Project Number: 40937 PCG No: 7246/GU2235-KAZ December 2011

Kazakhstan: Guarantee Facility for Fixed-Rate Notes Issued by Alliance Bank JSC and Secured by Diversified Payment Rights

In accordance with ADB’s Public Communications Policy 2011, this redacted version of the extended annual review report excludes information that is subject to exceptions to disclosure set forth in paragraph 97.

Extended Annual Review Report

CURRENCY EQUIVALENTS

Currency Unit – tenge (KZT)

At Appraisal At Project Evaluation

9 August 2006 15 November 2011 KZT1.00 – $0.0082 $0.0067

$1.00 – KZT122.56 KZT148.20

ABBREVIATIONS

ADB – Asian Development Bank ALB – Alliance Bank JSC bps – basis points CAR – capital adequacy ratio DPRs – diversified payment rights EROIC – economic return on invested capital NBK – National Bank of Kazakhstan NPL – nonperforming loan PSCM – Private Sector Capital Markets and Financial

Sectors Division PSOD – Private Sector Operations Department ROIC – return on invested capital SMEs – small and medium-sized enterprises WACC – weighted average cost of capital

NOTE

In this report, “$” refers to US dollars.

Vice-President L. Venkatachalam, Vice President , Private Sector and Cofinancing Operations

Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director R. van Zwieten, Capital Markets and Financial Sectors Division, PSOD Team leader C. Teo, Principal Investment Specialist, PSOD Team member A. K. Gaza, Investment Officer, PSOD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

I.  THE PROJECT 1 

A.  Project Background 1 B.  Key Project Features 1 C.  Progress Highlights 2 

II.  EVALUATION 3 

A.  Overview 3 B.  Project Rationale and Objectives 3 C.  Development Outcomes and Impact 3 D.  ADB Investment Profitability 10 E.  ADB Work Quality 11 F.  ADB Additionality 14 G.  Overall Evaluation 14 

III.  ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 15 

A.  Issues and Lessons 15 B.  Recommended Follow-up Actions 16 

APPENDIXES 1. Overview of the Banking Sector in Kazakhstan 17 2. Kazakhstan Private Sector Development Indicators and Ratings: Financial Intermediaries 22 3. Project-Related Data 25 4. Organization Chart of Alliance Bank JSC 30 5. Summary Diagrams of the Transaction 32 6. Financial Statements, Alliance Bank JSC, 2005–2010 36 7. Supporting Computations 41

BASIC DATA Alliance Bank JSC (40937/7246/GU2235-KAZ)

Key Project Data In ADB Loan Documents

($ million) Actual

($ million) Total project cost ADB investment

Guarantee Committed Risk participation from KfW Disbursed

100.00

100.00 50.00

Guarantee was not called

100.00

50.00 50.00

0.00 ADB = Asian Development Bank.

Key Dates Expected Actual Concept clearance approval Board approval Facility agreement

2006 2006 2006

July 2006 August 2006

13 November 2006 Financial and Economic Return on Invested Capital

Appraisal (%)

XARR (%)

Financial return on invested capital Economic return on invested capital

None None

Negative Negative

Investment Profitability None Satisfactory

XARR = extended annual review report.

Project Administration and Monitoring No. of Missions No. of Person-Days Fact-finding Appraisal (including due diligence) Project administration and risk assessment Extended annual review Others (including exit, final repayment, workout transfer) – joint mission as part of ALB’s debt restructuring

Several

Several

1

1

2

April and November 2005

Not recorded

6 person-days

2 persons – 18 to 26 July 2011

2 persons, 24 March

to 5 April 2009 and 16 to 18 April 2009

ALB = Alliance Bank JSC.

EXECUTIVE SUMMARY

The Asian Development Bank (ADB), through its private sector operations, provided a $100 million guarantee facility to Alliance Bank JSC (ALB) to support ALB’s $200 million securitization of diversified payment rights (DPRs), which it launched in November 2006. KfW joined this facility as risk participant for up to $50 million of the total guaranteed amount. The objectives of the facility were (i) to develop the Kazakhstani securitization market by diversifying funding options, procuring access to longer-term funds, specifically for medium-sized private banks, and attracting a new set of investors; and (ii) to enhance financing for small and medium-sized enterprises (SMEs) in Kazakhstan. ALB’s $200 million bond consisted of two tranches: (i) $100 million in fixed-rate notes (series 2006A, due in 2013), and (ii) $100 million in floating-rate notes (series 2006B, also due in 2013). ADB’s guarantee was extended only to the series 2006A fixed-rate notes. The first series of notes had a fixed rate of 5.10% per year, a tenor of 7 years with a grace period of 2 years, and interest serviced quarterly. The principal was amortized in equal quarterly installments after the grace period, but payment was accelerated when an early-amortization event was declared in April 2009. ADB received a guarantee fee of 1.10% per year, paid quarterly, on the balance of outstanding notes. The guarantee fee was shared equally with KfW as risk participant. The 7-year floating-rate notes in the second series were issued at 2.00% per year over the 3-month London interbank offered rate (LIBOR). The servicing of interest and principal payments was similar to that for the series 2006A notes. The series 2006A notes, with the credit enhancement provided by ADB’s guarantee, were rated AAA, while the series 2006B notes, without an ADB guarantee, were rated BBB−. Both series of notes were backed by DPRs generated from payment orders received by ALB on behalf of its customers. On 15 November 2006, Merrill Lynch International as sole structuring adviser and HSBC as joint bookrunner successfully placed the $200 million bond with international institutional investors. The bond provided ALB with a stable and longer-term source of funding to build its loan portfolio and expand its market share. ALB had fully drawn down ADB’s $50 million term loan facility by June 2006. The ADB guarantee facility together, with the term loan facility, represented one of ADB’s single-largest exposures to financial institutions at the time of approval. Earlier, in April 2009, ALB had begun negotiating debt restructuring agreements with all its creditors. ALB’s $200 million bond was not part of the restructuring and was dealt outside the country in accordance with the legal documentation. ALB’s default triggered the declaration of an early-amortization event on the bond in May 2009. Excess incoming foreign remittances were captured to accelerate the repayment of principal. The foreign remittances were eventually enough to retire the principal in full on 15 September 2010, ahead of the final maturity date of November 2013.

