Financial Analysis Of Vtb Bank Russia Finance Essay
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VTB Bank is the largest financial institution in Russia. It is the main entity
of the VTB Group, a leading universal Russian banking group offering a
wide range of banking products and services in Russia, the CIS, Western
Europe, Africa and Asia.
In 2007 disposable household income grew by 10.4%. The average salary
reached RUB 13,527; its real growth was 16.2%. These indicators are
reflected in the development of the banking sector. Positive economic
trends and rising household income led to increased activity of Russian
citizens on financial markets. VTB was in a strong position
to meet this growing demand as witnessed by the positive growth in all key
areas of the Bank's business.
Last year the Russian economy faced a series of problems. First and
foremost, the most pressing problem was inflation, which was tied to a
significant degree, to the rising prices for certain goods on world markets.
Our country, which is already highly integrated into the global economy, felt
the effect of the negative developments in the economy.
Thanks to effective delivery of its strategy, VTB managed to neutralize the
consequences of these trends and significantly decrease the level of
macroeconomic risks. The outcome of these efforts is VTB's impressive
results, which are reflected in this report.
The key indicators of banking activity in Russia allow us to characterize
2007 as a very successful year for the banking sector. The rate of growth of
most indicators was the highest in recent years. Banking sector assets grew
by 44.1%, while the rate of capital growth was 57.8%.
Even in this context, VTB's success stands out. Its growth significantly
outstripped the market average. For example, VTB's assets grew by 76.7%
due mainly to the IPO carried out this year, the largest among European
banks in 2007.
VTB's contribution to the development of the banking sector and the
Russian economy, as a whole, is increasing with every year. VTB is among
the leaders in virtually all spheres of financial activity, and is one of the
fastest growing banking groups
in the country.
Key Financial & Operational Indicators:
Financial Results
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CAMELS ANALYSIS
The banking sector has been undergoing a complex, but comprehensive
phase of restructuring since 1991, with a view to make it sound, efficient,
and at the same time forging its links firmly with the real sector for
promotion of savings, investment and growth. Although a complete
turnaround in banking sector performance is not expected till the
completion of reforms, signs of improvement are visible in some indicators
under the CAMEL framework. Under this bank is required to enhance
capital adequacy, strengthen asset quality, improve management, increase
earnings and reduce sensitivity to various financial risks. The almost
simultaneous nature of these developments makes it difficult to disentangle
the positive impact of reform measures. Keeping this in mind, signs of
improvements and deteriorations are discussed for the three groups of
scheduled banks in the following sections.
CAMELS Framework
Supervisory framework, consistent with international norms, covers risk-
monitoring factors for evaluating the performance of banks. This framework
involves the analyses of six groups of indicators reflecting the health of
financial institutions. The indicators are as follows:
CAPITAL ADEQUACY
ASSET QUALITY
MANAGEMENT SOUNDNESS
EARNINGS & PROFITABILITY
LIQUIDITY
SENSITIVITY TO MARKET RISK
The whole banking scenario has changed in the very recent past on the
recommendations of Narasimham Committee. Further BASELL II Norms
were introduced to internationally standardize processes and make the
banking industry more adaptive to the sensitive market risks. The fact that
banks work under the most volatile conditions and the banking industry as
such in the booming phase makes it an interesting subject of study.
Amongst these reforms and restructuring the CAMELS Framework has its
own contribution to the way modern banking is looked up on now. The
attempt here is to see how various ratios have been used and interpreted to
reveal a banks performance and how this particular model encompasses a
wide range of parameters making it a widely used and accepted model in
today's scenario.
Capital Adequacy
Capital base of financial institutions facilitates depositors in forming their
risk perception about the institutions. Also, it is the key parameter for
financial managers to maintain adequate levels of capitalization. Moreover,
besides absorbing unanticipated shocks, it signals that the institution will
continue to honor its obligations. The most widely used indicator of capital
adequacy is capital to risk-weighted assets ratio (CRWA). According to Bank
Supervision Regulation Committee (The Basle Committee) of Bank for
International Settlements, a minimum 8 percent CRWA is required.
