ArmInfo. The accelerated growth of non-performing loans (NPL) continues in the banking system of Armenia, pushing profit, and thereby depriving capital buffers of the opportunity to replenish.
This is the conclusion reached by the analysts of the national rating agency (CRA) AmRating, affiliated with the information company ArmInfo. In such a situation, analysts say, the banks have shown a determination not to postpone until tomorrow the solution of today's problems associated with clearing the loan portfolio from that part of the burden of defaults that were frozen for a year under the regulatory "concession" introduced since December 2020.
They believe that it is difficult to predict an improvement in the situation for the current year, since the emergence of a new coronavirus strain "delta" and the still slow vaccination process are likely to threaten with further restrictive measures. The fight against covid is still not over, and vaccination, now mandatory, is still proceeding slowly due to citizens' doubts about the effectiveness of vaccines in general and against new strains of the virus in particular.
Meanwhile, according to the company's experts, the share of NPL in the loan portfolio increased in the first half of 2021 to 10.2% from 8.4% in the first half of 2020, and in assets - from 5.6% to 6.2%. This phenomenon was observed against the background of a significant slowdown in the annual growth of credit investments from 19.1% to 2.5% and a less noticeable slowdown in asset growth from 14.1% to 13%. Moreover, only in the second quarter of 2021, lending lingered in a decline with an acceleration of rates from 1.1% to 4.6%, against the background of which the exit of assets from stagnation proceeds very slowly (from 0.2% to 1.7%). In their conclusions, the experts relied on the data of the Financial Rating of Banks of Armenia as of June 30, 2021, prepared by ArmInfo IC based on financial reports, which include a new format for presenting credit risk (according to IFRS9). However, this international format does not fully reflect the situation of the real quality of the loan portfolio and the presence of toxic loans (NPL) in it. This fact has been repeatedly noted in their reports by the world's largest rating agencies. As a result, the rating service of ArmInfo IC asks the banks for the necessary additional data, which makes it possible to more accurately calculate the total volume of overdue loans and, consequently, their share in the loan portfolio and banks' assets.
Growing bad loans maintain dominance among arrears
About 60% of NPL falls on dubious and hopeless risk groups, with the preservation of the last tangible dominant growing in volume. By industry, over 40% of overdue loans are consumer loans (including mortgages), with an annual increase in the volume of non-performing loans by 18.4%, while healthy loans declined by 5%. The second place in terms of the share of NPL is occupied by the trade sector, where more than 12% of non- performing loans (mostly bad) have accumulated, with an annual growth of 17.6%, with a decline in healthy loans by 10.2%.
The third place in terms of the share of NPL is occupied by agricultural loans - over 10%, with an annual increase in the volume of non-performing loans by 18%, with an increase in healthy loans by 14%. Then, in terms of the share of NPL, there are loans in the field of catering and services - about 9%, with an annual growth of 26.5% with a 3.4% decline in healthy loans.
The share of NPL in loans to the industrial sector is much lower - over 4%, with an annual decline in volume by 35.4%, with a 6% decline in healthy loans. And almost the same amount of arrears has accumulated in loans to the construction sector (about 4%), with an annual growth of 5.6% with a noticeable 34% increase in the volume of healthy loans.
The above segments dominate in the portfolio in terms of the share of credit investments: consumer loans - 26.7%, trade - 17.2%, industrial sector - 13.6%. At the same time, the share of mortgages accounts for 13.7%. And the shares of lending to the construction sector and catering / services amounted to 7.9% and 7%, respectively, and the agricultural sector - 5.7%.
Meanwhile, the annual dynamics of the volume of consumer loans turned from 28% growth to 5.3% decline, with continued high mortgage growth with an acceleration of rates from 36% to 37%. Lending to the agricultural sector has maintained growth, but with a slowdown in annual rates - from 14.1% to 12.1%, catering / services - from 8.1% to 4.1%. The growth rates of lending to the retail sector contracted more significantly - from 15.5% to 3.3%. The growth of lending to the industrial sector slowed down from double-digit growth to a stagnation level - from 12% to 0.8%. The growth of lending to SMEs also continued to slow down - from 5% to 4% (versus 15% two years earlier).