In March 2010 ALB successfully concluded its debt restructuring with the support of all its creditors and the Government of Kazakhstan. The government, through its sovereign wealth fund, Samruk-Kayzna, is the new owner of ALB, holding a 67% stake. The project was evaluated against the criteria given in ADB’s Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations (2007) and the related Project Administration Instructions (July 2008). These criteria are (i) development impact, (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. Overall, the project is rated successful.

The development impact of ADB’s investment in ALB is rated satisfactory against four criteria: (i) private sector development, (ii) business success, (iii) economic development, and (iv) environment and social performance.

The project’s private sector development is rated satisfactory on the basis of (i) its direct impact on ALB operations, and (ii) its impact beyond ALB operations. One of the main objectives of ADB’s investment was to allow ALB to on lend to SMEs and expand its SME portfolio with the bond proceeds. ALB succeeded in enlarging its SME portfolio, as can be seen from the growth in the amounts and number of loans and the number of borrowers. Loans to SMEs increased from KZT45,567 million in 2006 to KZT96,433 million in 2010; the number of SME loans, from 700 in 2005 to 8,957 in 2010; and the number of borrowers, from 674 in 2005 to 4,714 in 2010. ALB gained access to 7-year funding through this bond issuance and was therefore able to improve the liquidity gap for longer-tenor maturity of over 5 years and to achieve a better match of assets and liabilities of over 5 years. ADB’s guarantee facility for ALB’s $100 million bond was the first of its kind in the Kazakhstani securitization market. At that time the number of transactions is limited and dominated by the country’s big banks; only two securitization issues had been made before 2006. Through this project ADB left a footprint in the market and contributed to its development. ALB used part of the bond proceeds to on lend to SMEs. The output of SMEs as a percentage of gross domestic product has increased, and so has the number of employees in the SME sector. The SME share of total output grew from 19% in 2006 to 32% in the first half of 2011. The number of those employed in the SME sector as a percentage of the total workforce has also increased over the years, from 26% in 2006 to 30% in the first half of 2011. Therefore, the project met its objective of expanding the SME sector in Kazakhstan. The project’s business success is rated unsatisfactory, however, because of its weighted average cost of capital (WACC) of 5.24% and its negative return on invested capital (ROIC) due to ALB’s negative net worth. The negative economic return on invested capital (EROIC), the measure of contribution to economic development according to ADB’s guidelines, supports the unsatisfactory rating. On the other hand, other economic benefits from this project cannot be precisely measured or directly attributed. These benefits include the value created in output and employment by the dozens of companies to which ALB granted loan facilities. With part of the bond proceeds, ALB was able to provide longer-term financing and to pass on the lower funding costs to its customers.

The project’s compliance with environmental and social safeguard issues is rated satisfactory. The project was rated “C” in both the environmental and indigenous peoples and resettlement categories; hence, no assessment of environmental and safeguard impact was required. Also, this project was a bond issue, environmental, social, health, and safety requirements are customarily excluded from the prospectus for bond issues. ALB nonetheless confirmed the compliance of its sub-borrowers with the environmental law of Kazakhstan (Environmental Code of Republic of Kazakhstan of 9 January 2007, No. 212).

ADB investment profitability is rated satisfactory, as ADB collected a margin on its guarantee obligation that was in line with the market at the time and was adequately compensated for the risk taken.

ADB work quality is rated excellent against the following criteria: (i) project screening, appraisal, and structuring; (ii) monitoring and supervision; and (iii) ADB’s role and contribution. Project screening, appraisal, and structuring is rated excellent, as the securitization structure was extremely robust, even in the face of a payment default on the part of the originator of the bond. Monitoring and supervision is rated excellent on the basis of the swift actions taken by ADB in response to the payment moratorium by ALB, and its decision to declare an early-amortization event to protect its interest, as well as that of the risk participant and the holders of the notes. ADB also succeeded in excluding the bond from ALB’s global restructuring, and in “ring-fencing” the DPRs solely for the noteholders. ADB’s role and contribution is rated excellent. ADB’s guarantee for the series 2006A notes helped in dramatically improving the note’s rating and enabled ALB to gain access to long-term funds at competitive interest margins. Without ADB’s guarantee, ALB would not have been able to gain access to the international market, at such attractive pricing. ALB was able to tap the international markets for up to $200 million spilt into two tranches, one with ADB’s guarantee and the other without. ADB played a catalytic role in bringing about the other $100 million in 7-year long-term funding for ALB. ADB additionality is rated excellent, as ALB’s $200 million asset-backed securitization program of $200 million was well received by international investors and all the notes were successfully placed. ADB’s AAA rating enhanced the bond’s rating and provided comfort to bond investors who bought the series 2006A notes. From this project it is evident that securitization of assets is a good instrument to use when tapping longer-term funding. The robustness of this type of transaction is beneficial to the guarantor, the originator, and the investors. Securitization of assets, when packaged well, is a good source for borrowers seeking to tap funds in the capital markets and should therefore be encouraged. The DPR securitization product is viewed as one of the most secure and beneficial products in emerging-market finance and is actively promoted by development finance institutions such as the International Finance Corporation, FMO, and the European Bank for Reconstruction and Development. ADB’s involvement in two transactions in Kazakhstan has led to unsolicited follow-up interest from several banks in ADB’s developing member countries (Azerbaijan, Indonesia, Pakistan, Philippines, Sri Lanka). No follow-up action is necessary, as the bond was fully repaid on 15 September 2010 and ADB’s obligation under the guarantee was terminated after that.

