Financial Analysis Of Vtb Bank Russia Finance Essay

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:

ROA 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. 

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

 

2

Profit After Tax

278

287

208

511

1179

1514

 

3

Total Assets

7272

11228

17810

36723

52403

92609

 

4

Interest Income

530

665

1049

1759

3606

5387

 

5

Interest Expenses

182

345

475

920

1892

2831

 

6

Deposits

3722

6071

9278

19396

27575

51892

 

7

Borrowings

694

707

1729

2937

4468

5176

 

8

Non-Interest Income

419

263

546

779

1538

1702

 

9

Net Interest Income

348

320

574

839

1,714

2,556

 

10

Operating Expenses

263

391

628

850

2011

1460

 

11

Provision Against NPA's

 

 

196

103

442

526

 

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.