Banking Sector: Remaining The Regional Underperformer
BMI View : Ukraine's banking sector is set to remain a regional underperformer, plagued by ongoing asset quality problems, a weak macroeconomic environment and systemic FX risks. While profitability has improved by some metrics, any recovery will be protracted, and our expectations for a devaluation of the hryvnia, if realised, implies further loan quality deterioration lies ahead. Overall, we forecast aggregate loans to grow by just 3.5% in 2013, and have raised our forecast for deposit growth to 15.0% y-o-y, from 11.0% y-o-y.
Total loan growth in the first quarter of 2013 averaged just 3.3% y-o-y as the economy slunk back into recessio n. Household lending has held up better than business loan books, growing by 5.9% y-o-y in April, while lending to non-financial corporates grew at 3.4% y-o-y in the same period. This broadly mirrors the state of economic activity in the wider economy, where household consumption has remained relatively strong due to successive increases in social transfers from the government combined with a reduction in inflation to historical lows, boosting household purchasing power. L oans to households and non-financial corporations represent 23% and 74% of aggregate loans respectively, accounting for a combined 97% of the loan book.
|Corporate Loan Growth At Risk From Recession|
|Ukraine - Loan Growth, % chg y-o-y|
Weak asset quality continues to plague banks across both household and corporate loan books. Non-performing loans (NPLs) spiked to 16.5% in Q412 before falling slightly to 15.9% in Q113 , although we note that Ukraine's central bank adopted a highly unconservative NPL methodology post-2007 which flatters the headline figure. Using more widely adopted reporting procedures, we estimate the aggregate NPL rate to be at least twice the current level. With the economy now back in recession, we expect that non-financial corporate NPLs will rise slightly over the coming quarters. Furthermore, our expectations for a devaluation of the hryvnia, if realised, would see a substantial rise in both household and corporate NPLs due to higher debt servicing costs on FX loans, which still account for around 38% of total loans.
|A Gradual, Vulnerable Recovery|
|Ukraine - Banking Sector Profitability Metrics, %|
Liquidity conditions do appear to have improved slightly: rates on the interbank market have normalised, and the volume of liquidity supporting transactions carried out by the National Bank of Ukraine (NBU) have also declined since Q213. In light of the strong disinflationary trends that Ukraine has experienced over the last 12 months, and in line with our long held expectations, the NBU cut the benchmark rate by 50 basis points to 7.00% in June, underscoring the authorities' rising concern over the state of economic activity. In light of persistently low inflation, we expect further rate cuts may now be in the offing, and may look to adjust our benchmark rate forecast soon.
|FX Risk Still A Major Concern|
|Ukraine - FX Loan Metrics, %|
Nonetheless, the economic impact of further cut s is likely to be limited. Ukraine's monetary policy mechanism tends to be partially effective at best, with the efficacy of monetary policy transmission channels impaired by high levels of dollarization in the economy and collateral quality issues. Furthermore, ongoing concerns over currency stability will continue to keep credit standards tight across the sector. That said, it could help to improve bank net interest margins (NIM), which have been suffering recently. The aggregate NIM fell to just 3.98% in Q113, from 5.79% in Q111, although return on common equity improved to 7.12%, from -10.19% over the same period, and return on assets rose to 1.07%, from -1.45%. Nonetheless, improved profitability could prove transient, as tightening global liquidity pushes up external funding costs for Ukrainian banks.
|Exposure To Manufacturing Remains A Concern|
|Ukraine - Sectoral Composition Of Loans, % total|
Overall, we retain a highly negative outlook towards the sector. Banks will struggle to expand their loan books in light of the gloomy macroeconomic environment, and legacy impaired assets continue to act as a drag on bank balance sheets. Furthermore, the systemic FX risk present in the system is exacerbated by ongoing currency devaluation risks, which will continue to rise over the course of the year. We do not expect to see a significant turnaround in the fortunes of the sector for several years at the earliest, and expect it to remain an underperformer among regional peers.