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:

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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.