And only lending to the construction sector not only maintained high growth, but also accelerated the annual rate from 31% to 34.4%, which is due to the continued activity of housing construction. But, taking into account the opinion of experts who consider it shortsighted to continue to build buildings with the expected decrease in demand, it can be assumed that lending to this area in the short term will not only begin to lose pace, but also deteriorate in quality.
The total loan portfolio of Armenian banks by July 1, 2021 exceeded 4.1 trillion drams ($ 8.3 billion), and assets reached 6.8 trillion drams ($ 13.7 billion). At the same time, a noticeable slowdown in the annual growth of the former, with a moderate deceleration in the growth of the latter, reduced the share of loans in assets from 67% last year to the current 61%. Profit stagnates Accelerated growth in toxic loans drove profits into stagnation. Thus, the aggregate net profit of the banking system of Armenia, amounting to 40.7 billion drams ($ 82 million) in the first half of 2021, slowed down the annual growth from 6% to stagnant 0.1%, which was observed against the background of accelerating growth in the volume of overdue loans to 24% (from 8.2% a year earlier). And even the quarterly net profit, under pressure from write-offs of toxic loans, sharply slowed down the growth rate from 10-fold in the first quarter to 9.6% in the second quarter, while the volume of NPLs was moderately trying to decline. In particular, a decrease in profits, and a significant one, was observed in 9 out of 17 banks, but all banks completed the quarter and half a year with a positive level. At the same time, the annual decline in the volume of overdue loans was recorded only in 3 banks (by 12-32%), while of the remaining 14 banks that increased their portfolio of defaults, 7 had an impressive growth (2-6-fold). This state of affairs, analysts say, will be observed, in all likelihood, throughout 2021-2022, until the pre-covid upward trend in lending in particular and economic development in general is fully restored. Clearing the loan portfolio of current and "unfrozen" defaults will for some time push profits, but the positive trends emerging in the economy suggest that in the short term lending will return to double-digit growth, and then profits will cease to bear losses. The trend is accompanied by a slight slowdown in the decline in the value of healthy (standard) loans in Q2 from 1.7% to 1%, while the annual growth slowed down from 12% to 3%. It is pertinent to note that last year's double- digit upward trend fell on the period of initiation by banks from March 13 to June of credit payment holidays, implying renegotiation of contracts to keep them in a healthy category, and at the same time, banks were actively involved in the 1st and 2nd anti-crisis state programs on social and economic assistance to business entities affected by the consequences of covid.
Capital adequacy declines
The level of total capital adequacy on average in the banking market by July 1, 2021 decreased to 24.6% from 27.1% a year earlier (against 29.9% as of the same date in 2019), and the level of capital adequacy - from 27.6% up to 22.7%, with the required regulatory minimum at 12% and 9%, respectively. But in the quarterly view, there were still weak signs of growth in both indicators. The downward annual trend in the capital adequacy ratio is explained by almost 20% growth in risk-weighted assets with too weak growth of 3% in total capital. And the weak quarterly growth in capital adequacy was triggered by a 4% decline in risk-weighted assets with a stagnant 0.3% growth in total capital.
As for liquidity, the level of the general resumed growth, reaching 34.8% on average in the banking market by July 1, exceeding not only the level of 31.1% a year ago, but even the pre-covid level of 31.9%. At the same time, the level of current liquidity continued to decline - to 159.3% by July 1, 2021 from 167.7% a year earlier, which further distanced from the pre-covid 172.9%. But on a quarterly basis, both total and current liquidity were on the rise, and the overall one grew more rapidly than the current one. This is explained by a significant 41% annual increase in highly liquid assets, with a relatively moderate 13-21% growth in assets and liabilities on demand, and in the quarterly breakdown, 18% growth in highly liquid assets turned out to be much higher than the almost stagnant rates of total assets and too weak growth in demand liabilities. And the average level of newly introduced short-term (LCR) and long-term (NSFR) liquidity on average in the banking market as of July 1, 2021 amounted to 266.5% and 145.2%, respectively (with the minimum required 100%). Moreover, according to LCR, a significant excess (2-fold or more) of the required minimum is recorded in 10 banks, and according to NSFR, only 3 banks could provide a tangible prevalence (almost 2-fold) over the required minimum.
