First of all, it is important to be responsible for those investors, who have entrusted us with their money. I shall note that every year trust in us is increasing, as evidenced by the increase in deposits. The strategy used while managing these funds has been conservative from the start. We understand that our investors are mostly non-residents; they are not tied to any bank or a country. They can have accounts in Latvia, Switzerland, Hong Kong, and Singapore. That means we are competing not only within the country and Baltic companies, but also on a global scale.
It is important to remember that deposits can fluctuate, which is also one of the basics of asset management. If we analyse the past, we can conclude that we once made a faulty decision, because we got carried away by mortgage lending. In 2005–2007, we invested most of the bank’s assets in an asset that turned out to be non-liquid and had a long maturity period. However, for the last few years we have kept our assets structured in a way that the securities portfolio is the largest. Now it comprises 53–54% of the bank’s assets. The remainder is split into equal parts: the loan portfolio forms about 20% of the total assets, and the rest is the bank’s money in the interbank partner accounts (in other banks), which are completely liquid funds. We can definitely increase the share of the loan portfolio and decrease the share of the aforementioned available funds. When it comes to lending, we have been holding a conservative position since the crisis, although, compared to other Latvian banks, where loan portfolios keep falling or else remain at the same level, we have achieved an increase in our loan portfolio during the last three years.
Above all, 20 years of experience helped a lot. Given that the outside world is open for our clients, we always need to consider the risks, which is why our securities portfolio is notable for its high liquidity. One might even say that the main principle of ABLV Bank was to always keep the major share of the securities portfolio as liquid as money in the account.
The second principle is to increase asset quality. For example, there are not a lot of banks in the world that can boast high credit ratings. Their positions have weakened for various reasons. That is why it is safer to keep money in the form of some country’s securities than investing it in another bank. The rating of state-guaranteed securities is a lot higher than the rating of a bank where you can your keep funds, which has a BBB rating at best. Thus, we can achieve higher quality assets by investing in these securities.
Thirdly, it is also important that you can make some profits from securities. It is not the same as keeping money in an account or in other bank deposits, where negative rates in euros have become a regular occurrence. Our bank stands out with the fact that 60% of client deposits are in US dollars, which have higher interest rates. This is an advantage for us, because we can get higher profitability compared to keeping our resources in euros.
As I have mentioned, our securities portfolio’s control strategy is conservative. We organise it in a way whereby the portfolio remains stable under stressful conditions, because the profits and bank’s capital may depend on it. Nevertheless, by having such a large securities portfolio, we cannot afford to have its value fluctuate even by 10%, since we’re talking about hundreds of millions of euros. Therefore, 99% of our securities portfolio is invested in bonds, and less than 1% is invested in stocks. This is not because we do not like stocks as an asset, but because they are an investment whose value is a lot more volatile than fixed income securities or bonds.
It is clear that in the context of fluctuations, maturity periods are important. Even minor rate fluctuations can cause a sharp change in the value of a fixed income bond with a long maturity. That is why we are committed to another principle, i.e. that the securities portfolio cannot have long maturity periods. The average maturity period of our portfolio at the end of the previous year was 2.48 years. This does mean though that we are exposed to a small risk of interest rate hikes. Although we do not think that rates are going to rise in the US; if they do, the damage to us will be limited and will have no substantial impact on the bank’s financial results.
Nevertheless, our securities portfolio is diversified in terms of issuers and maturity periods, as well as in terms of cash flow. If rates increase, we can invest liquidated funds under new conditions. Thus, we can negate potential damage, invest at higher rates and receive higher interest returns from new investments.
To summarise, I will say that this strategy has produced excellent results both in recent years and overall. We have always been in the black. In 2015, the average profitability of the securities portfolio was 1.82%; including the unscheduled VISA International implementation deal — 2.27%. This does not seem like much, but it is nevertheless a substantial result for such a conservative portfolio, especially considering the situation with low rates on the financial markets.
