, according to central bank data.

Even Halyk Bank, often viewed as the country’s best-run lender and which controls two insurers as well as around 90% of the country’s payroll banking, is plagued by soured loans: 90-day NPLs rose from 16.3% of all loans at the beginning of 2011 to 18.8% by end-September 2012, another legacy of the 2007/08 crisis.

Finally – and perhaps belatedly – the country is acting. Kazakhstan’s plan of attack is simple and two-pronged. In June 2012, NBK chairman Grigoriy Marchenko announced the creation of a distressed asset fund responsible for helping rid the banking sector of some of its older and smellier bad loans.

The fund is a curious concoction. Theoretically an independent subsidiary of the central bank, it is overseen by an independent arbiter, American Appraisal. In appointing the Milwaukee-based consultancy, Marchenko has succeeded in looking both transparent and apolitical – not an easy trick to pull off in Kazakhstan. In an exclusive interview with Euromoney, the central bank chief is quick to point to the benefits of what he describes as the country’s “problem-loans fund”.

The distressed fund remains an enigmatic construct more than six months after its formation. It has no formal designation or estimated size, and Marchenko, perhaps unsurprisingly in a country where everything up to and including banking and loan bailouts is intensely political, is in no rush to fill in the blanks.

But a few facts are emerging as the fund’s independent arbiter gets down to business. Marchenko reckons it will be at least mid-2013 before the fund starts to properly weed out the industry’s stock of bad loans. And it is likely to take several years before most of the worst loans are written down or off.

Even here, ambitions and deadlines are vague. Marchenko describes dissolving legacy NPLs as a “medium-term problem” that should be resolved through the distressed fund “probably within two to three years”. But in its second-quarter 2012 financials, Halyk Bank estimated its core problem loans would not be resolved before June 2017.

Perhaps the biggest surprise has come from the central bank’s determination not to permit any loan collateralized by real estate assets to access the fund. This seems hard to comprehend, if only because any banker in Almaty, Kazakhstan’s financial capital, will tell you that the vast bulk of the country’s legacy NPLs are a direct product of exuberant lending to construction firms or property investors before the financial crisis.

As one Almaty-based banker notes: “It’s like managing a football team but only picking the really bad players.”

Yet Marchenko is adamant: “Our subsidiary is not involved and will not be involved in any problems with real estate [loans]. We believe real estate is a big, but also a complicated, market, and here we believe that the banks should solve their problems themselves.”

This brings us to the second prong of the attack. Prompted by Marchenko’s determination to allow only restricted access to the distressed asset fund, Kazakhstan’s banks, all 38 of them, have been left with little choice but to set up their own special purpose vehicles in which to quarter the worst of their bad loans, including property loans. Some analysts believe this was the NBK chairman’s plan all along: to force banks to solve their own problems.

It is not that Kazakhstan’s banks have been slow to take the bait. In October, Halyk Bank created a limited liability partnership, Halyk Project, into which the lender transferred an estimated T4 billion-worth of previously foreclosed collateral. If that process goes well, Halyk is planning to push ahead with further foreclosures in 2013.

Only then, reckons Jason Hurwitz, a senior financial sector analyst at Alfa Bank in Moscow who covers the Kazakh banking sector, will Halyk’s SPV actually start to make an impact. Hurwitz describes this process as the “public hanging effect”, wherein one borrower “sees another borrower lose his collateral, and only then starts to think twice about skipping payments. So those who have parked their money offshore might bring it back to repay their loans.”

If nothing else, by implicitly encouraging lenders to set up special vehicles in which to house dud loans, the authorities have succeeded, notes Hurwitz approvingly, in “switching power from bad borrowers back to the lenders”.

Nor was Halyk’s move a one-off. In November, Alliance Bank, the first Kazakh lender to default in 2009, announced that it would siphon NPLs worth $1 billion into a discrete new financial division. And on December 24, NBK granted Kazkommertzbank, another of the country’s biggest banks, approval to set up two bad bank units to house failed loans. The first will contain industrial and corporate loans; the other will house loans relating to residential and corporate real estate and incomplete construction projects.

