FinRating ArmInfo: Profits of Armenian banks stagnate under the  burden of growing NPLs

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.