Lending stagnation in Armenia - AmRating

ArmInfo.Armenia has entered a stage of lending stagnation. Evidence thereof is a considerable increase in bank profits due to highly active foreign exchange and  securities transactions rather than due to the major income item,  lending.

According to the ArmInfo Financial Rating of Armenian Banks,  as of March 31, 2022, incomes from bank lending showed an  insignificant 0.3% increase against an 8.6-fold increase in incomes  from foreign exchange transactions. Securities transactions showed a  32% increase, which resulted in a 59% increase in the banking  system's net annual profits. 

According to analysts of the AmRating Agency affiliated with ArmInfo,  this situation in banking was accompanied by recovered economic  growth, which exceeded the pre-pandemic growth, - an 8.6% annual  growth in the first quarter. Almost all the economic sectors showed  accelerated indices except for the agricultural sector (5.4%  decline). Among the economic growth drivers were the services sector  (22.2%), energy sector (16.7%), trade sector (7.6%), as well as the  construction sector (6.2%) and industrial sector (3.1%). Armenia's  banking system was hardly involved in this recovery, with lending  rates falling to 0.01% by this April, with a dramatic decline in the  corporate sector and decelerating growth in consumer lending. 

In the first quarter of 2019, 6.5% economic growth was recorded  mainly due to the services sector (17.3%), construction (10.8%),  trade (10.1%), and industry (only 2%). Lending showed a 14.2%  increase in the first quarter of 2019 as compared with the  corresponding period previous year, with accelerating corporate  lending (up to 7.3%) and retail lending (up to 30.3%), including  mortgage lending (29.6%).

The situation in the lending market is unlikely to improve because of  unfavorable forecasts by both international agencies and the RA  Central Bank. Both are expecting the GDP to slow down between 1.2%  and 1.6% as a result of the Russian-Ukrainian conflict and  unprecedented Western sanctions against Russia.  Every cloud has a  silver lining

In turn, Armenia, as a recipient country having close links with  Russia in terms of key economic indicators and money transfers, is  becoming an indirect target of the sanction warfare. It is  noteworthy, however, that Armenia, as a "relocation address" for some  part of Russia's IT community and an easy-to-reach tourist  destination, has been able to remain financially stable by enabling  its banks to retain high-rate growth in profits. Successfully  absorbed huge funds will have a positive effect on such aspects of  banking as card market development and, perhaps, mortgage lending. On  the other hand, domestic and foreign political instability may have a  negative effect on this favorable trend. 

Russia is continuing its "special operation" in Ukraine, with the  number of anti-Russian sanctions increasing. China and Iran  (Armenia's leading donors along with Russia), which have not joined  the sanctions, are preparing for confrontation with the United States  and its allies over sanctions. This has a negative impact both on  global economy and on the GDP of the United States, European, Asian  states and other regions, which, in turn, affects Armenia as well, as  Russia, although the major, is not the only trade and economic  partner of Armenia. The aggravating situation and total uncertainty  about a way out of it are reducing the possibility of recovering the  pre-pandemic economic growth rates, which, in turn, inhibits banks'  actions to overcome lending stagnation. Should sanctions continue  longer, it could cause a loan market break and inevitable profit  loss. 

Nevertheless, the CRA AmRating analysts believe that Armenia, with  Russia, China and EU member-states (mostly mineral raw materials) as  its major trade partners, has chances to get out of the global  economic and geopolitical crisis situation without serious losses,  with 2-2.5% economic growth in 2022.  Profit against all odds

The Armenian banking system's net profit totaled AMD 30.8bln  ($63.3mln) in the first quarter, with AMD 23bln received from foreign  exchange transactions. Incomes from securities transactions totaled  AMD 22.7bln ($56mln), with hardly any changes in incomes from lending  (AMD 107.2bln or $220.5mln) due to a 42% increase in the mortgage  portfolio up to AMD 711.bln ($1.5bln - 16.5% in the loan portfolio  against 8.5% in 2019). 

In the lending portfolio, the share of corporate lending decreased by  3.1%, with moderately growing retail lending up to 7.1% against 7.2%  and 7.4% respectively last year, which was much less as compared with  the corresponding pre-pandemic period (17.4% and 32% respectively). A  decrease in corporate lending has been recorded in all the sectors  except for construction. Specifically, lending to the industrial  sector decreased by 7.1%, to transport and communication by 24.6%, to  the trade sector by 4%, to the public catering and services sectors  by 1.1%. Lending to the construction and agricultural sectors  continued growing - 21.5% and 15.8% respectively, which must have  prevented a further decline in the lending portfolio. Lower-rate  lending to SME has been recorded - 11% down to 6.3%. Of interest is a  considerable increase in leasing (34%), a substantial decrease in  factoring down to the insignificant 3% and a 6% decrease in letters  of credit and bank guarantees. 

Consumer lending, which continues growing mostly due to mortgage  lending and, to an extent, due to loans on mortgage and car loans, is  showing sings of decline similarly to corporate lending in terms of  other loans - overdrafts, credit cards, lombard loans. 

Toxic loans still under control

Non-performing loans (NPL) showed a 28% year-on-year decrease by the  end of the first quarter - down to AMD 332bln ($683mln, with bad  loans included), with a simultaneous 0.2% decline in conventional  loans - down to AMD 3.6bln ($7.4mln). An opposite picture was  observed in the corresponding period last year - a 48% increase in  NPL, with a 3.2% increase in conventional loans. As a result, the NPL  share in the loan portfolio showed a year-on-year decrease from 11%  down to 7.7%, and in the assets, from 6.9% down to 4.6%. 

However, NPL continue dominating due to consumer loans (with mortgage  lending included), with their share being 43% against 35% last year.  Most of them are doubtful and bad loans. The NLP share in rapidly  growing mortgage lending was only 4.2% (against 3.1% last year).  Lending to the trade sector ranks second - 12% against 11% last year,  followed by lending to the public catering and services sector - 7%  against 6%, to the agricultural sector - 6% against 7%, to the  industrial sector - 5.5% against 5.2%, to the construction sector -  2.2% against 3.2%, to the transport and communication sector 1.3%  against 1.5%

However, the IFRS9, which does no require sectoral grouping in terms  of risks or indication of highly risky loans does jot fully show the  real quality of the loan portfolio and present of toxic loans (NPL).  To calculate the share of past-due loans in lending portfolio and  assets, the ArmInfo rating service applies to banks for additional  data. The world-famous rating agencies have repeatedly pointed to the  fact that the balance sheets released by Armenian banks do not  contain full information on lending risks. They forecast resumed  growth in lending next year, warning of risk of further increase in  NPLs.  

AmRating analysts believe that the growing incomes of Armenia's  banking system are most probably for a short period. Evidence thereof  is stagnant interests on loans, which are highly likely to decline.  And this trend this year will cause a decline in gross incomes. And  the decreasing lending in almost all sectors (industry, trade,  transport and communication, public catering and services), with  consume lending growing, is evidence of such a scenario, which  increases thee probability of resumed increase in NPLs, with most of  them being bad loans, eating away at the profits. It can hardly be  saved due to other assets, as their share in the gross incomes is  insignificant. Therefore, in case of large-scale write-off of toxic  loans long-term growth in profits cannot be ensured. AmRating  analysts believe the possibility of buffer replenishment in the case  of a decline in incomes will be reduced as well.