I. THE PROJECT

A. Project Background

1. In November 2006, the Asian Development Bank (ADB), through its private sector operations, approved a $100 million guarantee facility for Alliance Bank JSC (ALB).1 KfW joined this facility as risk participant for up to $50 million of the total guaranteed amount.2 2. The facility was to guarantee the timely payment of principal and interest on the fixed-rate notes issued by ALB, which were secured by cash flow generated through payment orders from ALB’s clients. The securitization of diversified payment rights (DPRs)3 gave ALB access to a stable source of longer-term funding. 3. The objectives of the facility were (i) to develop the Kazakhstani securitization market by diversifying funding options, procuring access to longer-term funds, specifically for medium-sized private banks, and attracting a new set of investors; and (ii) to enhance financing for small and medium-sized enterprises (SMEs) in Kazakhstan. While not explicit in the report and recommendation of the President, a further objective was to provide the assistance to Alliance Bank in a manner that would keep ADB’s credit risk to a minimum and thereby control the average risk of ADB’s investments in Kazakhstan. Remittance flows were to be used as collateral for this purpose. B. Key Project Features

4. On 13 November 2006, ALB, Alliance DPR Company, and ADB executed the guarantee and reimbursement agreement. 4 On 14 November 2006, ADB and Kfw executed the participation agreement. Earlier, on 10 November 2006, Merrill Lynch International as sole structuring adviser and HSBC as joint bookrunner had issued the prospectus for ALB’s bond issue with regard to its $200 million DPR securitization program. 5. The prospectus outlined in detail the terms and conditions of the bond issuance. The $200 million bond consisted of two tranches: (i) $100 million in fixed-rate notes (series 2006A, due in 2013), and (ii) $100 million in floating-rate notes (series 2006B, also due in 2013). ADB’s guarantee was extended only to the series 2006A fixed-rate notes. 6. The first series of notes had a fixed rate of 5.10% per year, a tenor of 7 years with a grace period of 2 years, and interest serviced quarterly. The principal was amortized in equal quarterly installments after the grace period, but payment was accelerated when an early-amortization event was declared in April 2009 (para. 12). ADB received a guarantee fee of 1.10% per year, paid quarterly, on the balance of outstanding notes.5 The guarantee fee was shared equally with KfW as risk participant.

1 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Guarantee for the

Diversified Payment Rights Securitization by Alliance Bank JSC. Manila. 2 Participation agreement of 14 November 2006 between ADB and KfW. 3 In this asset class, any kind of foreign remittance payment settled through a SWIFT system may be used as

collateral for the bond issue. Other asset classes use only one specific type of remittance (e.g., from credit card settlements or airplane ticket sales). The variety of collateral sources explains the use of the term “diversified.”

4 Guarantee and reimbursement agreement of 13 November 2006 between Alliance Bank JSC, Alliance DPR Company, and ADB.

5 Guarantee fee letter of 13 November 2006.

2

7. The 7-year floating-rate notes in the second series were issued at 2.00% per year over the 3-month London interbank offered rate (LIBOR). The servicing of interest and principal payments was similar to that for the series 2006A notes. 8. The series 2006A notes, with the credit enhancement provided by ADB’s guarantee, were rated AAA, while the series 2006B notes, without an ADB guarantee, were rated BBB−. 9. The transaction, as structured, called for ALB as originator and servicer of the notes to sell all its present and future DPRs to an offshore special-purpose vehicle, Alliance DPR Company, which would then issue notes backed by the DPRs.6 The placement proceeds from the notes would be channeled to ALB. Investors or holders of the notes would receive scheduled interest and principal repayments from the DPR cash flow. For the series 2006A fixed-rate notes, ADB guaranteed the timely payment of interest and principal. Details of the structure and the related DPRs and cash flow are shown in Appendix 5.7 C. Progress Highlights

10. On 15 November 2006, Merrill Lynch International as sole structuring adviser and HSBC as joint bookrunner successfully placed the $200 million bond with international institutional investors. The bond provided ALB with a stable and longer-term source of funding to build its loan portfolio and expand its market share. 11. Earlier, in June 2006, ALB had fully drawn down ADB’s $50 million term loan facility. This guarantee facility, together with the term loan facility, represented one of ADB’s single-largest exposures to financial institutions at the time of approval. 12. In April 2009, ALB began negotiating debt restructuring agreements with all its creditors. Its $200 million bond was not part of the restructuring and was dealt outside the country in accordance with the legal documentation. ALB’s default triggered the declaration of an early-amortization event on the bond in May 2009. Excess incoming foreign remittances were captured to accelerate the repayment of principal. The foreign remittances were eventually sufficient to retire the principal in full on 15 September 2010.

13. Accelerated prepayment in the event of default is purposely built into this type of transaction and makes the products exceptionally safe for emerging-market finance. The acceleration mechanism worked as expected, and DPR investors were repaid in full, ahead of schedule. ADB played a major role in guiding the law firms, the trust bank administering the cash flows, other investors, and the borrower through the process. 14. In April 2010 ALB successfully concluded its debt restructuring with the support of all its creditors and the Government of Kazakhstan. The government, through its sovereign wealth fund, Samruk-Kayzna, is the new owner of ALB, holding a 67% stake.

6 ALB generated DPRs by acting as recipient of payment orders from a variety of transactions, including those from

merchants in Kazakhstan exporting goods or services to their customers outside Kazakhstan, foreign direct investment, personal remittances, and overseas payments for goods and services.