Out of 17 banks operating in Armenia, the annual decrease in the total and fixed capital adequacy was observed in 11, the level of total liquidity - in 7, and current liquidity - in 8. Moreover, a couple of banks, including large creditors of the economy, have come too close to the minimum required threshold (for total capital - 12%, fixed capital - 9%, total and current liquidity- 15% and 60% respectively).
Central Bank strengthens banks' resilience to liquidity shocks
The risks of an outflow of funds against the background of the crisis phenomena associated with the uncertainty of the timing of the exit from the coronavirus pandemic, due to the ongoing mutation of the virus into new more formidable strains, and domestic and foreign policy shocks, predetermined the steps of the Central Bank of Armenia to take early proactive measures to neutralize short-term and long-term shocks liquidity of the financial system. As part of these measures, new prudential liquidity ratios recommended by Basel III were introduced in 2021: short- term (LCR - Liquidity Coverage Ratio ) and long-term (NSFR - Net Stable Funding Ratio).
These measures, along with an increase in capital requirements, were proposed for introduction long before 2020 - in December 2017, but were periodically postponed and the deadline for implementation was to enter into force on January 1, 2023. However, the surging coronavirus pandemic, with an endless undulating course, and the second Karabakh war had a negative impact on the economy and the level of real incomes of the population, leading to a deterioration in the quality of the banks' aggregate loan portfolio and the pushing of profits, which predetermined the faster introduction of new liquidity standards. And even the envisaged gradual increase in the minimum LCR and NSFR values, from the initial 60% in the first half of the year to 80% in the second half of the year and then 100% from January 1, 2022, passed at an accelerated pace, thanks to the determination of Armenian banks to start right from the final bar. Along with them, as usual, the liquidity risk ratios of total and current liquidity at the level of min 15% and 60%, respectively, continue to operate.
The Central Bank has a restrained attitude to other Basel requirements - three capital adequacy premiums, as evidenced by the countercyclical capital buffer kept at a zero level (CCyB - introduced from August 2020) and not introducing premiums to maintain capital adequacy and for systemically important banks. By this decision, the Central Bank mitigates the negative consequences of the coronavirus and martial law on the financial system, and contributes to the continuity of lending to the Armenian economy. The Central Bank still considers it inappropriate to toughen the CCyB, and regarding the other two allowances, it declares its readiness to introduce them in case of preconditions. In the meantime, the Central Bank estimates the capital buffers of the banking sector to be sufficient to maintain the stability of the financial system. But, restraining from introducing the Basel III recommended premiums, the Central Bank resumed since 2020, after a 12-year hiatus (then at the level of min 8%), the capital adequacy ratio, first at a minimum level of 10%, subsequently reducing to 9% in May along with which the current standard of total capital adequacy was maintained at the level of min 12%.
According to AmRating analysts, the regulator is thus signaling banks to use the buffers of formed capital to ensure the continuity of banking operations in order to withstand stressful situations and absorb losses during the coronavirus crisis.
