FinRating ArmInfo: Toxicity of Armenian banks` loan portfolios starts  to increase again

ArmInfo. The growth of non-performing loans accelerated in the banking system of Armenia. Thus, the share of NPL in the loan portfolio increased in Q3 from  8.3% to 9%, and in assets it reached 6.1%, against 9% and 5.9%,  respectively, recorded a year earlier.

This was observed against the background of the acceleration of the y-o-y growth of credit investments from 13.5% to 21.4% and the growth of assets from 14% to  16.5%, with a sluggish acceleration of quarterly growth in both cases  (loans - from 3.2% to 5, 9%, assets - from 1.5% to 4.8%).

These indicators are presented in the Financial Rating of Banks of  Armenia as of September 30, 2020, prepared by ArmInfo IC based on  financial reports, which include a new format for presenting credit  risk (according to IFRS9), which does not fully reflect the real  situation of the quality of the loan portfolio and the presence of  toxic loans (NPL). But ArmInfo IC requests the necessary data from  banks, which allow calculating the total volume of overdue loans and,  consequently, their share in the loan portfolio and banks' assets.

The accelerated growth of toxic loans, in turn, has led to decline in  profits. Thus, the net profit, amounting to 58.6 billion drams ($  119.9 million) in 9 months, decreased by 0.9% per annum (against an  increase of 14.2% a year earlier), which was observed against the  background of an increase in overdue loans by 20, 3% (while  accelerating quarterly growth from 10.1% to 13.1). And this was  accompanied by a weak attempt to increase the amount of healthy  (standard) loans for the reporting quarter by 3.5% (from a 0.5%  decline in the Q2) with a y-o-y growth of 9.1%, presumably to a  greater extent secured due to the renewal of agreements during the  credit payment holidays (from March 13 to June) and active  participation in the 1st and 2nd anti-crisis state programs.

Toxicity of consumer loans goes up

Doubtful and bad risk groups account for about 55% of NPL, and the  latter group retains a significant dominance. In a breakdown by  industry, over 35% of overdue loans are consumer loans (including  mortgages), with a y-o-y increase in the volume of non-performing  loans by 45.3%, while healthy loans increased by 19.7%. Moreover,  almost half of non-performing consumer loans are doubtful and bad  groups, the latter to a greater extent.

The second place in terms of NPL share is occupied by the trade  sector, where more than 20% of non- performing loans have  accumulated, with a y-o-y decline in their volume by  3%, but with an  increase in healthy loans by 21.1%.

Agricultural loans occupy the third place by the share of NPL - over  11%, with a y-o-y increase in the volume of non-performing loans by  7.8%, while the growth of healthy loans accelerates to 22.1%. Then,  in terms of the share of NPL, loans to the industrial sector follow -  about 10%, with a y-o-y decline in their volume by 5.4% with a more  pronounced decline in healthy loans (by 13.6%). The share of NPL in  loans to the catering and services sector is slightly lower, with a  16.1% y-o-y decline in their volume with a modest 6.5% growth in  healthy loans. And after the share of NPL loans follow the  construction sector, with an annual decline in volume by 2.2%, while  healthy loans increased by 39.1%.

The same sectors also dominate in terms of the volume of credit  investments: consumer loans - 28.2%, trade - 17.3%, industrial sector  - 14.7%. The mortgage accounts for 11%. The share of lending to the  catering / service sector was 6.8%, the agricultural and construction  sectors - 5.3-6.2%.  The volume of consumer loans slowed down the  y-o-y growth from 35.2% to 23%, with a miserable slowdown in mortgage  growth from 40.3% to 36.3%. Lending to the catering / services sector  sharply slowed down growth from 24.3% to 8.6%, the retail sector -  accelerated growth from 11% to 18.1%, and the industrial sector -  worsened the dynamics from 18% growth to 9% decline ... Investments  in the construction sector - from 3% to 34.3% and in the agricultural  sector - from 2.5% to 19.6% were also in the growth with a sharp  acceleration of rates. At the same time, the volume of lending to  SMEs continues to lose in growth, slowing down from 13.7% to 6.6%.