Capital adequacy ultimately determines how well financial institutions can
cope with shocks to their balance sheets. Thus, it is useful to track capital-
adequacy ratios that take into account the most important financial risks-
foreign exchange, credit, and interest rate risks-by assigning risk
weightings to the institution's assets.
A Capital Adequacy Ratio is a measure of a bank's capital. It is expressed as
a percentage of a bank's risk weighted credit exposures.
Also known as ""Capital to Risk Weighted Assets Ratio (CRAR).
Capital adequacy is measured by the ratio of capital to risk-weighted assets
(CRAR). A sound capital base strengthens confidence of depositors.
This ratio is used to protect depositors and promote the stability and
efficiency of financial systems around the world.
Capital Adequacy ratio: For year 2007, 2005, 2004 & 2003 was 14.5%,
14.1%, 12.0% & 19.6% respectively which are exceeded minimum 8%
recommended by Basel Accord.
Asset Quality:
Asset quality determines the robustness of financial institutions against loss
of value in the assets. The deteriorating value of assets, being prime source
of banking problems, directly pour into other areas, as losses are eventually
written-off against capital, which ultimately jeopardizes the earning
capacity of the institution. With this backdrop, the asset quality is gauged in
relation to the level and severity of non-performing assets, adequacy of
provisions, recoveries, distribution of assets etc. Popular indicators include
non-performing loans to advances, loan default to total advances, and
recoveries to loan default ratios.
The solvency of financial institutions typically is at risk when their assets
become impaired, so it is important to monitor indicators of the quality of
their assets in terms of overexposure to specific risks, trends in
nonperforming loans, and the health and profitability of bank borrowers-
especially the corporate sector. Share of bank assets in the aggregate
financial sector assets: In most emerging markets, banking sector assets
comprise well over 80 per cent of total financial sector assets, whereas
these figures are much lower in the developed economies. Furthermore,
deposits as a share of total bank liabilities have declined since 1990 in many
developed countries, while in developing countries public deposits continue
to be dominant in banks. In India, the share of banking assets in total
financial sector assets is around 75 per cent, as of end-March 2008. There
is, no doubt, merit in recognizing the importance of diversification in the
institutional and instrument-specific aspects of financial intermediation in
the interests of wider choice, competition and stability. However, the
dominant role of banks in financial intermediation in emerging economies
and particularly in India will continue in the medium-term; and the banks
will continue to be "special" for a long time. In this regard, it is useful to
emphasis the dominance of banks in the developing countries in promoting
non-bank financial intermediaries and services including in development of
debt-markets. Even where role of banks is apparently diminishing in
emerging markets, substantively, they continue to play a leading role in
non-banking financing activities, including the development of financial
markets.
One of the indicators for asset quality is the ratio of non-performing loans to
total loans (GNPA). The gross non-performing loans to gross advances ratio
is more indicative of the quality of credit decisions made by bankers. Higher
GNPA is indicative of poor credit decision-making.
NPA: Non-Performing Assets
Advances are classified into performing and non-performing advances
(NPAs) as per RBI guidelines. NPAs are further classified into sub-standard,
doubtful and loss assets based on the criteria stipulated by RBI. An asset,
including a leased asset, becomes non-performing when it ceases to
generate income for the Bank.
An NPA is a loan or an advance where:
Interest and/or installment of principal remains overdue for a period of
more than 90
days in respect of a term loan;
The account remains "out-of-order'' in respect of an Overdraft or Cash
Credit (OD/CC);
The bill remains overdue for a period of more than 90 days in case of bills
purchased
and discounted;
A loan granted for short duration crops will be treated as an NPA if the
installments of
principal or interest thereon remain overdue for two crop seasons; and
A loan granted for long duration crops will be treated as an NPA if the
installments of
principal or interest thereon remain overdue for one crop season.
The Bank classifies an account as an NPA only if the interest imposed
during any quarter is not fully repaid within 90 days from the end of the
relevant quarter.
This is a key to the stability of the banking sector. There should be no
hesitation in stating that Indian banks have done a remarkable job in
containment of non-performing loans (NPL) considering the overhang issues
and overall difficult environment. For 2008, the net NPL ratio for the Indian
scheduled commercial banks at 2.9 per cent is ample testimony to the
impressive efforts being made by our banking system. In fact, recovery
management is also linked to the banks' interest margins. The cost and
recovery management supported by enabling legal framework hold the key
to future health and competitiveness of the Indian banks. No doubt,
improving recovery-management in India is an area requiring expeditious
and effective actions in legal, institutional and judicial processes.
