ANALYSIS: Foreign banks drive M&A activity in Kazakhstan

analysis

ANALYSIS: Foreign banks drive M&A activity in Kazakhstan

By SRI ⋅ July 25, 2008 ⋅

Unlike in most emerging economies, Kazakhstan’s banking sector has so far remained largely in local hands. However, recent acquisitions of local lenders by European and Asian banks suggest that the trend is changing.

Last year, M&A activity on Kazakhstan’s banking market, long dormant, picked up pace, and two of the country’s larger banks came under foreign control. Moreover, as Kazakh banks continue to struggle with insufficient liquidity to fund growth and repay their liabilities, more acquisitions are likely waiting ahead.

Kazakhstan remains an attractive target for foreign banks as its growth potential has yet to be fully realized, despite rapid development of the banking sector in the past years. And further increasing the draw is the ambition of the Kazakh government to become a regional financial hub and a trading center linking Europe and Asia.

M&A on the rise

Until last summer, M&A activity in Kazakhstan’s banking sector consisted largely of smaller transactions between local or Russian banks. Last year, however, several record-breaking deals took place that jumpstarted a wave of activity in the sector.

Last July, just before the credit crisis hit Kazakhstan’s economy, Italian UniCredit Group acquired ATF Bank, Kazakhstan’s fourth-largest bank, in a deal worth USD2.2 billion. Several months later, Korean Kookmin agreed to purchase a 30 percent stake in Bank CenterCredit, the sixth-largest lender, for USD530 million with the intention to acquire a majority stake before 2011.

Then last week, Raiffeisen International, an Austrian banking group, announced that it would open a banking subsidiary in Kazakhstan by 2009. Raiffeisen was long seen as a potential suitor for a number of mid-size banks, but eventually decided to enter the market on its own. At the same time HSBC, long active in Kazakhstan but with not much to show for it, said it would expand operations in the country and develop its network.

Temir Bank, a retail-oriented subsidiary of BTA Bank, Kazakhstan’s second largest bank, has long been “in play” as BTA Bank tries to raise funds following its cutoff from international capital markets. Alliance Bank, also badly hit by the lack of liquidity, is another local institution actively seeking a strategic partner. Both banks have already hired Western investment banks to advise them on the sale. It seems that it is a matter of when rather than if the right suitors are found.

Credit crunch

The wave of M&A activity is not accidental. Kazakhstan’s banking sector, which grew at record pace since the early 2000’s, came to a screeching halt in the summer of 2007 when international credit dried up. The banks that had relied on the Eurobond markets for credit suddenly found themselves unable to fund further growth and facing repayments on accumulated debt with little hope for refinancing at an acceptable rate.

Focus on repayments has left most banks without room for growth, as they had to stop issuing loans to repay their debts. “Most of the banks are sacrificing the size of their loan books in order to repay their debts. Any expansion of their credit portfolio could prove challenging,” Jason Hurwitz, a research director at Visor Capital, Kazakhstan’s leading investment bank, said to Euromoney.

The banks’ focus on repayment has seemingly born fruition as the banks have been able to meet all payments - at least so far. Yet, as Kazakhstan’s economy slows and inflation rises, banks face a new threat as their credit portfolios deteriorate.

In its recent report on Kazakhstan, Fitch, the rating agency, cited the decreasing quality of the banks’ loan portfolio as a significant risk to the overall economy. According to Fitch, the ratio of non-performing loans on the banks’ books almost tripled to 5.1 percent since last June.

Ekaterina Trofimova, a credit analyst with S&P, another rating agency, said that the overall ratio of “distressed loans”, both performing and non-performing, is as high as 15-20 percent. “This estimate exceeds by far the overdue debt reported by banks,” she said. “To avoid showing high ratio of overdue debt, Kazakh banks restructure bad loans and extent grace periods.”

Positive outlook

Among the emerging economies, Kazakhstan has probably been hit hardest by last summer’s liquidity crunch. Yet, while the overall effect of the crisis on the country’s economy and the banking sector is far from clear, it seems that it has weathered the storm reasonably well. If the interest of foreign banks and other strategic investors is an indicator, both the Kazakh economy and its banking sector have a bright future ahead.

While international investors clearly have confidence in the growth prospects of the Kazakh banking sector, most local banks have been hit hard by the cutoff from international capital markets and slowing economic growth. The London-listed trio Kazkommertsbank, Halyk and Alliance lost collectively more than half of their value since their high in the summer of 2007.

This, however unfortunate it may have been for local institutions, opened a door of opportunity for foreign banks keen not to miss out on the potential of the Kazakh market. In the last 12 months alone, three major banking groups - UniCredit, Kookmin and Raiffeisen - have entered the Kazakh banking sector, and more are expected to arrive. French BNP Paribas, Russian Sberbank, and Hungarian OTP are just a few of those interested.

With the advent of experienced, well-funded foreign players, the consolidation (and likely internationalization) of the sector will continue. ATF Bank, recently renamed UniCredit, has already shown the benefits of having a strong financial backer as it issued Eurobonds at a time when international capital markets are closed to most other banks.

Foreign expertise and introduction of new products will advance the development of the sector, already considered the most progressive in the CIS, and support Kazakhstan’s ambition to become a regional leader in financial services. Moreover, local banks, faced with experienced, well-funded competition will need to rethink their business models as cheap funding from abroad will no longer be available.

The arrival of new banks will further drive the consolidation of the sector, as many of the mid-size banks will not be able to compete with the trio of largest Kazakh lenders, Halyk, BTA, and Kazkommertsbank, and the deep-pocketed foreign banks. And as all banks, perhaps with the exception of Halyk Bank, struggle with liquidity, it is clear that consolidation will be driven from abroad.

Expecting a bonanza of M&A deals, several investment banks have already strengthened - or are planning to reinforce - their presence in Kazakhstan. Russian Troika Dialog and Renaissance Capital have been aggressively expanding their operations on the Kazakh market, and JPMorgan and UBS, two global players, have announced plans to set up representative offices in Almaty.

Foreign banks will not come to control 90 percent of all Kazakh banking assets as is the case in the Czech Republic, to name the most extreme example. Yet, the time when the role of foreign banks was reduced to little more than representational presence has clearly passed.