Moody’s reports: Negative outlook for Armenian banking system

The fundamental credit outlook for the Armenian financial institutions is negative, reflecting the operating environment’s potential volatility and lingering political tensions, says Moody’s Investors Service in its new Banking System Outlook on Armenia. Moody’s negative outlook for the Armenian banking system expresses the rating agency’s view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades.

“Given that the Armenian banking sector is still at an early stage of development, its banks have not been exposed to US sub-prime risk, failed western banks or other international risky asset classes and, during 2007 and 2008, were able to weather the international credit crisis relatively unscathed. Nonetheless, local banks remain reliant on international institutional funding to finance domestic lending and, subsequent to the disruption in international credit markets, particularly in Q4 2008, were faced with increasing spreads for whatever little funding they could access,” explains Stathis Kyriakides, a Moody’s Assistant Vice President and author of the report.

Moody’s negative outlook reflects concerns over potentially rising asset quality problems as a result of the projected slowdown of the domestic economy and, equally importantly, of the economies of Armenia’s main trading partners during 2009. Concerns over asset quality (which is currently still very good) are compounded by the unseasoned nature of loan portfolios (and the consequent potential for accelerated deterioration under less favourable market conditions) in Moody’s view and borrowers’ potentially unhedged foreign currency positions translating into currency-induced credit risk for banks.

Moody’s cautions that operational risk also remains heightened for banks in Armenia, among other reasons as a result of the country’s developing technical infrastructure, as does political risk, as shown by the events surrounding the general election in March 2008. In particular, the controversy over the result and the subsequent riots and state of emergency highlight the still material political risks in the country. “Nonetheless, Moody’s notes that as the climax of the turmoil during March 2008 was short-lived, customers maintained their confidence and the banking sector was largely unaffected,” says Mr. Kyriakides.

Moody’s recognises that the sector benefits from high levels of aggregate capitalisation (although this varies significantly between financial institutions) and high but declining liquidity (both of which are shields against deteriorating market conditions), and still good prospects for growth for banks with access to capital funds as the level of financial intermediation (despite increasing) remains low and demand for credit reportedly is higher than supply.

Going forward, and depending on the extent of any economic slowdown, Moody’s expects the better positioned banks with strong capitalisation and good domestic franchises to be able to successfully steer themselves through any difficulties, while there may be an acceleration of market consolidation.