Management Soundness
Management of financial institution is generally evaluated in terms of
capital adequacy, asset quality, earnings and profitability, liquidity and risk
sensitivity ratings. In addition, performance evaluation includes compliance
with set norms, ability to plan and react to changing circumstances,
technical competence, leadership and administrative ability. In effect,
management rating is just an amalgam of performance in the above-
mentioned areas.
Sound management is one of the most important factors behind financial
institutions' performance. Indicators of quality of management, however,
are primarily applicable to individual institutions, and cannot be easily
aggregated across the sector. Furthermore, given the qualitative nature of
management, it is difficult to judge its soundness just by looking at financial
accounts of the banks.
Nevertheless, total expenditure to total income and operating expense to
total expense helps in gauging the management quality of the banking
institutions. Sound management is key to bank performance but is difficult
to measure. It is primarily a qualitative factor applicable to individual
institutions. Several indicators, however, can jointly serve-as, for instance,
efficiency measures do-as an indicator of management soundness.
The ratio of non-interest expenditures to total assets (MGNT) can be one of
the measures to assess the working of the management. . This variable,
which includes a variety of expenses, such as payroll, workers compensation
and training investment, reflects the management policy stance.
Efficiency Ratios demonstrate how efficiently the company uses its assets
and how efficiently the company manages its operations.
Asset Turnover Ratio=Revenue/ Total Assets
Indicates the relationship between assets and revenue.
Things to remember
Companies with low profit margins tend to have high asset turnover, those
with high profit margins have low asset turnover - it indicates pricing
strategy.
This ratio is more useful for growth companies to check if in fact they are
growing revenue in proportion to sales.
Asset Turnover Analysis:
This ratio is useful to determine the amount of sales that are generated
from each dollar of assets. As noted above, companies with low profit
margins tend to have high asset turnover, those with high profit margins
have low asset turnover.
Earnings & Profitability
Earnings and profitability, the prime source of increase in capital base, is
examined with regards to interest rate policies and adequacy of
provisioning. In addition, it also helps to support present and future
operations of the institutions. The single best indicator used to gauge
earning is the Return on Assets (ROA), which is net income after taxes to
total asset ratio.
Strong earnings and profitability profile of banks reflects the ability to
support present and future operations. More specifically, this determines
the capacity to absorb losses, finance its expansion, pay dividends to its
shareholders, and build up an adequate level of capital. Being front line of
defense against erosion of capital base from losses, the need for high
earnings and profitability can hardly be overemphasized. Although different
indicators are used to serve the purpose, the best and most widely used
indicator is Return on Assets (ROA). However, for in-depth analysis, another
indicator Net Interest Margins (NIM) is also used. Chronically unprofitable
financial institutions risk insolvency. Compared with most other indicators,
trends in profitability can be more difficult to interpret-for instance,
unusually high profitability can reflect excessive risk taking.
ROA-Return On Assets
An indicator of how profitable a company is relative to its total assets. ROA
gives an idea as to how efficient management is at using its assets to
generate earnings. Calculated by dividing a company's annual earnings by
its total assets, ROA is displayed as a percentage. Sometimes this is
referred to as "return on investment".
The formula for return on assets is:
ROAÂ tells what earnings were generated from invested capital (assets).
ROA for public companies can vary substantially and will be highly
dependent on the industry. This is why when using ROA as a comparative
measure, it is best to compare it against a company's previous ROA
numbers or the ROA of a similar company.Â
The assets of the company are comprised of both debt and equity. Both of
these types of financing are used to fund the operations of the company.
