Success formula of INECOBANK is being optimistic despite the trend

ArmInfo. Pioneer and one of the consumer lending leaders on the Armenian market, INECOBANK will shortly become one of the largest financial institutions of Armenia. To attain that goal, the Bank has settled the problem of capitalization successfully and effectively. To meet the Armenian Central Bank’s requirement that comes into effect in 2017, the Bank has recently increased its capital by acquiring the Armenian subsidiary of the German ProCredit Bank and attracted the European Bank for Reconstruction and Development (EBRD) – a reliable partner and institutional investor as a stakeholder. In an interview with ArmInfo, Chairman of the Management Board of INECOBANK Taron Ganjalyan speaks of the merger and further development strategy of the Bank.

How much will it be possible to increase the total capital of INECOBANK due to the merger with ProCredit Bank (Armenia)?

By early 2016, the total capital of INECOBANK (by IFRS) will amount to about 40 bln AMD. The capital will grow due to a 9.8 bln AMD ($20.3 mln) equity investment of the EBRD. The proceeds of the EBRD investment will finance the acquisition of 100% of shares of ProCredit Bank (Armenia) from ProCredit Holding AG & Co. The expected 3.8-4 bln AMD will also be taken into account. The merger with ProCredit Bank (Armenia) will be held in two stages. The first stage is already over – on December 14 we acquired ProCredit Bank (Armenia) and on December 16 the EBRD was registered as a stakeholder. The second stage will be of technical nature – we will complete the merger process within 4 months. Actually, the major part of the deal is over today.

How will the EBRD’s participation in INECOBANK’s capital distribute the stakes of the other shareholders? What stake has the IFC obtained in the merger process? 

As the EBRD has joined the capital of INECOBANK, the stakes of the majority shareholders will be distributed in the following way: the summary stake of the two large shareholders – Avetis Baloyan and Karen Safaryan – will be a bit higher than 51% (versus the current summary 65.57% stake), the EBRD’s stake will be 22.7%, and the stakes of the other investors - DEG and IFC – will decline. As a result, the Bank will have 11 shareholders versus the current 10.

As regards the 20 mln USD loan recently provided by the IFC to INECOBANK, it is not directly related to the acquisition of ProCredit Bank (Armenia) and it will be partly spent on financing some obligations of the German bank. Nevertheless, these funds can be considered as a part of the merger deal and expansion of funding opportunities for our active operations. It was impossible to acquire the bank at the expense of loan funds because we would have faced a capital adequacy problem; on the contrary, we sought to increase the capital by acquiring another bank, at the same time ensuring a balanced GAP.

At the moment of the merger, ProCredit Bank had a tangible accumulated loss. How was this problem settled? Won’t it be a heavy burden for INECOBANK?  

When the capital has a tangible accumulated loss for over a year, the bank has to regularly clear it to avoid more serious losses. ProCredit Bank (Armenia) regularly increased the capital and the funds were spent on recovery of losses. The fueling of the capital continued until the merger deal and at the moment of the deal the problem of the bank’s losses was actually settled.

When we considered acquiring ProCredit Bank, we understood what problems we would come across. Having estimated them, we realized that we would be able to manage its assets more effectively. From the fundamental point of view, ProCredit Bank (Armenia) has no serious problems. The bank obtained revenues mostly from the interest margin (loans and deposits) and fixed payments. INECOBANK is traditionally good at managing fixed (non-interest) revenues. The comparison with ProCredit Bank has revealed utmost similarity in all aspects, except fixed expenditures, which were rather tangible in the Armenian subsidiary of the German bank. We will be able to considerably reduce part of these expenditures within a day. For instance, the matter concerns the expenditures for personnel training at ProCredit Holding abroad. Yes, training abroad is a good but cost-intensive thing. INECOBANK’s personnel are also well-trained and the training courses are held in Armenia, but in some cases we send the key employees to training courses abroad. Butthisconcernsspecificemployees, notthewholestaff. In addition, ProCredit Bank has big expenditures related to advanced software and information technologies provided by the parent structure. This component is well-developed at our bank and can compete with foreign analogues. So, we can rule out these expenditures, too. Actually, we are considerably cutting the costs, but we are not going to reduce the payroll. First of all, we are pleased with the fact that the quality of the loan book of ProCredit Bank (Armenia), like the loan book of INECOBANK, is high and we are not afraid of deductions. They will not be big and we will cope with them well enough.