At the same time, the Central Bank has so far refrained from introducing the maximum debt burden ratio (DBR), due to the difficulties of accounting in calculating the recorded and unaccounted income of a potential borrower. But discussions continue and various kinds of calculations are carried out to find the correct option for using this standard. However, in return for this, the regulator announced in June its intention to introduce the LTV (Loan-to- Value Ratio) standard from July 2021. The results of the next quarters will show how effective this ratio will be in terms of eliminating overlending of borrowers and improving the loan portfolio. In addition to overseeing the banking system, the Central Bank also focused on ensuring price stability. Seeing the trend of accelerated deepening of inflation, the Central Bank has repeatedly taken steps to tighten monetary conditions, increasing the refinancing rate five times this year - from December 5.25% to September 7.25%. Judging by the permanent upward movement of both actual and real inflation - with an exceeding by September of the 8% y-o-y level, apparently, the refinancing rate in the direction of growth will be revised more than once until it is possible to return inflation to the target (4%). And since the Central Bank plans to bring inflation closer to the target threshold in 2022 and stabilize it at the target level in the medium term, it can be assumed that during this entire period, at least until the target of 4% is achieved, the refinancing rate will continue to grow. Interestingly, interest rates are still very weakly responsive to the decisions of the Central Bank, making imperceptible attempts to grow, thereby preventing the margin from returning to the precovid level, in addition to which weakening interest incomes are increasingly moving efficiency ratios (ROA and ROE) away from their former high levels. So, according to the results of the first half of 2021, the return on assets (ROA) of the banking system decreased to 1.2%, and the return on equity (ROE) - to 9.1%, from the pre-covid 1.5% and 9.9% in the first half of 2019. "And against this background, the banking system is becoming less and less transparent, since with the transition to the new IFRS9 reporting, the new format does not fully disclose the structure of loan quality, calling into question the usefulness of the portfolio classification by risk groups. The greatest concern is the absence of the most formidable and dangerous to assess the reliability of banks, article on bad loans, the volume of which, against the background of the ongoing pandemic, falling incomes of the population and weak prospects for economic recovery, will definitely grow and have a negative impact on profits. As a result, the above 60% does not fully reflect the toxicity of the portfolio. However, the massive "presence of bad loans indicates a noticeable deceleration in the rate of interest income from lending from 14.4% to 4.6%, and for the quarter with entering a 2.5% decline, and stagnation of profits," the analyst of the national rating agency AmRating Karina Melikyan noted.
A year ago, the agency's analysts suggested that the process of write-offs of bad loans from the balance sheets after the credit payment holidays (from March 13 to June) would continue, the actual materialization of which over the next months began to "push" the level of profitability of the banking sector up to a decline of 20% in 2020. This trend spread to 2021, during which the situation, as predicted by AmRating analysts, began to be complicated by the beginning process of "unfreezing" of part of the burden of non-refunds transferred within the framework of regulatory "concessions" from last year to the current one. It will be possible to restore the previous growth rates no earlier than 2025 The likelihood of rectifying the situation and restoring pre-pandemic indicators in the short term is not visible. Moreover, even before 2023, it is unlikely that it will be possible to approach the previous levels. Now, the latest forecasts predict a possible recovery of the previous economic growth rates no earlier than 2025. In its June forecast, the EDB improved its expectations for GDP growth in Armenia for 2021 by only 0.9 p.p. - up to 4.2%, indicating a very gradual movement of the economy towards the level of its potential. This upgrade was driven by improved estimates of economic growth in Russia, the Eurozone and the United States for 2021, strong remittance inflows (both actual and expected), and higher copper prices. Meanwhile, the World Bank, having updated its forecast in June, left without changes expected in 2021 GDP growth in Armenia at the level of 3.4%. The International Monetary Fund, which initially gave the most conservative forecast for GDP growth in Armenia for 2021 at the level of a meager 1%, with the September update sharply improved expectations to 6.5%, but warned that the risks of a slowdown remain elevated, including due to geopolitical tensions, a slowdown in external demand and increased volatility in the global financial market. Moody's, in its August report on Armenia's sovereign rating, predicted 4.5% growth in real GDP in 2021, citing a pickup in manufacturing, agriculture and mining, with continued weakness in services such as tourism ( share in GDP 13% - according to WTTC). Moody's points to the risks of additional coronavirus waves, which will affect domestic activity, as well as reduce the prospects for a rapid recovery of the tourism industry. And an earlier (March) forecast by the Fitch rating agency predicted Armenia's real GDP growth of 3.2% in 2021, which will partly be due to the underlying effects and support for expansionary policies, especially in the field of public investment.