The ROA figure gives investors an idea of how effectively the company is
converting the money it has to invest into net income. The higher the
ROA number, the better, because the company is earning more money on
less investment. For example, if one company has a net income of $1
million and total assets of $5 million, its ROA is 20%; however, if another
company earns the same amount but has total assets of $10 million, it
has an ROA of 10%. Based on this example, the first company is better at
converting its investment into profit. When you really think about
it, management's most important job is to make wise choices in
allocating its resources. Anybody can make a profit by throwing a ton of
money at a problem, but very few managers excel at making large profits
with little investment
Liquidity
An adequate liquidity position refers to a situation, where institution can
obtain sufficient funds, either by increasing liabilities or by converting its
assets quickly at a reasonable cost. It is, therefore, generally assessed in
terms of overall assets and liability management, as mismatching gives rise
to liquidity risk. Efficient fund management refers to a situation where a
spread between rate sensitive assets (RSA) and rate sensitive liabilities
(RSL) is maintained. The most commonly used tool to evaluate interest rate
exposure is the Gap between RSA and RSL, while liquidity is gauged by
liquid to total asset ratio.
Initially solvent financial institutions may be driven toward closure by poor
management of short-term liquidity. Indicators should cover funding
sources and capture large maturity mismatches.
The term liquidity is used in various ways, all relating to availability of,
access to, or convertibility into cash.
An institution is said to have liquidity if it can easily meet its needs for cash
either because it has cash on hand or can otherwise raise or borrow cash.
A market is said to be liquid if the instruments it trades can easily be
bought or sold in quantity with little impact on market prices.
An asset is said to be liquid if the market for that asset is liquid.
The common theme in all three contexts is cash. A corporation is liquid if it
has ready access to cash. A market is liquid if participants can easily
convert positions into cash-or conversely. An asset is liquid if it can easily
be converted to cash.
The liquidity of an institution depends on:
the institution's short-term need for cash;
cash on hand;
available lines of credit;
the liquidity of the institution's assets;
The institution's reputation in the marketplace-how willing will counterparty
is to transact trades with or lend to the institution?
The liquidity of a market is often measured as the size of its bid-ask spread,
but this is an imperfect metric at best. More generally, Kyle (1985)
identifies three components of market liquidity:
Tightness is the bid-ask spread;
Depth is the volume of transactions necessary to move prices;
Resiliency is the speed with which prices return to equilibrium following a
large trade.
Examples of assets that tend to be liquid include foreign exchange; stocks
traded in the Stock Exchange or recently issued Treasury bonds. Assets that
are often illiquid include limited partnerships, thinly traded bonds or real
estate.
Cash maintained by the banks and balances with central bank, to total asset
ratio (LQD) is an indicator of bank's liquidity. In general, banks with a
larger volume of liquid assets are perceived safe, since these assets would
allow banks to meet unexpected withdrawals.
Credit deposit ratio is a tool used to study the liquidity position of the bank.
It is calculated by dividing the cash held in different forms by total deposit.
A high ratio shows that there is more amounts of liquid cash with the bank
to met its clients cash withdrawals.
Sensitivity To Market Risk
It refers to the risk that changes in market conditions could adversely
impact earnings and/or capital.
Market Risk encompasses exposures associated with changes in interest
rates, foreign exchange rates, commodity prices, equity prices, etc. While
all of these items are important, the primary risk in most banks is interest
rate risk (IRR), which will be the focus of this module. The diversified
nature of bank operations makes them vulnerable to various kinds of
financial risks. Sensitivity analysis reflects institution's exposure to interest
rate risk, foreign exchange volatility and equity price risks (these risks are
summed in market risk). Risk sensitivity is mostly evaluated in terms of
management's ability to monitor and control market risk.
Banks are increasingly involved in diversified operations, all of which are
subject to market risk, particularly in the setting of interest rates and the
carrying out of foreign exchange transactions. In countries that allow banks
to make trades in stock markets or commodity exchanges, there is also a
need to monitor indicators of equity and commodity price risk.
Interest Rate Risk Basics
In the most simplistic terms, interest rate risk is a balancing act. Banks are
trying to
balance the quantity of repricing assets with the quantity of repricing
liabilities. For
example, when a bank has more liabilities repricing in a rising rate
environment than
assets repricing, the net interest margin (NIM) shrinks. Conversely, if your
bank is asset
sensitive in a rising interest rate environment, your NIM will improve
because you have
more assets repricing at higher rates.
An extreme example of a repricing imbalance would be funding 30-year
fixed-rate
mortgages with 6-month CDs. You can see that in a rising rate environment
the impact
on the NIM could be devastating as the liabilities reprice at higher rates but
the assets do
not. Because of this exposure, banks are required to monitor and control
IRR and to
maintain a reasonably well-balanced position.
