Armenia's small banking sector wants to follow in neighbouring Georgia’s footsteps and become the next darling of frontier market investors.

As Ameriabank, the country's largest bank, readies itself to go public in London, the rest of the banking sector is raising equity and assets, and consolidating in a merger and acquisition (M&A) frenzy sparked by regulatory changes.

Ahead of new minimum capital requirements that became mandatory in January 2017, the sector’s lenders boosted capital by 32.7% y/y to AMD648.5bn (€1.26bn) in 2016, while the number of banks consolidated from 21 to 17.

2017 promises to bring more changes in the form of mergers and acquisitions, Gevorg Tarumyan, deputy general director and chief financial officer at Ameriabank, told bne IntelliNews in an interview. "Since the [banking] sector is on the verge of technological upgrade, smaller lenders will further lose their competitive advantage, even if they comply with [regulatory requirements]".

The sector is dominated by local banks, with Ameriabank, Ardshinbank and Armbusinessbank, the three largest lenders, accounting for almost 45% of sector assets. Among the banks with foreign capital are ACBA-Credit Agricole, which is owned by France's Credit Agricole, and the local subsidiaries of VTB Bank (Russia), HSBC Bank (UK) and Bank Mellat (Iran).

Three of the four banks that disappeared from the market in 2016 were foreign owned - ProCredit Bank (Germany), BTA Bank (Kazakhstan) and GazpromBank (Russia; their investors were unwilling to foot the bill to raise the capital of their Armenian subsidiaries six-fold to AMD30bn in order to comply with the new regulations.

With assets at just under 40% of GDP, the banking sector has not been much of a driver for economic growth - agriculture and mining have been playing that role thus far. However, the rise in equity and assets, together with the consolidation among lenders, could mean that Armenia's banks will play an increasingly important role in driving economic growth going forward.

Armenia's economic growth has been disappointing as of late, mainly because of a drop in trade with, and investment and remittances from, Russia in 2014-2015, from which the small and Russia-dependent Armenian economy has yet to recover. In 2016, the economic activity index, a narrower gauge for GDP growth, expanded by a mere 0.5% y/y, one sixth of the government's growth target.

As lending grows and the economy stagnates, the banking sector’s non-performing loan (NPL) ratio has risen to around 10%, up from 7% at end-2014. However, Tarumyan insists that "the system is becoming much healthier and that most of the non-performing assets have already been adequately provisioned".

Tarumyan anticipates that asset growth in the banking sector will slow down to 10% in 2017. "The biggest uncertainty during the upcoming year is going to be the [parliamentary] election in April. This can slow down the economy, though in the baseline scenario we don't assume any major surprises," he says. Indeed, the ruling Republican Party is expected to win the April ballot and to continue with similar economic policies thereafter.

A good year

Ameriabank started 2016 on the right foot. In January, the European Bank for Reconstruction and Development (EBRD) injected $40mn into the bank for a 20% stake. The acquisition was a vote of confidence in the lender – the only one in Armenia to have exceeded $1bn in assets – ahead of its planned initial public offering (IPO) in London. A few days after the EBRD deal, Ameriabank moved to sign a subordinated debt transaction with the International Finance Corporation for $50mn.

"Geared up with this new equity and regulatory capital boost, we made 2016 noteworthy for Ameriabank," Tarumyan says. Over the course of the year, the lender's loan book exceeded $1bn, its assets grew by almost 40% y/y to AMD718bn, and the bank debuted on the local stock exchange, Nasdaq OMX Armenia, with a $15mn corporate bond placement, the largest issuance of its type in Armenia to date.

But 2017 promises to bring further changes, as the bank has overhauled its strategy and is looking to rebalance its "lending profile". At the moment, some 85% of Ameriabank's loans go to corporate clients. The lender aims to reduce that ratio to some 45% in the next one to two years to favour more retail lending. Tarumyan says that the "huge leap" will require additional capital, a higher asset base, wise asset allocation and effective absorption.

"The ‘fuel’ we received recently is not sufficient," he says, referring to the EBRD capital injection. "Yes, we will look for new equity and new investors, because several factors will contribute to the aggressive erosion of our capital adequacy rate", he adds, listing the change in lending profile as one of them.

One market segment which Ameriabank could tap into further is small and medium enterprises (SMEs), a market segment that the lender has been a champion for. So much so, that Tarumyan credits the existence of many Armenian SMEs to Ameriabank's support in the form of advisory services, project finance, consultancy and investment banking over the last 15 years.

"As a result, many SMEs are up and running simply because Ameriabank believed in their success and ventured into funding, which other commercial banks would never do," he says.

The lender's interest in SMEs coincide with that of its shareholder EBRD, which has financed SMEs in the Caucasus for years and even created a €30mn fund specifically to promote Armenian SMEs in 2016.

Thirsty for growth

All eyes have been on Ameriabank since the bank announced in 2016 that it is preparing for an initial public offering (IPO) in London. If and when that happens  – Tarumyan's answers suggest that it will not be before one to two years from now –  Ameriabank will join Georgia's TBC Bank and Bank of Georgia as the third regional lender to boast a listing on the London Stock Exchange.

And while the bank is looking for equity partners, it is not ruling out the issuance of a Eurobond, its investment banking director Arno Mosikyan told Reuters last year, without elaborating on the amount that it was looking to raise through the issuance.

"Of course our thirst for growth is not quenched yet. We have rolled out quite an ambitious business plan for the next three years," Tarumyan says, adding that the bank will likely easily reach $1.5bn in assets this year, and that it aims to rank first in "asset size, total loan book and corporate loan portfolio" and to remain the largest deposit taker in the market with a double-digit return on investment. However, due to the changes in the structure of its loan portfolio, capital adequacy could become a "growth constraining factor, and we should focus on its replenishment as we speak".

Last year, the lender mulled various M&A deals, but decided not to go through with any of them. Seeing how the "landscape remains flat with a high propensity for large, systemic deals to come", Tarumyan says that Ameriabank will continue to keep an eye out for similar opportunities in 2017 -2018.

"The new minimum regulatory capital threshold has pushed dozens of local commercial banks into an ‘M&A frenzy’ in search of a matching partner. Ameriabank is currently evaluating potential acquisition and to lesser extent possible merger deals with couple of M&A targets, and with available acquisition debt finance opportunities from league table investment banks. This process, we believe, is just a matter of time," he says.