ukrainian banking sector outlook 2015-16

Ukrainian Banking System: After the Perfect Storm

Ukrainian Banking Forum, October 2015

Yaroslav Sovgyra, Associate Managing Director, Financial Institutions Group

‹#›Ukrainian Banking Forum, October 2015

Agenda

1. Ukraine on Moody’s rating scale

2. Operating environment

3. Banking system outlook


Agenda

Ukraine on Moody’s rating scale1

Operating environment2Banking system outlook3


Ukraine on Moody’s Rating Scale1

Ukrainian Banking Forum, October 2015 5

Ukraine’s Sovereign Rating is Ca

» Local currency bond and deposit ceilings are Caa2 » Foreign currency bond ceiling is Caa3, deposit ceiling is Ca

LT Issuer Rating (Domestic)

Ca


Sovereigns Rated Caa1 - C

» There are currently 8 sovereigns rated by Moody’s Caa-Ca

Rating Sovereign

B3 Barbados, Bosnia and Herzegovina, Cyprus, Democratic Republic of the Congo, Ecuador, Egypt, Ghana, Honduras, Moldova, Nicaragua, Pakistan

Caa1 Belarus Argentina (LC) – unresolved 2002 default on government debt

Caa2 Cuba – unresolved 1986 default on government debt Jamaica – distressed deb exchange in 2013 Belize – distressed debt exchange in 2013 Caa3 Greece, Venezuela

Ca Ukraine – in default until debt exchange is completed

c none


Ukraine Will Rely on IMF’s Support as Market Access is Likely to Remain Limited

» Moody’s treats Ukraine’s agreed debt restructuring as distressed exchange

» On average, sovereign governments remained out of international capital markets for 5.6 years after default and 4.4 years after final default resolution

» Length of market exclusion was highly correlated with the loss imposed on investors during the debt restructuring

Source: Moody’s Investors Service


Key Rating Drivers of the Sovereign Rating

Credit Strengths

» Substantial natural resources

» Educated and low-wage labor force

Credit Challenges

» Weak external liquidity

» Low institutional quality

» Large contingent liabilities

» High domestic political risks and very high geopolitical risks


Ukraine’s Rating Factors

Government Bond Rating Range

Government Financial Strength

Caa2 - C

Economic Resiliency

Institutional Strength Fiscal Strength Susceptibility to

Event Risk

Very High (+)

Very Low (-)

Very Low (-)

Economic Strength

Very Low (+) Very Low (-) Very Low (+)

Factor Score Assessments and Indicative Rating Range


What Can Change Rating Up / Down

An upgrade would likely require » Improvements in its external liquidity position » Positive policy track record of structural reforms » Improved economic growth prospects and » Positive debt dynamics

Moody’s would downgrade Ukraine's rating if bond holders were to incur higher losses than what is captured by the Ca rating as a result of the planned debt restructuring, or any other default by the government


Operating Environment3


GDP Contraction

» Ukrainian economy has not recovered from 2008-09 crisis and was double hit by the new economic, financial and political crisis

» Real GDP contracted 6.8% in 2014 and 15.8% in 1H2015 » Moody’s estimates GDP decline of 7.5% in 2015 and 2.0% in 2016

70%

80%

90%

100%

110%

-30%

-21%

-12%

-3%

6%

2008 2009 2010 2011 2012 2013 2014 2015 2016

GDP growth, YoY GDP growth, 2008=100%

79.1%80.8%

87.3%

93.7%93.7%93.5%

88.7%85.2%

100.0%100.0%

85.2%88.7%

93.5% 93.7% 93.7%

87.3%

80.8%79.1%

Source: State Statistics Service of Ukraine, Moody’s forecast


High Inflation

» Ukraine’s economic downturn partly reflects the erosion of the purchasing power of households as a consequence of rising inflation, in turn due to ▪ the depreciation of the hryvnia and ▪ hike in administered prices