7 A detailed analysis of the transaction structure and cash-flow mechanism is beyond the scope of this report.

3

II. EVALUATION

A. Overview

15. The project was evaluated against the criteria defined in the ADB guidelines for performance evaluation reports on nonsovereign operations. 8 The project rationale and objectives given below are those envisaged during project approval. The investment is then rated according to (i) development impact and outcomes, (ii) ADB investment profitability, (iii) ADB work quality, and (iv) ADB additionality. Finally, an overall evaluation of the project is presented. B. Project Rationale and Objectives

16. The project was conceived to develop the Kazakhstani securitization market given the lack of diversity in funding sources within the banking system, and to introduce a new asset class and investors to the Kazakhstani capital markets. ADB’s DPR securitization program for ALB was the first of its kind in Kazakhstan for a medium-sized private bank. The transaction was foreseen to help other banks of similar size and with similar rating gain access to this type of funding. Furthermore, ALB would on lend the proceeds to SMEs and retail clients. With the proceeds of the securitization, ADB looked forward to providing ALB with much-needed funding to broaden and deepen its outreach to SMEs throughout the country via its broad network of branches, and especially to the rural areas. ADB would thus help the Government of Kazakhstan toward more balanced, SME-led, growth and away from dependence on the oil and natural resource sectors. 17. DPR securitization is viewed as limited-recourse financing 9 suitable for emerging markets because of the structure’s ability to withstand the bankruptcy of the borrower and interference by government regulators. Development finance institutions like the International Finance Corporation, FMO, and KfW actively promote this product for emerging-market financial institutions, and ADB’s intended to support the popularization of the product in Kazakhstan at a time when only a small number of transactions of this kind had been closed. 18. The bond issue had a tenor of 7 years and was meant to help ALB find a better maturity match and close the gap in its funding periods. Kazakhstani banks had very little access to funding in excess of 3 years. 19. ALB’s bond was not of investment grade and bond issuance is a complex transaction. But ADB’s existing relationship with ALB was expected to help smooth out any problems and bring the transaction to a speedy close.

C. Development Outcomes and Impact

1. Overview

20. The satisfactory rating for overall development outcome and impact is based on component ratings of satisfactory for private sector development, unsatisfactory for business

8 ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila. 9 DPR securitization is described as limited recourse in the sense that repayment comes from only one asset of the

borrower—its international remittances. However, in the event of default, many of these transactions, the Alliance DPR among them, become a senior obligation of the borrower, thereby converting into a full-recourse structure.

4

success, unsatisfactory for contribution to economic development, and satisfactory for environment, social, health, and safety performance.

2. Private Sector Development

21. Private sector development is rated under two categories: (i) direct impact on ALB operations, and (ii) impact beyond ALB operations. The private sector impact of the project has been satisfactory. Further details of private sector development indicators and ratings are presented in Appendix 2.

a. Direct Impact on ALB Operations

22. One of the main objectives of the project was for ALB to use the proceeds of the bond for on lending to SMEs and expanding its SME portfolio. ALB succeeded in enlarging its SME portfolio, as the increase in the amounts and number of SME loans made and in the number of borrowers. Table 1 shows the growth trend.

Table 1: SME Portfolio of Alliance Bank JSC

Item 2005 2006 2007 2008 2009 2010

Loans to SMEs (KZT million) 8,525 45,567 80,121 62,266 86,110 96,433

Number of SME loans 700 4,539 7,358 5,139 7,147 8,957

Number of SME borrowers 674 3,978 7,268 4,216 3,851 4,714

SMEs = small and medium-sized enterprises. Source: Alliance Bank.

23. Loans to SMEs increased from KZT8,525 million in 2005 to KZT96,433 million in 2010; the number of SME loans, from 700 in 2005 to 8,957 in 2010; and the number of SME borrowers, from 674 in 2005 to 4,714 in 2010. 24. ALB’s bond issuance helped the bank improve its liquidity gap for longer-tenor maturity of over 5 years and achieve a better match of assets and liabilities of over 5 years.10

b. Impact beyond ALB

25. The impact beyond ALB is discussed under the following stated objectives: (i) contribution to the development of the securitization market, and (ii) contribution to the expansion of the SME sector. 26. Contribution to the development of the securitization market. ADB’s guarantee facility for ALB’s $100 million bond was the first of its kind in the Kazakhstani securitization market. At that time the number of securitization issues was limited and dominated by the country’s big banks; only two securitization issues had been made before 2006, as shown in Table 2.

10 Source: ALB’s audited financial statements for FY2005 (page 67), FY2006 (page 66), and FY2007 (page 65).

5

Table 2: Securitization Transactions in Kazakhstan, 2003–2007

Originator Product

Type Rating Agency

Closing Date Amount Tenor Remarks

Halyk Savings Bank

Future flows

Oct 2003 $100 million

Kazkommertsbank Future flows

S&P Nov 2005 $950 million

Multiple series

Alliance Bank Future flows– DPRs

Fitch Nov 2006 $100 million

7 yrs Credit enhancement provided by ADB in the form of a guarantee

BTA Bank Future flows

S&P Oct 2007 $750 million

Multiple series

ATF Bank Future flows– DPRs

2006 $100 million

5 yrs Secured and funded through a loan

ADB = Asian Development Bank, DPRs = diversified payment rights. Source: Various sources. 27. After the ALB bond issuance, BTA Bank followed suit. ATF Bank’s DPR-secured loan was completed in the same year as ALB’s. 28. ADB also assisted the Government of Kazakhstan in drafting rules for the implementation of its securitization laws (Law No. 126/3 and 127/3 of 20 February 2006).11 29. Although the number of transactions is limited, most of the major banks in the country have adopted the product. Through this project ADB has left its footprint in the securitization market and contributed to its development. One of the central risks of securitization transactions is borrower default. Only a small number of transactions worldwide are ever subjected to this test and every new bankruptcy attracts intense scrutiny from securitization specialists. The fact that the transaction’s solid structuring made it impossible to include the DPR securitization in ALB’s debt restructuring, despite attempts by some lenders and the borrower to the contrary, was a major success for this transaction and for DPR securitization in general. This success was due in large part to the important role ADB played in safeguarding the other DPR investors’ interests, facilitating negotiation with law firms and the borrower, and resolving issues between investors, the borrower, and the trust bank.