As for the portfolio’s quality, 91% is invested in investment grade securities. In addition, as much as 75% of the portfolio is invested in securities with a very high rating (AA- and higher). In recent years, we have successfully invested in US Treasury securities, at a time when rates were high, and prices were low. If we look at them in terms of their distribution on a country by country basis, the largest share — 36% — is invested in US Treasury securities, which is quite obvious, because the US dollar is the main currency of our clients. Moreover, returning to liquidity, there are only two “super liquid” securities at the moment — US and Germany government securities. That is why our second largest investment is German government bonds, which comprise about 14% of the portfolio.
The loss of liquidity in the last three years is related to increasingly strict regulatory measures, which prohibit banks from holding large trade portfolios. The aim of these measures is to limit speculation in order to avoid a repeat of 2008, when banks took large risks through the use of financial instruments. However, now the regulation of this sector has led to the other extreme, namely, banks cannot use financial instruments for trading, because as soon as someone decides to buy or sell something, the prices change sharply.
Сокращение ликвидности за последние три года связано с более строгими мерами регулирования, запрещающими банкам держать объемные торговые портфели. Цель этих мер — борьба со спекуляцией, чтобы не допустить повторения 2008 года, когда банки посредством финансовых инструментов взяли на себя большой риск. Но теперь регулирование этой отрасли привело к другой крайности — банки не могут держать финансовые инструменты для торговли, поэтому, если кто-то решает купить что-то или продать, сразу наблюдаются резкие изменения цен.
Therefore, the majority of banks have chosen the “Buy and Hold” strategy. We have also been using this strategy for a while now. We buy securities, which we are ready to hold until maturity. In this regard, our strategy is aligned with that of other banks. Everybody understands that it is pointless to actively trade during this period of low rates, because the spread — the difference between the purchase and selling price — is affected by the loss of liquidity and increased regulatory measures, and has become so big that it eats away a sizable chunk of the potential returns.
Of course. We have invested an additional 10% in Latvian government securities. We are the primary dealers of the Latvian government, that is, we have an unwritten obligation to participate in any emission of Latvia’s government securities. Latvian bonds have ensured a large share of our portfolio’s profits, because when we began purchasing them on the market, the rates were not that low. Now the Latvian government can also issue loans for six months with negative interest rates.
We also invest in Canadian and Swedish securities, and the top six regions that we invest in are rounded off by Russia. We believe that we are experts of this country’s market. Thanks to our investments in Russian securities, we were able to overcome the crises of 1998 and 2008. Thus, we have an approximate understanding of which issuers are safer to invest in. Now, the economic situation in Russia is difficult, which is why we are not investing in mid-size companies, as the crisis is affecting them the most. As a result, we are choosing issuers of higher quality. These investments are very profitable now, which helped us at the end of 2014, when oil prices plummeted and the rouble lost its stability. Then we decided to make additional investments in this country, hoping that the prices would reach the former level within a year, given that it took about 12 months for the most high quality securities to return to their former level in 2008. It turned out that we made the right choice. Of course, we have set a limit for investments in Russia, which we do not exceed. You need to consider that investments in this country are risky. They are additional sources of revenue to us — the primary investments are made in bonds of Germany and the US. Thanks to these, not only can we sleep peacefully at night, but so can our clients.
Как я уже говорил, акциями мы не увлекаемся. Однако если принимаем решение о покупке акций, то делаем это, учитывая индекс. История доказала, что 80% всех управляющих фондами мира не способны превысить общий акционный индекс, — и мы не считаем себя такими экспертами, чтобы выбирать акции, стоимость которых будет расти быстрее, чем стоимость акционного индекса.
We do not have any alternative investments in our securities portfolio. However, we take part in AmberStone Group — a company established to separate investment operations from private capital. We have invested EUR 8.8 million in it, and its total capital amounts to EUR 35 million.
I could also mention the investments in the companies of Pillar Group, which was established in order to separate the bank from real estate operations, which emerged in the wake of the inability of debtors to pay their mortgages. Now we are close to the point where all the previously exempted properties have been sold. As a result, our expertise in this field has grown, and Pillar became a springboard for business that we do not think is compulsory anymore. We have also established Pillar Investment Group, which is a company that will invest in real estate (mostly commercial).
Once again, I would like to point out that in both cases this is not about our securities portfolio, which consists only of investments in publicly sold financial instruments. Our requirement is that the portfolio has to be liquid, so we can sell the securities, or find out their price at any moment. By doing so, we have no problems with audits, because everything is on the surface, and the price of particular securities can be easily compared to, for example, figures available on the Bloomberg platform.