Inflation

-10%

0%

10%

20%

30%

40%

2008 2009 2010 2011 2012 2013 2014 2015 2016

22%

12%9%

5%

-0% 1%

25%

36%

18%

Source: State Statistics Service of Ukraine, Moody’s forecast


Local Currency Depreciation

» The UAH lost more than 60% if its value and remains highly vulnerable to further volatility:

▪ falling exports -> the supply of FX on the market is scarce

▪ NBU's FX reserves remain depleted

UA

H p

er 1

US

$

0

10

20

30

40

US

$ bi

llion

- 0

6

12

18

24

YE2011 Jun-12 YE2012 Jun-13 YE2013 Mar-14 Jun-14 Sep-14 YE2014 Mar-15 Jun-15

UAH per US$1 (LHS)FX reserves (RHS)Source: National Bank of Ukraine


Ukrainian Banks: Current State and Moody’s Forecasts

15


Key Drivers for Ukraine’s Negative Banking System OutlookFactor Trend CommentsOperating environment

Deteriorating - Economic contraction will deepen in 2015 and continue in 2016

- Ongoing military conflict in industrial regions

- Sharp hryvnia depreciation and high inflation -> weak internal consumption

Asset quality and capital

Deteriorating - Further erosion of already weak asset quality

- Problem loans will rise to 60% of gross loans in 2015, while NPLs will rise to 40% from 25% - Provisioning needs would completely erode Ukrainian banks' capital

Funding and liquidity

Deteriorating - Deposit outflows until recently

- We expect further distress exchanges to extend maturities

Profitability and efficiency

Deteriorating - Pre-provision profitability will deteriorate because of declines in performing loans

Systemic support

Deteriorating - Ukrainian government has very limited ability at present to provide timely capital support to banks


Performance of Ukrainian Bank’s Core Industries Exposure Will Be Weak in 2015-16

17

Source: National Bank of Ukraine, State Statistical Service of Ukraine, Moody’s Investors Service

Exposure as of 1 April

2015

% total corporate loan book

Foreign currency

denominated

Asset quality trend for 2015-16 Rationale

1Wholesale trading 228,082 25% 52% ↓ Weak internal consumption

2Construction and real 135,600 15% 53% ↓ Weak internal consumption

3 Agriculture 59,027 7% 47% ↔ Stable export and production

4Metals and mining 58,988 7% 84% ↓

Low production and export, production in military conflict

5Food production 56,479 6% 65% ↓

Trading barriers from Russia, limited progress with EU

6 Retail trading

54,577 6% 26% ↓ Weak internal consumption

7Professional services 43,293 5% 30% ↓ Weak internal consumption

8Transportations and

41,287 5% 81% ↓

Weak internal consumption, low foreign trade activities

9Energy and public

33,318 4% 60% ↓ Low production

10 Chemicals 26,800 3% 77% ↓ Low production and export

TOTAL 737,452 82% ↓


Asset Quality Is Weak and Continues to Deteriorate

18

Source: National Bank of Ukraine, Moody’s estimates

40% 40% 37% 35%

45%

60%

15% 14%16%

13%

18%

35%

0%

5%

10%

15%

20%

25%

30%

35%

40%

0%

10%

20%

30%

40%

50%

60%

70%

2010 2011 2012 2013 2014 2015F

Problem loans % loans, Moody's est. (LHS) LLR % Loans, Local GAAP (RHS)

» Economic contraction together with sharp LC devaluation weakened borrowers’ ability to service debt. We expect NPLs to increase to 40% at YE2015 and restructured loans to comprise another 20%

» Reported LLR do not cover in full even NPLs, let alone restructured loans


Exposure to FX Risk

19

FX-denominated loans, % of Net loans

0%

18%

35%

53%

70%

State-owned banks Foreign-owned banks Large private banks Rest of the system System-average

53%

32%

43%

67%

56%

37%

23%27%

55%

39%

YE2013 1H2015

» Hryvnia depreciation inflated the value of foreign-currency denominated loans » Revaluation of legacy NPLs in FX call for additional LLR

Source: National Bank of Ukraine, Moody’s estimates


Banks Will Remain Loss-Making in 2015-2016

20

» Ukrainian banks’ earning are eroded by large NPLs (need for LLRs) and high funding costs » Recurring revenues can only absorb additional credit costs of 3% of gross loans