Liquidity risk is financial risk due to uncertain liquidity. An institution might
lose liquidity if its credit rating falls, it experiences sudden unexpected cash
outflows, or some other event causes counterparties to avoid trading with or
lending to the institution. A firm is also exposed to liquidity risk if markets
on which it depends are subject to loss of liquidity.
Liquidity risk tends to compound other risks. If a trading organization has a
position in an illiquid asset, its limited ability to liquidate that position at
short notice will compound its market risk. Suppose a firm has offsetting
cash flows with two different counterparties on a given day. If the
counterparty that owes it a payment defaults, the firm will have to raise
cash from other sources to make its payment. Should it be unable to do so,
it too we default. Here, liquidity risk is compounding credit risk.
Accordingly, liquidity risk has to be managed in addition to market, credit
and other risks. Because of its tendency to compound other risks, it is
difficult or impossible to isolate liquidity risk. In all but the most simple of
circumstances, comprehensive metrics of liquidity risk don't exist. Certain
techniques of asset-liability management can be applied to assessing
liquidity risk. If an organization's cash flows are largely contingent, liquidity
risk may be assessed using some form of scenario analysis. Construct
multiple scenarios for market movements and defaults over a given period
of time. Assess day-to-day cash flows under each scenario. Because balance
sheets differed so significantly from one organization to the next, there is
little standardization in how such analyses are implemented.
Regulators are primarily concerned about systemic implications of liquidity
risk.
Business activities entail a variety of risks. For convenience, we distinguish
between different categories of risk: market risk, credit risk, liquidity risk,
etc. Although such categorization is convenient, it is only informal. Usage
and definitions vary. Boundaries between categories are blurred. A loss due
to widening credit spreads may reasonably be called a market loss or a
credit loss, so market risk and credit risk overlap. Liquidity risk compounds
other risks, such as market risk and credit risk. It cannot be divorced from
the risks it compounds.
An important but somewhat ambiguous distinguish is that between market
risk and business risk. Market risk is exposure to the uncertain market
value of a portfolio. Business risk is exposure to uncertainty in economic
value that cannot be marked-to-market. The distinction between market risk
and business risk parallels the distinction between market-value accounting
and book-value accounting.
The distinction between market risk and business risk is ambiguous
because there is a vast "gray zone" between the two. There are many
instruments for which markets exist, but the markets are illiquid. Mark-to-
market values are not usually available, but mark-to-model values provide a
more-or-less accurate reflection of fair value. Do these instruments pose
business risk or market risk? The decision is important because firms
employ fundamentally different techniques for managing the two risks.
Business risk is managed with a long-term focus. Techniques include the
careful development of business plans and appropriate management
oversight. book-value accounting is generally used, so the issue of day-to-
day performance is not material. The focus is on achieving a good return on
investment over an extended horizon.
Market risk is managed with a short-term focus. Long-term losses are
avoided by avoiding losses from one day to the next. On a tactical level,
traders and portfolio managers employ a variety of risk metrics -duration
and convexity, the Greeks, beta, etc.-to assess their exposures. These allow
them to identify and reduce any exposures they might consider excessive.
On a more strategic level, organizations manage market risk by applying
risk limits to traders' or portfolio managers' activities. Increasingly, value-
at-risk is being used to define and monitor these limits. Some organizations
also apply stress testing to their portfolios.