INECOBANK has intensified its activities on the SME market. ProCredit Bank (Armenia), in turn, is known to have specialized in SME lending. Will you keep increasing this portfolio at a fast pace? 

If we keep increasing the SME portfolio at the same pace, the portfolio dynamics will shortly grind to a halt, because one can’t jump over one’s own head. Therefore, our goal is to retain the current SME lending share in the merged bank instead of increasing that share, as the merged bank already covers 20-23% of the SME lending market with its high-quality portfolio. This is an ideal situation that brings stable profit. We do not consider increasing the coverage to 30-50%, because we realize the problems stemming from it.

During the signing ceremony, the head of ProCredit Bank (Armenia) hinted that the withdrawal of the bank from the Armenian market is due to the problems on the SME segment. Wouldyoupleasecommentonthatviewpoint?    

The problem is not the SME market. The problem is the concept of functioning of all banks of ProCredit Holding, including the Armenian bank. Yes, the SME market in Armenia is not large and the competition among the lenders (banks and credit companies) is high. But unlike the rest of the lending market participants, which have diversified their portfolios in various segments, ProCredit Bank focused its activities on that particular segment, which could not theoretically promise high profits amid such high competition. In addition, ProCredit Bank entered the Armenian market on the threshold of the crisis and had to fulfill that concept in a hard period for the business and economy, needless to say about the high competition on the SME lending market.

Actually, the lack of diversified assets caused a serious unilateral problem and did a bad turn to ProCredit Bank, didn’t it? 

Yes. Were it not for retail business, INECOBANK would also face that problem because we also have fixed costs related to software, information technologies, personnel training, etc.  

Problems do exist, but some of them are typical to SME entities worldwide, and part of them are characteristic of the Armenian market, particularly, the mentality of Armenian entrepreneurs. Nevertheless, I would stress that SME lending is calmer and more stable than lending to large business. Of course, everything is relative but today the SME lending situation is more stable than half a year ago. 

What has changed during half a year? What about the external shocks?

A wave of pessimism is felt throughout Armenia. During my 20-year-long experience in various countries, I saw three crises. Naturally, I have learned the psychological and emotional state of customers in such hard periods. Emotions not based on facts are not strange to people. Meantime, our work is based on facts only. We try to find out if they are based on reality or wrong calculations.  However, even despite this, I’d like to say that the situation today is more favorable than in January 2015. Then we were concerned that the year 2015 will not be successful, but tried to be optimistic and continued to work as usually. This helped us operate at profit that exceeded last year’s level by more than 6% (by CB’s standards, as of late Nov 2015). Although the quality of our loan portfolio has certainly deteriorated, compared to last year, it still looks better.

I can bring other facts too. These are statistical data, issues concerning calculations and intentional changes. However, all together, the situation is not that bad as we expected. Such contradictory situation is anticipated in 2016 too. We will just continue operating and staying optimistic. Now, we are merging with ProCredit Bank (Armenia) and after becoming one of the largest banks in the country, we will take even more active steps in the lending market and introduce new interesting retail products. Along with this, we will boost SME finance to help them face the anticipated challenges. 

What new retail products are you speaking about? What is INECOBANK’s final goal in retail lending?  After all, this segment bears default risks.

We seek to become a full-fledged retail bank. To achieve this goal, we are developing new retail products related to current bank accounts and deposits, first, and then - loans.

I would like to explain why we start with current accounts. Commission fees at our banks are uncertain and not transparent for customers.  Making a transaction with a bank, a customer often does not know how much it will cost him finally. For instance, opening an account and depositing money, a customer does not know when, for what and what size of commission fee he may face. We have decided to develop a product that will facilitate the service of the bank account for customers. A customer will be required to make a one-time fixed payment for his account and will manage it without worrying that he will face a commission fees. We seek to turn a bank account into a kind of wallet easy for use and free of charge.