The total loan portfolio of Armenian banks by October 1, 2020 reached  4.3 trillion drams ($ 8.7 billion), and assets - 6.3 trillion drams  ($ 12.9 billion), a more significant acceleration in the annual  growth of the loan portfolio with a less noticeable acceleration in  the growth of the assets  increased the share of loans in assets from  65.1% last year to 67.8%.

Profits began to sag under the pressure of portfolio toxicity

Analysts of the national rating agency AmRating note that the  transparency of the banking system in connection with the transition  to new reporting under IFRS9 has significantly decreased due to the  "concealment" of the structure of loan quality, namely, the  classification of the portfolio by risk groups.  Independent analysts  are especially concerned that the new format lacks "bad loans"  article, the most forbidding and dangerous one in assessing the  reliability of banks, while the regulator, namely the Central Bank,  turns a blind eye on that. As a consequence, the above-mentioned 55%,  coming to doubtful and hopeless risk groups do not disclose the true  "danger" of portfolios. However, despite this, the "massive" presence  of bad loans is evidenced by the moderate growth of interest income  from lending (and modest for the quarter) and the subsidence of  profits. This confirms the earlier assumption by analysts that the  process of write-offs of bad loans after the loan payment holidays  will continue, thereby declining the level of profitability of the  banking sector.

Analysts at the same time predicted that this process will continue,  at least until the moment when the maximum debt ratio will be  applied, designed to exclude over-borrowing of borrowers, with an  accompanying real recovery of the loan portfolio.

So far, according to the agency's analysts, low interest rates, a  significant decrease in margins and weak growth in interest income  are holding back expectations for the reaching of ROA and ROE ratios  a high level: by the end of 9 months of 2020, the return on assets  (ROA) of the banking system decreased to 1 , 3%, and the return on  equity (ROE) - up to 8.9%. In 2020, all this is complicated by the  economic and social consequences of the coronavirus pandemic with  uncertain forecasts on the timing of the exit from the current  situation. And the second wave of the virus that surged in autumn  with greater force, coupled with the consequences of the  Azerbaijani-Turkish aggression against the NKR and martial law, even  questioned the prospects for economic recovery in 2021. According to  analysts, the economy will be able to grow at best in 2022 if the  financial sector manages to withstand the crisis without tangible  losses.

The Central Bank is still wary of the Basel requirements

Against this background, the Central Bank prefers to have a  restrained attitude to Basel III requirements, as evidenced by the  persistence of a countercyclical capital buffer (CCyB) at 0% of  risk-weighted assets in Q3. Taking this decision, the Central Bank  was guided by the goal of mitigating the possible negative  consequences of the coronavirus and martial law on the financial  system, and promoting the continuity of the process of lending to the  Armenian economy.

In addition to this buffer, it was also planned to introduce two more  from 2020 - a buffer to maintain capital adequacy and a buffer for  systemically important banks. But the Central Bank of Armenia at this  stage chose to refrain from these innovations in order to ensure a  smooth transition to the new regulatory field in the interests of  preserving the formed capital and liquidity buffers. At the same  time, since 2020, after a 12- year pause (then at the level of min  8%), the fixed capital adequacy ratio came into force again, reduced  in May from a minimum 10% to 9%, which was used on a par with the  current total capital adequacy ratio at the level min 12%.

Thus, the regulator sent appropriate messages to banks to use the  capital formation buffers to ensure the continuity of banking  operations, to resist stressful situations and absorb losses in a  state of prolonged economic downturn (recession). Such instruments  are capital buffers, established in addition to capital adequacy  ratios and designed to contain risks (including systemic ones) common  in a stressful period.  In addition, in order to ensure uninterrupted  implementation by banks of financing the real sector of the economy,  the Central Bank postponed the implementation of two new liquidity  ratios established by Basel III - the liquidity coverage ratio (LCR)  and the net stable funding ratio (NSFR), which should come into force  in January 2021. At the same time, the general and current liquidity  ratios that regulate banks' liquidity risk continue to operate as  usual at the level of min 15% and 60%, respectively.  As of October  1, 2020, on average in the banking market, the level of total capital  adequacy was 25.67%, which is lower than a year ago (28.9%), and the  level of capital adequacy was 24.24% (versus 27.56% for July 1 and  30.6% as of April 1 this year). The level of total liquidity on  average in the banking market amounted to 31.32%, and current  liquidity - 161.09%, and in both cases, comparison with the  indicators of a year ago demonstrates a decrease from 31.99% and  174.07%, respectively.