30. Contribution to the expansion of the SME sector. Another objective of this project, besides the development of the securitization market, was the expansion of the SME sector and a reduction in government dependence on the oil and extraction sector. 31. Private enterprises in Kazakhstan are defined by size, as shown in Table 3.

11 The Private Sector Operations Department hired legal counsel to assist the government in this regard; some of the

rules that were drafted were eventually adopted by the government (Source: E-mail from Stephen Wermert, Kazakhstan Resident Mission).

6

Table 3: Size Classification of Private Enterprises in Kazakhstan

Size of Enterprise No. of Employees Average Annual Assets

($ million)

Small ≤50 ≤0.5

Medium 50 ≤ 250 0.5 ≤ 3.0

Large >250 >3.0

Source: Kazakhstan’s Agency of Statistics (www.stat.kz), Law on Private Entrepreneurship

32. The structure of current active SMEs is shown in Table 4.

Table 4: Structure of Active SMEs in Kazakhstan, 1st half of 2011

SME Type Number (’000)

Enterprise 73

Sole proprietorship 431

Farm 171

SMEs = small and medium-sized enterprises. Source: Kazakhstan’s Agency of Statistics (www.stat.kz), Law on Private Entrepreneurship. Status as at 1st half of 2011.

33. SME output as a percentage of gross domestic product has increased over the years and so has the number of employees in the SME sector. Tables 5 and 6 trace this growth.

Table 5: GDP Contribution of SMEs in Kazakhstan

2006–2011 ($ billion, at current exchange rate)

GDP = gross domestic product, nr = half-year, r = year, SMEs = small and medium-sized enterprises Source: Kazakhstan’s Agency of Statistics (www.stat.kz).

69,5 87,4

109,2115,7

148,4

68,8

13,1 17,2 16,5

36,546,6

22,1

19% 20%15%

32% 31% 32%

0,0 20,0 40,0 60,0 80,0 100,0

120,0

140,0

160,0

180,0

200,0

2006 г. 2007 г. 2008 г. 2009 г. 2010 г. 1 пг. 2011 г.

GDP SME output SME share of total output

7

34. The SME share of total output increased from 19% in 2006 to 32% in the first half of 2011. It dipped to 15% during the financial crisis year of 2008, but it has since remained at around 30%.

Table 6: Employment in SMEs in Kazakhstan, 2006–2011

(’000)

SMEs = nr = half-year, r = year, small and medium-sized enterprises. Source: Kazakhstan’s Agency of statistics (www.stat.kz).

35. The number of those employed in the SME sector as a percentage of the total workforce has increased over the years, from 26% in 2006 to 30% in the first half of 2011. This upward trend demonstrates the expanded role of the SME sector in job creation.

3. Business Success

36. The return on invested capital (ROIC) was calculated to measure the project’s contribution to business success and then compared with the weighted average cost of capital (WACC). Details of the calculation can be found in Appendix 7. 37. ALB’s calculated WACC is 5.24%. ROIC is negative because ALB’s net worth is negative. 38. The project’s business success is thus rated unsatisfactory. 39. Key financial highlights of ALB’s operations are presented in Table 7.

7 404 7 631 7 857 7 903 8 114 8 204

1 952 2 121 1 995 2 297 2 522 2 487

26% 28%25%

29% 31% 30%

0

2 000

4 000

6 000

8 000

10 000

12 000

2006 г. 2007 г. 2008 г. 2009 г. 2010 г. 1 пг. 2011 г.

Employed population Employed in SMEs SME share of total employment

8

Table 7: Key Financial Highlights, Alliance Bank JSC, 2005–2010 (KZT million)

