Why Consolidation and Mergers in UA Banking is a Must to Survive and Grow

Vladyslav Rashkovan, PartnerKyiv, 21/10/2016 1

Ukrainian Banking Forum 2016

Why to merge? Definitely not only due to the regulator’s requirements

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Consolidation is needed for the local banks not only to survive but to increase the efficiency & effectiveness

§ Synergy (2+2>4)§ Economies of scale§ Economies of scope§ Elimination of

inefficient management

§ Entry to new geo or product markets

§ Market share and power (monopoly gains)

§ Mean and speed for growth

§ Cost of capital/funding lower (financial synergy)

§ Target undervaluation

§ Diversification§ Tax considerations

§ Empire building§ Hiding inefficiencies§ Security due to size§ Hubris

§ Capital requirements§ Bank resolutions

Banks M&A motives in UA

Economic Financial Managerial Regulatory

Increased capital requirements to be a driver for the further consolidation of the market

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Capital requirements and number of banks which comply now

Owners to invest 23.3 bln uah of fresh capital to the banks by 2024, including 16.2 bln by 2019

+3.5 bln +5.8 bln +6.8 bln +7.1 bln

Majority of local banks are quite small and still not faced NBU capital stress tests and related parties lending questions

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§ Top 50 banks count for ~98% of the banking sector; with top 5 = 56%; In order to be ranked in top25 bank should have assets >200 mln eur eqv;

§ Majority of 68 local banks are quite small; many of them have problems with capital and capital adequacy;

As of 30.06.2016

Note: for the purposes of this scheme Privatbank (local SIFI) recognized as a member of local banks

Different groups of banks experienced different risks during the 2014-2015 crisis, but small/mid local banks were hit the most

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Foreign banks

Russian banks

State banks

Local SIFIs

Local banks

Insolvent banks

Related party

lendingCapitalneeds

Liquidity(deposits outf low)

NPLsNBU refinancing

Corporate gover-nance

UBOTranspa-

rency

Local banks passed through

the latest crisis in the most painful

way loosing players and MkS

Due to incapability to face fight with crisis, MkS of local banks significantly shrunk

§ During 2014-2016 the UA banking sector experienced the most sizable shake up, led to closure of 82 local banks (3 banks returned to the market being acquired from Deposit Guarantee Fund by new investors);

§ None of foreign banks has collapsed in 2014-2016, but many of them left the market after the 2008-2009 crisis;

§ MkS of local banks sizably decreased in the last 2 years (till 12.8% from 57.1% 10 years ago). 6

Number of banks by groups Assets MkS by groups of banks, bln uah

Local banks loosing MkS both in loans and deposits

§ Due to the closure of local banks and continuous deleveraging and provisioning by Russian banks, MkS of foreign banks increased in 2014-2015, but still below the levels of end of 2008;

§ Foreign banks also experience better and more sustainable growth of yields on assets (not only loans, but mostly Government securities and NBU deposit certificates) 7

Net loan portfolio MkSby groups of banks, %

Deposits MkSby groups of banks, %

Majority of the local banks are really small (avg MkS on corporate loans 0.1%, 0.07% on Retail loans)

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Retail / Corporate Loans MkS of individual local banks as of 30.06.2016

There is no way to ensure the economy of scale / scope with such a positioning

Most of the local banks are under provisioned comparing to their foreign banks peers

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Loan provisioning of individual local banks as of 30/06/2016

Forthcoming stress tests will bring the call for the capital

Cost of funding of the small local banks is much higher than for the larger banks

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Cost of funding and Yilds of individual local banks as of 30/06/2016

Consolidation may bring to the financial synergy (lower costs of funding)

Many local banks have very poor efficiency ratios, below their foreign banks peers

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NIM, CIR of individual local banks as of 30/06/2016

Consolidation is one of the tools to increase efficiency

We looked at small and mid local banks through three dimensions: sustainable ownership, business model and risk assessment

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Ownership

Business model

Risk

Owner 48 Transparent16 Semi2 Low

Capital risk12 Low8 Mid37 High9 Very high

Related party16 Low22 Mid24 High4 Very high

Risk4 Low25 Mid21 High16 Very high

EWS27 Low20 Mid11 High8 Very high

Business model3 Retail3 Corporate41 Typical Ukr3 Universal11 Frozen5 AML

Supervision cluster1 Retail32 Market9 Not market14 Captive5 Frozen5 AML

Then we run the neural network (self-organized Kohonen map) to cluster analyzed banks according to seven indicators

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Worst clusters# 3 & # 4

Best cluster # 1

• 22 banks in Cluster #1 – local banks which have a high probability to survive until 2020 (backed by the necessary capital increases from the shareholders, implementing the proper business models and not compromising on risks

• Other owners need to start thinking about the consolidation

Key fears of the current owners of the bank owners

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All risks are manageable – lets start developing the consolidation learning curve

2 key formulas worth to memorize for the owners of small banks

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50% x 1 > 100% x 0

50% x 1 = 25% x 2

Better to be open and prepared for the mergers than to prepare for the exit

Our contacts

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SD Capital LLC

Business Center TorontoVelyka Vasylkovska 100Kyiv – 03150, Ukraine

Tel: +38 044 363 0000Email: rv@sd.capital