How much impact will the state distressed asset fund and individual bank-level SPVs have on Kazakhstan’s outsized stock of non-performing loans? Even though it is still early days, the likely answers are, respectively: ‘little if any’ and ‘potentially an awful lot’.

Certainly, the SPVs could be a game-changer. Before the SPV ruling, which came into effect in August 2012, banks were forbidden to earn capital (rent) on foreclosed assets, ensuring that the overall stock of NPLs was kept needlessly and perilously high. Another quirk of the old rule meant that banks were forced to sell assets within a year of foreclosure. Again, the new rules transfer the balance of power within the industry by allowing banks to retain assets housed and unsold within the SPV for five years or more, letting them dispose of soured assets at their leisure.

Hurwitz expects to see “some improvement” in tackling the industry’s legacy store of NPLs “within one or two years”. By contrast, few expect the government’s distressed fund to have much tangible bearing on the overall stock of NPLs, largely because of Marchenko’s unwillingness to absorb soured property loans. “There will likely be no positive impact felt on banks’ [balance sheets]” as a result of the distressed asset fund, reckons Hurwitz.

At least the new rules are finally forcing Kazakhstan’s banking community into action, and not before time. This after all is a country with enormous potential: a sort of vast natural resources supermarket boasting everything from silver and gold to oil and yellowcake uranium. Yet Kazakhstan’s two key pressure points remain the same ones that have hobbled the economy in the 22 years since independence: a weak banking system and a lack of economic diversity.

The first pressure point is, theoretically at least, being tackled. And it’s clear that Marchenko, for one, is sick of the country’s often self-destructive banks. Since 1991, Kazakhstan’s banking sector has suffered two systemic crises. The first, in early 1999, was the end result of years of out-of-control domestic lending. The second, in 2007/08, was born elsewhere, but the effects were exacerbated again by excitable lending to over-leveraged speculators at home, as well as by excessive foreign-currency borrowing by expansion-oriented domestic banks.

Marchenko, logically and reasonably, appears determined not to let Kazakhstan’s banks tread this path a third time. “In 2007, just before the crisis, the external debt of our banking sector was around $47 billion, 50% of GDP,” he says. “This was clearly unsustainable. Now our banks have only $11.3 billion in foreign liabilities, 6% of GDP, and foreign liabilities are 17% of all debts.”

The NBK chairman reckons it’s possible to keep these numbers low. “Deposits are growing at 15% to 20% a year, so foreign funding is steadily being replaced by growing corporate and retail deposits.”

This newfound conservatism has reached right to the heart of government. Kazakhstan seems unlikely to issue sovereign bonds in the near future, the central bank chief insists: “We have no plans to, although the government is independent of us, and if they don’t want to follow our advice, that’s OK.”

Marchenko adds: “There’s a lot of pressure from all sides to issue debt that we don’t need. Debts get too big and [countries] struggle to repay it – the US and several European countries are clearly in that position. As a sovereign country we don’t have that problem, so why should we [issue debt]? You don’t need to issue sovereign bonds to prove that you’re in good shape. You can do that by actually being in a good fiscal state.”

Kazakhstan’s total gross foreign-currency and gold reserves fell 3.6% during 2012, according to NBK figures, to $28.3 billion, while inflation inched up to 7% in February, having spent most of the past year below the 5% mark.

The other challenge facing the economy – diversification – is far thornier, offering few simple solutions. Marchenko clearly wants to see Kazakhstan become a producer and exporter of finished manufactured or processed goods. “We need more diversification,” he says. “It has a been a consistent theme for us since independence, and we will remain committed to that ambition for the next 20 years.”

Yet again, achieving that goal won’t be easy. Marchenko wants to see Kazakhstan emulate Australia and Canada, becoming a leading manufacturer and exporter of processed agricultural products. But he laments the fact that the government seems more determined to turn Kazakhstan into a leading producer of high-tech hardware and software, an ambition that seems a stretch given the country’s remote location and poor infrastructure.

The most likely outcome, he concedes, is a sort of well-meaning inertia, in which diversification is parroted as a national goal, without being taken too seriously, while the economy continues to be driven by traditional primary industries such as mining and energy extraction. “It isn’t easy to diversify when one commodity dominates and is profitable,” he says with a sigh.

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