This will increase the trust of our customers even more. We will create a customer history depending on the management of his account and we be able to consider him as potential borrower for lower rates in the future. Eventually, both the bank and the customer will gain from this. The goal of this retail product is to improve the bank’s liability structure i.e. we seek to increase the funds raised from customers.

Don’t you think that the service of these resources may cost high to the bank? Frankly speaking, many banks today try to get non-interests incomes from any deal. 

Well, it will be an expensive undertaking, indeed. However, we have been operating in the market for already 20 years and there are all the preconditions for our bank to stay in the market for as many years. We try to look far in the future, not just 1-3 months ahead. We make far-going plans - for five and more years. Crises come and go. We develop our new products to see their efficiency in the future.

In the loan portfolio of INECOBANK, trade finance and agricultural loans suffered decline in 2015. Instead, financing of the industrial, transport and communications, public catering and services sectors and even the construction sector intensified. In the market of consumer lending, the Bank traditionally maintains its growth rates. What made the Bank cut trade finance after taking leading positions by this indicator? Did the stagnating construction sector prove more attracting to you or was it forethought? 

What an interesting question. I would like that we managed our loan portfolio by sectors purposely. We have such plans for 2016. So far, our loan portfolio is being built bottom-up. We seek solvent and creditworthy businesses to invest in irrespective of the sector. Consequently, the dynamics of our lending sectors varies.  As to the trade finance reduction, it is a consequence of imports decline (by 27%), which affected the trade sector negatively, while this sector accounts for 33% of INECOBANK’s loan portfolio. I am speaking about retail trade loans. Nevertheless, even the 12.4% decline of trade finance in 2015 did not brought the Bank down from the Top Three Banks by this indicator. It should be noted that the trade finance loans we provided earlier are normally being repaid. Simply these customers no longer need such big loans. We provided them loans for purchase of goods, but imports decline has affected the retail trade. As a result, the demand for trade finance has decreased certainly.

What about the construction sector? Have you found a success formula and decided to go against the trends?

Although we actively finance the construction sector, not everything is that good there. Simply, in this sector like in any other sector there are successful and failed projects. We have two customers that proved successful in housing construction. Besides, there are not expensive projects and we decided to support them.

Getting a status of a big bank by the size of assets, INECOBANK will probably have to continue developing the risk management system. EBRD is known to pay a high attention to these issues and provide its partners a substantial technical support in improvement of risk management mechanisms and development of corporate governance principles.

We have rather ambitious goals and always strive for better. This means that will accept EBRD’s support and improve our risk management system. As you have said, our bank is amalgamating and the risk management requirements will increase too. The sector-based management of portfolio along with serious mechanisms of risk management will lead us to a completely new level of relations with borrowers, which will in turn enable us to ensure a minimum level of loan default.

Will you introduce a new system of corporate governance?

We have no problems here, as DEG and IFC - our shareholders of the last 10 years – have already made serious changes in the mechanisms of the Bank’s corporate governance. The Board operates quite actively and independently and has rather an effective Audit Committee, and is creating more committees. EBRD will have its representative at the Board. There will be a new independent member of the Board. We have done much in the corporate governance system and will do what we have not done yet. We are more interested in EBRD’s risk management mechanisms.

What is your assessment of the lending market amid the economic problems and mental crisis in Armenia?

External influence may be positive one year and negative in the other year. This does not mean that we must be complacent. We understand the situation our customers are driven to by the crisis. For instance, the December crisis of 2014 created financial problems for many of our successful business customers and they have problems with loan repayment now. We immediately offered them our help and affordable refinancing schemes. However, some companies face financial problems due to mismanagement and inefficient use of assets. Actually, there are to problems: external factor – in such case we hurry to help our customers overcome their problems – and mismanagement - this is fraught with big problems and, eventually, collapse.