Item 2005 2006 2007 2008 2009 2010 Balance Sheet Total assets 332,758 920,750 1,160,931 748,308 419,094 427,584 Total liabilities 304,726 822,351 995,071 968,868 944,865 470,344 Total equity 28,032 80,038 158,975 (227,180) (525,771) (105,035) Total deposits 138,083 245,261 241,817 189,044 153,776 208,798 Total loans 180,097 619,800 819,194 433,475 243,707 251,827 Income Statement Net interest income 6,254 39,843 88,879 65,409 3,641 4,391 Net fee and commission income 2,502 2,629 2,121 (11,767) 6,934 4,122 Operating expenses (9,109) (25,333) (47,246) (263,396) (186,810) (14,440) Operating profit 1,379 19,968 49,180 (225,355) (293,458) 11,398 Net profit 1,596 14,010 42,683 (386,210) (298,440) 334,434 Selected Ratios (%) Return on equity 6.00 26.00 36.00 1,132.00 79.00 (106.00) Return on assets 0.50 2.20 4.10 (40.50) (51.10) 79.00 Cost-to-income ratio 87.00 56.00 49.00 692.00 (175.00) 56.00 Total equity to total assets 8.40 8.70 13.70 (30.40) (125.50) (24.60) Total liabilities to total assets 91.60 89.30 85.70 129.50 225.50 110.00 Total deposits to total liabilities 45.00 30.00 24.00 20.00 16.00 44.00 Total loans to total deposits 130.00 253.00 339.00 229.00 158.00 121.00 Capital adequacy ratio 14.00 16.00 19.20 (17.00) (104.10) 13.90 Growth Rates (%) Asset growth 176.70 26.09 (35.54) (43.99) 2.03 Deposit growth 77.62 (1.40) (21.82) (18.66) 35.78 Loan growth 244.15 32.17 (47.09) (43.78) 3.33 Net profit growth 777.82 204.66 (1,004.83) (22.73) (212.06) Operating profit growth 1,348.01 146.29 (558.22) 30.22 (103.88) Operating expenses growth 178.11 86.50 457.50 (29.08) (92.27) Source: Alliance Bank, audited financial statements, 2005–2010. 40. From 2005 to 2010, ALB went through three different stages of growth: (i) drastic expansion (2005–2007), (ii) deceleration and debt restructuring (2008–2009), and (iii) rebuilding (since 2010). 41. Both assets and liabilities ballooned during the 2005–2007 period of expansion. Total assets increased from KZT332 billion to KZT1.160 trillion. The increase in assets was due mainly to an increase in loans, from KZT180 billion to KZT819 billion. The loan growth rate for 2006 was 244%. The expansion of the loan portfolio came at the expense of portfolio quality, but this became obvious only in the following years. Only modest nonperforming loan (NPL) ratios were recorded in 2006 (1.2%) and 2007 (3.8%). Total liabilities also underwent a drastic increase during the period—from KZT304 billion to KZT 995 billion. Total deposits grew about 75%, but total loans increased more than 200%. The expanded liability base was funding expanded loans. The equity injection during this period, from KZT24.90 billion to KZT97.60 billion, was small compared with the huge increases in loans. With the capital injection, ALB’s capital adequacy ratio (CAR) was healthy, at 14% in 2005,16% in 2006, and 19.2% in 2007. No dividends were paid for 2005–2007.

9

42. From 2008 to 2009, there was a rapid deceleration in asset building as ALB suffered heavily from the poor quality of its assets. Weaknesses in corporate governance and poor credit control led to an increase in nonperforming loans. The overconcentration of loans to the construction and real estate sectors, which collapsed during the financial crisis, and unrecoverable related-party loans were the main reasons for the poor asset quality. In addition, internal fraud amounting to $1.1 billion, uncovered in 2009, aggravated the situation. NPL ratios were 30.5% in 2008, 66.65% in 2009, and 75.25% in 2010. Debt restructuring began in April 2009, putting much of the business on hold as management focused on trying to solve the bank’s NPL and funding problems and on trying to salvage the bank. Depositor confidence dropped during this period, as can be seen from the reduction in total deposits from KZT189,044 billion to KZT 153,776 billion. 43. Since the completion of its debt restructuring in March 2010, ALB has started to rebuild its business. But while loans and deposits have increased, the bank is still burdened with weak earnings, poor profitability due to high funding cost, and negative capital, compounded by the carrying costs of the nonperforming loans. In August 2011, ALB announced the sale of a retail loan NPL portfolio. The successful conclusion of this transaction is one more step taken by ALB to clean up its bad loans. Other recently announced ALB initiatives to address its negative capital is the decrease in dividends on preferred shares. 44. The bank’s CAR fluctuated from 14% in 2005 to −104% in 2009 and then to 13.9% in 2010. The positive CAR in 2010 was due to the capital injection of KZT24 billion and the subscription of preference shares of KZT105 billion by Samruk-Kayzna, the government’s sovereign wealth fund.

4. Economic Development

45. The economic rate of return was calculated according to ADB guidelines (footnote 8). The economic return on invested capital (EROIC) is used as a proxy for the economic internal rate of return because the guarantee facility did not target specific capital investment projects. 46. In 2010, ALB’s capital was a negative KZT105,035 million. This will result in a negative EROIC. The project’s contribution to economic development is therefore rated unsatisfactory. 47. However, additional economic benefits resulting from this bond issue cannot be precisely measured or directly attributed. These benefits include the value created in output and employment by the dozens of companies to which ALB has granted loan facilities. By tapping the proceeds of the bond, ALB was also able to provide longer-term financing and to pass on the lower funding costs to its borrowers.

5. Environment, Social, Health, and Safety Performance

48. This project is rated “C” in both the environmental and the indigenous peoples and resettlement categories. Assessment of environmental and safeguard impact is not required. However, ALB has confirmed the compliance of its sub-borrowers with the environmental law of Kazakhstan (Environmental Code of Republic of Kazakhstan of 9 January 2007, No. 212). The environmental, social, health, and safety performance of this project is thus rated satisfactory. 49. Also as this project was a bond issue, the prospectus customarily excludes environmental, social, health, and safety requirements.

10

D. ADB Investment Profitability

50. ADB charged a guarantee fee of 110 basis points (bps) and a work fee of $100,000. Over the life of the guarantee, ADB received a net fee of about $1.8 million. Table 8 summarizes the guarantee fees received by ADB.

Table 8: Summary of Fees Received

Value Date Nature of Payment Total Amount

Share of Risk Participant Net to ADB

2006 (Nov) Up-front work fee 100,000.00 50,000.00 50,000.00

2007 Guarantee fee 1,121,388.88 560,694.44 560,694.44

2008 Guarantee fee 1,124,444.44 562,222.22 562,222.22

2009 Guarantee fee 868,986.70 434,493.35 434,493.35

2010 Guarantee fee 311,401.65 155,700.83 155,700.83

Total Guarantee Fees 3,426,221.67 1,713,110.84 1,713,110.84

Total Fees 3,526,221.67 1,763,110.84 1,763,110.84

Source: ADB. 51. Two comparators were considered in transaction pricing.12 These were Yapi Kredi in Turkey (rated BBB–) and Kazkommertsbank in Kazakhstan (rated Baa1/BBB).13 Both banks issued bonds securitizing their DPRs. Like the ALB bond, these bonds had a tenor of 7 years and a grace period of 2 years. Guarantee fees ranged from 75 bps to 95 bps, and work fees from zero to $120,000. Table 9 summarizes and compares the data on these bond issues.