Profitability Ratios
Million US $
No
Description
2002
2003
2004
2005
2006
2007
Trends
1
Net Worth
2194
2478
2709
5269
6992
16501
Â
2
Profit After Tax
278
287
208
511
1179
1514
Â
3
Total Assets
7272
11228
17810
36723
52403
92609
Â
4
Interest Income
530
665
1049
1759
3606
5387
Â
5
Interest Expenses
182
345
475
920
1892
2831
Â
6
Deposits
3722
6071
9278
19396
27575
51892
Â
7
Borrowings
694
707
1729
2937
4468
5176
Â
8
Non-Interest Income
419
263
546
779
1538
1702
Â
9
Net Interest Income
348
320
574
839
1,714
2,556
Â
10
Operating Expenses
263
391
628
850
2011
1460
Â
11
Provision Against NPA's
Â
Â
196
103
442
526
Â
1
Return on Equity = (2/1)
12.67%
11.58%
7.68%
9.70%
16.86%
9.18%
3.08
2
Return on Assets = (2/3)
3.82%
2.56%
1.17%
1.39%
2.25%
1.63%
2.92
3
Net Interest Margin = (4-5)/3
4.79%
2.85%
3.22%
2.28%
3.27%
2.76%
2.99
4
Interest Income Ratio = (4/3)
7.29%
5.92%
5.89%
4.79%
6.88%
5.82%
3.03
5
Interest Expense Ratio = 5 / (6+7)
4.12%
5.09%
4.32%
4.12%
5.90%
4.96%
3.05
6
Non-Interest Income Ratio = (8/9)
120.40%
82.19%
95.12%
92.85%
89.73%
66.59%
2.91
7
Operating Expense Ratio = (10) / (8+9)
34.29%
67.07%
56.07%
52.53%
61.84%
34.29%
2.78
8
NPA Provision Ratio = (11/9)
0.00%
0.00%
34.15%
12.28%
25.79%
20.58%
3.35
Mostly flat or declining Trend
Few Financial Data & Analysis
2003 2002 2001
Assets increased to US$92,609 million, up 76.7% from 2006, and net loans
and advances to customers increased to US$58,549 million, up 100.1% from
2006. The proportion of the net loan portfolio to total assets has increased
to 63.2% from 55.8% in 2006.
At the same time as we increase assets, we are maintaining a firm grip on
credit quality. The share of overdue and rescheduled loans in the gross loan
portfolio decreased to 1.4% by the end of 2007 from 2.1% at the end of
2006, while the provisioning rate decreased to 1.3% from 1.8%. Coverage of
overdue and rescheduled loans by allowances for loan impairment stood at
a comfortable level of 176.5% as of December 31, 2007.
VTB Group's consolidated net profit for 2007 amounted to US$1,514 million,
up
28.4% from 2006, as a result of strong loan portfolio growth. Core income,
which includes net interest and fee and commission income before
exceptional
item, rose by 48.0% to US$ 3,056 million, reflecting strong growth
throughout
the Group's key strategic areas. Net interest income grew by US$842
million
(49.2%), and net fee and commission income, adjusted for the IPO-related
depositary appointment fee, grew by US$149 million (42.5%) compared to
2006. Net interest margin remained broadly stable at 4.4% with increased
contribution from our retail business.
Operating costs increased by 42.2% in 2007, reflecting the investment in
growing the business, particularly in retail, as we rolled out the branch
opening programme for VTB24. As a result our cost to income ratio
increased to 53.6% from 50.8%, but this investment will help us achieve our
long-term objectives.
With a consolidated BIS Tier 1 capital of US$15,594 million, compared to
US$6,357 million at December 31, 2006, and total BIS capital of US$16,978
million, compared to US$7,646 million at December 31, 2006, the bank has
been
able to continue to capitalise on its advantage in the fragmented domestic
financial services market to win new customers and increase volumes. By
the end of December 31, 2007, our total capital adequacy ratio was at 16%
up from 14% one year ago.
Given the current economic climate, VTB's strategy of diversifying its
funding
sources has been particularly important. With its strong brand and financial
stability, VTB was able to increase customer deposits by 85.6% to
US$37,098
million. Wholesale funding (which includes debt securities issued, other
borrowed funds and subordinated debt) increased by 32.7% to US$ 22,836
million.
In 2007, VTB successfully completed a number of planned funding
transactions.
Landmark fund raising deals include a Series 11 issue for EUR 1 billion, the
largest Eurobond in EUR among Russian banks, and a Series 12 issue for
GBP 300
million, the first ever GBP issue from Russia. Despite the uncertainty in the
international financial markets in the second half of 2007, in October VTB
issued a double-tranche Eurobond offering for the aggregate amount of
US$2
billion within the new EMTN programme. This operation is the largest
international Eurobond issuance by a Russian non-sovereign borrower. This
issue received strong support from the international investment community
in a number of different financial markets, demonstrating confidence among
international investors in the strength of VTB's credit, and the stability of
the Russian banking sector.