VTB - Bumper Year, Tougher One Ahead

VTB has published a good set of 2Q21 IFRS results, rounding off a very strong 1H21 (with an 18.3% ROE). The management duly raised 2021 earnings guidance, and the business looks set for a bumper year (we see R301 bln in net income). However, the outlook into next year looks more challenging, and we see earnings growth slowing to just 6% 2022-23 EPS CAGR. VTB also remains captive to its complex capital structure and weak capital position, and the CBR's ecosystem plans could also prove highly disruptive to its business model and potential dividend flows in coming years. Amid these uncertainties, we remain neutral on the stock, keeping our HOLD recommendation while raising our target price by 29% to $1.55 per GDR. > Heading for bumper 2021. Strong 1H21 earnings leave VTB on track to deliver record 2021 earnings of R301 bln, with a 15.6% ROE (11.6% to common shareholders). The main highlights in the 1H21 numbers included impressive core revenue growth, with NII up 21% y-o-y, NIM edging up to 3.8%, retail loans up 11% YTD, fee income rising 38% y-o-y and fees/average assets still low at 0.9%. Russia's economic rebound is also helping asset quality: Stage 3 loans fell from 8.3% at end-2020 to 8% at end-1H21, with a 0.8% cost of risk and 1% guided for 2021. > Outlook for 2022 more challenging. VTB's management commented on the 1H21 conference call that the higher interest rate environment is going to make it tough to even hit the R310 bln 2022 net income guidance (we think VTB will just manage it), with the balance sheet negatively disposed to higher interest rates. But as rates may well start to fall during 2022, the outlook for 2023 should look more promising. > Low-quality capital structure remains. VTB's N20.1 (group CET1) CAR fell 40 bps in 1H21 to 8.5%, versus the 8.0% minimum (Sber's N1.1 was 12.0% at the start of July). The core capital position remains weak, but may be supported in the future by a possible transition to the IRB approach, which may come in a year or so. That said, we see no imminent resolution to the low-quality capital structure: common equity is just 20% of total nominal equity and tangible equity just 45% of total equity. > Uncertainty over ecosystem regulation and dividends. There remains much up for discussion with the CBR, but VTB looks more exposed than most to the CBR's approach of targeting "immobilized assets" beyond pure ecosystem assets (for example, it had about $8.5 bln of non-core assets on the balance sheet at end-1H21). Given the limited room for maneuver on the capital front, this poses risks to VTB maintaining a 50% dividend payout in the years to come, and we cut our payout assumption to 40% for 2021E, implying a 10.8% dividend yield. > Still some asset quality concerns. VTB's management sees the normalized cost of risk at around 1%, but Stage 2 and 3 loans combined still amounted to 22.8% of total loans at end-1H21 (Sber: 13.4%), with specific coverage of Stage 3 loans at just 53% (Sber: 73%). We think at some stage this will feed into higher risk costs, and we have an around 1.2% average cost of risk for 2022-23. > Updated assumptions - we expect 6% 2022-23 earnings CAGR. We raise our 2021-23 net income forecasts by 42-48%, primarily driven by stronger loan growth and core revenues in NII and fee and commission income. We therefore see a 6% 2022-23 EPS CAGR, with an around 10-11% ROE attributable to common shareholders (after preferred dividends and perpetual debt coupons) in 2022-23. > Valuation offers limited upside given the risks. We value VTB using a GGM model using a 10.0% long-term ROE attributable to common shareholders (in line with our 2023 forecast), an 18% cost of equity (driven by sanctions and the weak capital position) and 4% terminal growth to derive our $1.55 per GDR target price. We think VTB's 50-60% discount to its closest local peer and EM banks does not look stretched. While progress has clearly been made operationally, the questionable sustainability of earnings, the weak capital position and the uncertainties around the impact from ecosystem regulation leave us neutral on the stock.