I think that many years of working with our clients have proven to them and us too that we can provide the highest level of service, akin to that of the world’s leading financial centres. That is why clients hold their money here, and total deposits are increasing after the crisis.
Twice a year, we conduct so-called stress tests. That is how we check our liquidity under various circumstances. We have found out that about half of the investments are stable and have a maturity period of over a year. The previous crisis also proved that. For example, in 2008, about 25% of deposits flowed away from the bank. Obviously, this was a major blow, but we overcame it, because our assets were very liquid. Now we are stronger in this regard.
Now the situation is as follows: clients, who previously used offshore companies, have started to realise that the use of such companies is not the best way of conducting operations in international business. They look worse in the eyes of their partners, and it makes large holdings lack transparency; for example, in regard to financial statements etc. We have noticed that clients are increasingly choosing onshore structures. One of the arguments for offshores is that they allow tax optimisation. However, that is not the most important task now, and many people are starting to wonder which country should they set up their business in and where should they register their company. And we are asking — why not to do so in Latvia?
In Latvia’s case, the activity is not as large as we would like it to be. Besides, this could be the right moment to make the legislative amendments needed to make Latvia a place where international companies could base themselves. That includes matters of taxation and administration. For example, why not allow companies to submit annual reports in English, like in Estonia, thus resolving the translation problem. At present, companies also need to look for a natural person, who is prepared to represent their interests and be a member of the board. If you do not have close acquaintances in Latvia, you are forced to trust a stranger. We need to establish a practise that would allow using corporate directors for such purposes, as is the practice in all the world’s financial centres. In other words, one company signs an agreement about representing another company as a legal entity. We are slowly promoting this initiative, but have not received a positive response yet. Let us hope that eventually our politicians will understand that the financial centre will bring extra profits.
The facade of the former Riga Bourse, currently — a museum
After the financial crisis, the heads of the financial system understood that we could not repeat the scenario of the last century’s Great Depression, when all of the banks failed and the economy only returned to the level of the 1920s and 1930s some 20–25 years later. Therefore, they decided to combat the crisis by injecting funds into the financial system. The banks were saved and provided with liquidity afterwards. Now we see that this gave the US some results — their economy is recovering a lot faster than Europe’s. As a result, last year was the first time in several years that the base interest rate increased in the US. This indicates that the US Federal Reserve believes that the economy has stabilised. The hike in interest rates means that the availability of these resources is decreasing. On the other hand, it is also no picnic for the US, because last year stock indices were stagnant for the first time since the previous price hikes. Now, the American companies are generating lower income levels than last year. It seems that the Federal Reserve System needs to reconsider the need for such a steep increase in the base rate.
As for Europe, the situation is even worse. The economic area of Europe consists of many different economies, and all the decisions that are adopted within a couple of days in the US, take a lot more time here. Perhaps, during the onset of the crisis, Europe was too slow to make the necessary decisions.
Yes; resulting in the stagnation of the European economy and the European Central Bank ending up having to increase negative rates on deposits. This, in turn, means that regional commercial banks are forced to pay for money held with the Central Bank. The other thing is that new resources are pouring into the financial system. Within the framework of the ECB TLTRO (Targeted longer-term refinancing operations) programme, banks operating in the Eurozone can receive four times more financial resources than the growth of their loan portfolio for the corresponding period. Thus, the availability of resources is stimulated, so that banks can credit the real economy with this money. In addition, from June 2016, the rate at which the banks will be able to borrow money through this ECB programme could well equal the negative rate on deposits in euros, which at the moment is -0.4%.
It is hard to say what the outcome will be, but the negative rate may be used on regional bank deposits in euros. Perhaps this will give the clients of financial institutions food for thought — maybe it would be better to invest the money in the real economy, instead of holding it in accounts. Most likely, this is one of the reasons why the ECB is implementing this policy. I hope that they will succeed — the situation is under control. Europe’s problem is its market which is greatly segmented. The noble goal to create a single economy has been partially achieved, but the developmental levels of the EU states vary so greatly that this is hampering the efficient operation of the whole system.