Table 9: ALB and Comparable Bond Issues, 2006

Item Alliance Bank Kazkommertsbank Yapi Kredi Country Kazakhstan Kazakhstan Turkey Rating at time of approval BBB– Baa1/BBB BBB– Tenor 7 years 7 years 7 years Grace period 2 years 2 years 2 years Guarantee fee 110 bps 80–85 bps 75–95 bps Work fee $100,000 $100,000 $0–$100,000 Guarantor ADB Ambac XL Capital, Radian,

Ambac ADB = Asian Development Bank, bps = basis points. Source: ADB.

52. Para. 34 of Project Administration Instruction (PAI) 6.07B 14 states that guarantee fees can be evaluated as multiples of actual or notional comparator margins at approval. ADB’s guarantee fee of 110 bps was 1.3 times the average of the guarantee fees charged on similar

12 Guarantee committee meeting held at ADB on 11 September 2006 between the Private Sector Operations

Department, the Office of Cofinancing Operations, the Office of the General Counsel, the Controller’s Department, the Risk Management Unit, and the Treasury Department.

13 Yapi Kredi is Turkey’s first privately owned bank. In late 2006 and early 2007, Yapi Kredi issued bonds backed by its DPRs. The bonds totaled $1.2 billion and carried financial guarantees by XL Capital Assurance, Ambac Assurance Corporation, and Radian Asset Assurance Ltd. Kazkommertsbank is one of the largest banks in Kazakhstan and the Commonwealth of Independent States (CIS) region. In December 2005, it issued $250 million worth of bonds to securitize its DPRs. The bonds were guaranteed by Ambac Assurance Corporation.

14 ADB. 2008. Extended Annual Review Reports For Nonsovereign Operations. PAI No. 6.07B. Manila

11

bonds issued by Kazkommertsbank and Yapi Kredi.15 Investment profitability is therefore rated satisfactory. Table 10 shows how the multiple was computed.

Table 10: Comparison of Guarantee Fees and Multiples

Item Kazkommertsbank Yapi Kredi Guarantee fee charged to comparator banks

Minimum 80 bps 75 bps Maximum 85 bps 95 bps Average fee (A) 82.5 bps 85 bps

Guarantee fee charged by ADB to ALB (B)

110 bps 110 bps

Multiple (B/A) 1.33 times 1.29 times ADB = Asian Development Bank, bps = basis points. Source: ADB.

E. ADB Work Quality

53. ADB work quality is rated excellent on the basis of (i) project screening, appraisal, and structuring; (ii) monitoring and supervision; and (iii) ADB’s role and decisive contribution in helping ALB administer the DPR transaction after ALB’s default, supporting other investors and the trust bank, and securing full repayment of all investors.

1. Screening, Appraisal, and Structuring

54. In June 2006, ADB’s Private Sector Operations Department (PSOD) provided a 5-year term loan facility to ALB as part of ADB’s assistance to several financial institutions in Kazakhstan. 16 The assistance came on the heels of missions to Kazakhstan in 2005, which identified the financial sector as a potential area of cooperation. ADB’s Board of Directors had come away from a visit to the region convinced of the need for intervention by ADB’s private sector operations in the market. 55. Soon after the loan was made to ALB, ADB, in line with its aim to build its cofinancing operations, especially its guarantee operations, saw a strategic fit in applying the credit guarantee to an asset-backed securitization product. 56. ADB wanted to develop the securitization market in Asia and drew up a strategy for achieving this through various ways and across different classes of assets. Three business lines were identified: (i) establishing a securitization vehicle to facilitate funding to multiple originators, (ii) guaranteeing asset-backed securities, and (iii) investing in the mezzanine tranche of asset-backed securities. The following asset classes were selected: (i) DPRs, (ii) export and other trade receivables, (iii) consumer finance (including mortgages), (iv) SME and other loan receivables, and (v) whole-business securitization. 57. To develop the securitization market, ADB explored the use of DPRs in Indonesia, Kazakhstan, Pakistan, the Philippines, and Sri Lanka, and the securitization of export receivables in the People’s Republic of China, Indonesia, and Thailand. 15 ADB’s guarantee fee was divided by the average guarantee fees charged to Kazkommertsbank and Yapi Kredi to

arrive at the multiple. 16 In 2006 and 2007 ADB made loans to several banks including Kazkommertsbank, BTA Bank, and Bank

CenterCredit.