The Central Bank of Armenia turned out to be much more optimistic, with each quarterly update of the forecast, improving expectations for GDP growth for 2021 - from 1.4% in March to 4.6% in June, followed by an increase in September to 5.4%. And calling the agricultural sector and the service sector the main drivers of economic growth, the Central Bank improved their forecast growth for 2021 to 4.2% and 8.1% (from the previous 2.3% and 6.1%, respectively).
The socio-economic difficulties that began in 2020 from the outbreak of the coronavirus pandemic are still noticable, and the undulating course of the virus with a mutation into new, more formidable strains prevents an early exit from this situation. And even attempts of curbing the pandemic by compulsory vaccination is unlikely to bring the timeline for a complete economic recovery closer, since with each wave of covid it becomes less malleable to current vaccines, which in turn threatens new challenges with not bright prospects. And while economic development is in a sluggish current state, with the prospects for a slowdown in 2022 and already weak growth, banks are trying to cope with the problems accumulated during the crisis at the expense of the capital buffer formed during the pre-covid period. But the sufficiency of this airbag is not unlimited, especially in the situation of more and more accumulated non-performing loans (with a dominant of bad loans), which by affecting profits do not allow capital to grow. And so that the capital buffer is not under threat, and banks can confidently develop and grow steadily, it is necessary to return the economy to pre-pandemic growth as soon as possible.
As predicted by AmRrating analysts, the unbalanced and weak economy of Armenia, which is a recipient country, under the influence of the economies of donor countries affected by the coronacrisis, experienced an aggravated impact - pushing through the main macroeconomic indicators. The latter reacted particularly painfully to the deteriorating economic situation in Russia, which traditionally keeps them highly dominant. At the end of 2020, the share of the Russian Federation was: in foreign trade turnover - 30.3% (in exports - 26.6%, in imports - 32.4%), in total investments - 37.4% (in FDI - 75.1% ), in remittances - 64% in net inflow (45% in inflow, 36% in outflow). Since 2021, there has been a very slow recovery in the economies of donor countries, which, in turn, pushed economic activity in Armenia to growth. However, the more formidable delta strain of the virus that appeared in the spring, with the forced resumption of quarantine measures, may postpone the phase of approaching the pre-covid pace to a later date. To some extent, the widespread mandatory vaccination could help keep the economy in the recovery stage. But even with this approach, the prospect of a complete resuscitation of the economy in the short term is doubtful due to the high uncertainty of the incessant undulating flow of covid with mutation into new strains.
This is evidenced by the latest updated forecasts of the World Bank and the International Monetary Fund. Thus, the World Bank expects a slowdown in GDP growth in 2021-2023 in the leading trading partners of Armenia - Russia and China from 3.2-8.5% to 2.3-5.3%, in the world economy - a slowdown in GDP growth from 5.6 % to 3.1%, in the Eurozone economy - from 4.2% to 2.4%, in the US economy - from 6.8% to 2.3%. The IMF expects a slowdown in global growth in 2021-2022 from 6% to 4.9%, the Eurozone economy - from 4.6% to 4.3%, the US economy - from 7% to 4.9%, the Chinese economy - from 8 , 1% to 5.7%, the Russian economy - from 4.4% to 3.1%.
Considering these forecasts on the prospects for the exit of the economies of Russia and other donor countries from the coronavirus crisis, AmRrating analysts are inclined to the likelihood of postponing the recovery of the pre-covid levels of macroeconomic indicators in Armenia at a later date. Analysts explain their assumption by the fact that, due to a sharp increase in the prevalence of the new delta strain with a low number of vaccinated, Armenia again found itself in an epidemiologically dangerous "red zone" (according to EU criteria), which implies restrictions for the country and its citizens. But this is unlikely to affect the upward trend in remittances, since the main driver of growth today is transfers from the United States, which, judging by the expected additional financial support by the states of their citizens in the second half of 2021, will continue to grow, thanks to the altruistic assistance of the Armenian Diaspora. It will most likely be possible to restore the key macroeconomic indicators at the pre-covid level no earlier than 2025, if before that mandatory vaccination develops population immunity and forms herd immunity.
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