And I totally agree! The controllers of European banks have already said that their main concern now is not the capitalization of financial institutions, but the profitability of banks under these low rate conditions. Basically, banks need to revise their business models. During the next few years, European controllers will monitor the ability of banks to make profits under low rate conditions. If they cannot, they will have to consider spending cuts or merging to improve the situation.
I think that the low rate period will go on for the next five years; it will be difficult to maintain the former profitability of the security portfolios. In addition, under low rate conditions, any market fluctuations will cause major changes in the prices of financial instruments. That is why you have to consider the possibility of significant price changes. Whereas previously crisis recurred every 10–15 years, then now the interim period between crises may be only 7–8 years long.
I do not want to predict anything bad, but, in any case, you need to be ready for something unexpected to happen that could cause new problems for the global economy.
I reiterate that our portfolio is ready for such adverse scenarios. Generally speaking, we believe that in the next five years, our portfolio will continue growing, because we see no basis for scenarios under which the amount of deposits would decrease.
Even if the deposits remain at the present levels, we have reserves for issuing new loans. The competition in the Latvian loan market is very big, although, unlike for us, it is the only way for many competitors to allocate assets. For example, the Scandinavian banks cannot simply buy US government bonds, because they have been open for loan services. In other words, we see that the revenue from loans has become so insignificant that it is more profitable to buy, for example, bonds of Apple, which we are already doing. However, our colleagues have to compete in the loan market in terms of prices by any means. As a result, we have this situation in which all the active Latvian banks are fighting until the last breath for any decent project.
Nevertheless, we are able to withstand the competition, and our loan portfolio is even growing. Clients are coming to us, despite the fact that our interest rates are higher than, for example, those of Scandinavian banks.
I will add that the planned increase in the loan portfolio will mostly happen by increasing the amount of commercial loans. We do not plan to increase mortgage lending during the next few years.
If we need to single out specific economic sectors, then in Latvia’s case, these would be fundamental industries like transit, wood processing, pharmacy, and agriculture. Just like in any other bank, a large part of our loan portfolio consists of mortgage loans secured by real estate. We want to try to diversify this loan portfolio by involving other sectors. We are also considering sectors, which are able to generate revenue and service loans in Latvia.
Of course, some other promising interim stage may emerge. Being a conservative bank, we demand proprietary investments, although, the company can contact the aforementioned AmberStone Group at any time and draw up a mutually beneficial agreement to reach the level of capital where you can qualify to receive a loan from the bank.
Creative team: Arnis Artemovičs, Ernests Bernis, Jānis Bunte, Anna Celma, Ilmārs Jargans, Jekaterina Koļesina, Sergejs Mazurs, Samanta Priedīte, Jūlija Surikova, Romans Surnačovs
Project managers: Anna Celma, Jūlija Surikova
Interviews: Jānis Bunte, Ingrīda Drazdovska, Konstantīns Gaivoronskis, Katrina Gordejeva, Ilmārs Jargans, Jekaterina Koļesina, Sergejs Mazurs, Romāns Meļņiks, Sergejs Pavlovs, Romans Surnačovs, Jānis Šķupelis
Text authors: Leonīds Aļšanskis, Jānis Bunte, Anna Celma, Vladislavs Hveckovičs, Jānis Grīnbergs, Māris Kannenieks, Ļubova Kazačenoka, Jekaterina Koļesina, Zane Kurzemniece, Aleksandrs Pāže, Gints Pumpurs, Dmitrijs Semjonovs, Jūlija Surikova, Kaspars Vanags, Benoit Wtterwulghe
Photography: Arnis Artemovičs, Uldis Bertāns, Mārtiņš Cīrulis, Ieva Čīka, Krišjānis Eihmanis, Andrejs Hroneloks, Alise Jastremska, Valdis Kauliņš, Valts Kleins, Marks Litvjakovs, Sergejs Mazurs, Reinis Oliņš, Samanta Priedīte, Gatis Rozenfelds, Polina Viljun, LETA foto, Marka.photo, Studija F64
Proofreader: Jānis Frišvalds
Translators: Jekaterina Koļesina, Nataļja Malašonoka, Lidija Marsova, Jūlija Surikova
Design: Aivis Lizums, Valters Horsts
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