Forecasts of economic prospects have become more negative

The World Bank (WB), in the October updated forecast of the prospects  for the development of the economy of Europe and Central Asia,  worsened expectations for Armenia's GDP for 2020 towards a larger  decline - by 6.3% against the previously predicted 2.8% and the  actual 7.6% - growth in 2019.  In terms of sectors of industry the  World Bank's forecast for Armenia's GDP in 2020 are as follows: the  agricultural sector will enter growth by 1.7% (from an actual 2.6%  decline in 2019), while the industrial sector and the service sector  will be in a 2.4% decline and 9.9%, respectively (against actual  growth of 7.1% and 10.4% in 2019).

For Russia, which is Armenia's main trading partner, the World Bank  predicts a 5% decline in GDP in 2020 against the previously expected  6% and actual 1.3% growth in 2019.  The World Bank report notes: "The  COVID-19 pandemic has plunged the global economy into the deepest  recession in eight decades. In emerging market economies and  developing countries in Europe and Central Asia, GDP is expected to  decline by 4.4% in 2020. Regional output collapsed in the first half  of 2020 as growing domestic outbreaks and pandemic-related  restrictions plummeted domestic demand, exacerbated supply  disruptions, and halted production and service activities. Countries  with strong trade or value chains with the Eurozone or Russia, as  well as countries heavily dependent on tourism or energy and metal  exports suffered most. At a poverty line of $ 3.2 a day, estimates  suggest that another 2.2 million people could slip into poverty in  the region's countries with emerging market economy  and developing  states, and with the $ 5.5 a day poverty line commonly used in upper  middle-income countries, this indicator could reach 6 million. "

The International Monetary Fund (IMF) in its November forecast for  Armenia for 2020 predicts a decline in GDP of more than 7%, noting:  "The Armenian economy has been hit hard by the COVID-19 pandemic and  the worst military confrontation since the early 1990s. These shocks  have led to disruption of domestic supply and demand, and were  exacerbated by sharp declines in export and tourism revenues,  remittances, and to some extent weakening capital flows. Uncertainty  about recovery is high, but growth according to the IMF forecast will  remain modest in 2021 and then accelerate as adaptation of the  economy to the impact of these shocks and the associated economic  scars. Short-term negative risks associated with external events,  uncertain economic and political environment, increased regional  tensions, and the intensity and duration of the pandemic are  counterbalanced by the potential positive consequences of a faster  recovery from the pandemic, more limited more scarring and faster  implementation of reforms. "

Back in September, the Central Bank of Armenia revised its GDP  forecast for 2020, expecting a larger decline - by 6.2% against the  previously forecasted 4%. In the sectoral breakdown, the Central Bank  in the updated forecast for 2020 worsened expectations towards a  larger decline in the construction sector - to 18.7% (from the  previous 11.2%), in the service sector - to 6.1% (from the previous  4.3%). the agricultural sector - up to 1.1% (from the previous 0.4%),  and the decline in the industrial sector will be 2% (against the  previously predicted 2.2%). The Central Bank worsened the forecast  for the decline in private investment to 20% (from the previous  14.7%). The Central Bank of Armenia also downgraded the forecast for  exports and imports for 2020 to a uniformly significant decline of  29-32%, against the previously expected decline in imports by 15-17%,  and exports - by 12-15%, and their actual growth in 2019 by 9.1% and  10.3% respectively. The Central Bank slightly improved its forecast  for 2020 on the decline in private transfers to 19-22% (from the  previously expected 22-25%).

Considering the fact that the lion's share of remittances comes to  Armenia from Russia (54% in 2019), Russia also holds the lead in  foreign trade turnover (27-28% in 2019 for exports and imports), in  terms of investments, Russia also holds the lead (34.3 % in the total  volume and 65.2% in the volume of FDI), therefore, as a recipient  country, Armenia will painfully endure the recession of the economies  of donor countries, and the predicted deterioration of the economic  situation in Russia in 2020 will have a particularly negative effect  on Armenia, since the main macroeconomic indicators of the country  face the threat of decline.