0%

10%

20%

30%

40%

State-owned banks Foreign-owned banks Large private banks Rest of the system System average

3.0%2.2%0.4%

4.3%5.5%

22%

11%14%

25%

35%

LLR / Gross loans PPI /Average gross loans

Note: Recurring PPI (Pre-provision income) = Net interest income + Net fee and commission income – Operating expense Source: National Bank of Ukraine, Moody’s Investors Service estimates


Regulatory Capital Adequacy Ratio Under Moody’s Base-Case Scenario

21

Source: National Bank of Ukraine, Moody’s Investors Service estimates

8.4%

2.0%

-13.7%-3.3%

-2.2%

-8.8%

-20%

-15%

-10%

-5%

0 %

5%

10%

15%

Regulatory CAR asat Q1 2015

Retained earningsafter four quarters

Additional LoanLoss Charges

Securities exposureTier 2 amortisation CAR after stress &capital

replenishment

» Our scenario analysis generates a negative capital adequacy ratio sector-wide in a one-year horizon provided all necessary provisions are expensed


Capital Dynamics by Group

22

Note: Net of insolvent banks

Source: National Bank of Ukraine, Moody’s Investors Service estimates

» New capital injections are needed to restore solvency » Private shareholders do not inject much capital

-40%

-30%

-20%

-10%

0%

10%

20%

Regulatory CAR as at Q1 2015

-0.109

-0.292

0.076

0.107

-0.135

-0.303

0.062

0.106

-0.026

-0.203

0.096

0.0810.005

-0.15

0.054

0.101

state-owned foreign-owned large private system-average


Liquidity Risks Due to Vulnerability of Deposit-Base

» Contraction of real income capital control contain expansion of customer deposit base

UA

H b

illio

n

-0

200

400

600

800

Dec Mar Jun Sep Dec Mar Jun Sep

Local currency Foreign currencyDevaluation effect

Source: National Bank of Ukraine


High Reliance on Foreign Currency Wholesale Funding

» Ukrainian banks are locked out of the capital markets and rollover rates are low » Unlike in case of sovereign debt, Oschadbank’s and Ukreximbank’s debt restructuring terms

do not envisage any grace period and therefore no significant pain relief is expected

0%

8%

16%

24%

32%

US

$ bi

llion

- 0

8

15

23

30

2010 2011 2012 2013 2014 1H2015

Foreign debtFC Wholesale funding, % Total liabilities…, net of foreign banksSource: National Bank of Ukraine, Moody’s estimates


Liquidity - Sufficient But Depended on NBU Funding

25

Source: National Bank of Ukraine

» Liquid assets are mainly composed cash and equivalents and Ukrainian government bonds

0 %

10%

20%

30%

40%

50%

60%

-

100

200

300

400

500

600

700

800

2009 2010 2011 2012 2013 2014 Aug-15

Deposits (LHS) Liquid assets (LHS) Liquid assets % total deposit (RHS) Liquid assets % total assets (RHS)


Government Support: LC Liquidity Supply and Regulatory Forbearance

26

» Capital support

▪ tight budget does not allow the government to participate in recapitalization of banks

▪ IMF support package does envisage any funding for bank recapitalization either

▪ NBU allows banks to breach prudential ratios

» Liquidity support

▪ NBU provides repo facilities against state bonds collateral

▪ the repayment deadline is extended until 2020

▪ various administrative measures - cap on foreign-currency deposit withdrawals, ban on prior-to-

maturity withdrawal of time deposits


Conclusion

27

Banks face highly adverse operating conditions1Asset quality is weak pressured by rapid build-up of new NPLs,

driving up provisioning needs2

3Banks are in need of massive recapitalization; Ukrainian authorities

have limited capacity to support the banking sector4Funding: weak depositors confidence and lack of access to market

funding remain key concerns 5

Banking system is expected to be loss-making both in 2015 and 2016


Yaroslav Sovgyra

Tel. +7 495 228 6076

AMD, FIG

[email protected]


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