12

58. In July 2006, ADB closed the securitization of an Indonesian motorcycle loan portfolio jointly with Deutsche Bank AG.17 ADB also closed securitizations of nonperforming mortgages in Malaysia and the Philippines18 and provided technical assistance and other forms of support to educate and to formulate securitization laws. 19 59. As part of the capital markets, securitization served to mobilize savings and provide long-term funding. The development of the securitization market was therefore an important component of deepening and broadening the capital markets. 60. ALB, a medium-sized private bank, was unable to gain access to the international market on its own merits. It needed ADB’s credit guarantee to enhance its credit rating and thus have access to long-term funding at lower cost. As asset-backed securitization is a much more complex product, ADB chose ALB after it had already established a loan relationship with it. Furthermore, after entering into loans with ALB and BTA Bank, ADB considered using safer structured products such as securitization for ALB (and later Kazkommertsbank) as a way of controlling credit risk while increasing total transaction amounts. 61. At appraisal, ADB conducted a sensitivity analysis of ALB’s DPR flow and concluded that even if monthly flows were to be reduced by 20%, the debt service coverage ratio would still be 7. 62. Regarding the transaction structure, ADB negotiated terms and conditions to protect its interest. These included (i) ADB as controlling party of the notes, (ii) early-amortization events, (iii) waterfall payments, (iv) mandatory redemption, and (v) security. 63. The transaction structure was extremely robust even in the face of a moratorium of payment by ALB, the originator of the bond. The issuer of the bond, being a bankruptcy-remote vehicle, was insulated from both originator and sovereign risks. The cash flow (DPRs) was captured offshore, outside the country, and tightly controlled with mandatory cash flow waterfall and debt service coverage ratio. The structure provided for early amortization in the event of default of covenants by the originator. Hence, principal repayments were accelerated when ALB declared a moratorium of payments to its creditors in April 2009. Under the circumstances, the fixed-rate notes were fully repaid in September 2010, ahead of its maturity date of November 2013. 64. For the above reasons, project screening, appraisal, and structuring is rated excellent.

2. Monitoring and Supervision

65. The Project Administration Unit (PAU) in the Capital Markets and Financial Sectors (PSCM) of PSOD was responsible for the administration of the guarantee facility and for the monitoring of the DPR transaction (contractual covenants as well as remittance cash flows). Unlike the senior loan ADB had extended to ALB, the DPR transaction had covenants focused

17 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Financing and

Partial Credit Guarantee for the Acquisition and Securitization of Motor Loan Portfolios by Deutsche Bank AG (Indonesia). Manila.

18 Eucalypt Funding in Malaysia and the National Home Mortgage Finance Corporation in the Philippines. 19 ADB. 2005. Technical Assistance to the People’s Republic of China for Development of the Asset-Backed

Securities Market and Restructuring of Asset Management Companies. Manila. In 2006, ADB also provided support to the Philippine government in the interpretation and application of the (then) new Securitization Law.

13

on the size and timeliness of remittance cash flows used for ALB’s interest and principal payments on the transaction. ADB monitored these cash flows and other corroborating materials from ALB monthly. The quality of ADB’s monitoring was so high that calculation inaccuracies at the bond trustee, The Bank of New York, could be corrected at a later stage using ADB’s calculations. Credit reports (then called “private sector investment management [PSIM] notes”) were created quarterly. Rating action was not taken on the transaction prior to default for two reasons. ADB’s senior corporate loan had neither defaulted nor been in breach of covenants, so that except for market rumors a firm rationale for a downgrade was not given.20 The DPR transaction itself and its covenants were performing well. 66. After ALB’s default, ADB and the bond trustee, The Bank of New York, worked closely together to monitor the collection accounts21 and ensure compliance with the terms of the bond. Upon the default of ALB on its loan obligations in April 2009, ADB in consultation with KfW took swift action to address this default by declaring an early-amortization event, which served to protect the interest of ADB as guarantor and KfW as risk participant. Once the early-amortization event was declared, all cash remaining in the collection accounts after amounts were set aside for scheduled interest and principal repayment, was applied toward the payment of principal (60%) or remitted to ALB (40%). Before the early-amortization event was declared, all excess cash was paid to ALB.

67. ADB’s monitoring and supervision during the transaction’s normal life was conducted professionally and diligent enough to be used later to amend calculation mistakes at the trust bank. Particularly because of ADB’s strong contribution to the monitoring of remittance cash flows and disbursement cash flows to investors after the default (often several times a week), its performance in this category is rated excellent.

3. ADB Role and Contribution

68. ADB’s guarantee acted as a credit enhancement to this transaction, and the guarantee was the main feature of the fixed-rate notes. Without a guarantee by ADB (or a limited number of other potential guarantors active at the time), ALB’s transaction would not have been marketable. ADB as guarantor played a critical role in the success of the transaction. By using credit enhancement, ALB gained access to a new group of overseas investors, raised long-term funding, which was not available onshore, and obtained a lower borrowing cost, which ultimately benefited its customers. 69. Eventually, ALB was able to tap the international markets for up to $200 million, which was split into two tranches, one with ADB’s guarantee and the other without. ADB played a catalytic role in bringing about the other $100 million of 7-year long-term funding for ALB.

70. After ALB’s default, Merrill Lynch International as sole structuring adviser and HSBC as joint bookrunner provided practically no support to ALB’s securitization team, to The Bank of New York as the trust bank, or to the DPR’s investors. While most investors’ credit risk was

20 The rating scale used at the time was composed of 9 rating levels, as opposed to the current 14. It used

noncompliance with covenants or default as the main criterion for a downgrade. Neither event occurred. On hearing the market rumors surrounding BTA Bank, the Private Sector Capital Markets and Financial Sectors Division (PSCM) discussed possible steps at length, but eventually decided not to override the rating scale but instead increase monitoring of cash flows and field a mission to Kazakhstan. The mission took place in March 2009.

21 Collection accounts were set up to collect foreign remittances, and these are channeled from the five main correspondent banks of ALB—The Bank of New York, Deutsche Bank Trust Company, Citibank N.A., American Express Bank Ltd, and Wachovia Bank N.A.

14

covered by ADB’s credit guarantee, the change in accelerated cash flows and legal issues created a large degree of insecurity and investors turned to ADB for guidance. Similarly, ALB’s securitization team, weakened by the demands of other default-related issues, were hard pressed to deal with the increased administrative demands posed by the accelerated repayment of the DPR securitization. 71. Through hands-on involvement and sharing of product and transaction knowledge available at ADB, the Private Sector Capital Markets and Financial Sectors Division (PSCM) and ADB’s counsel were able to resolve a number of legal and financial issues that arose in connection with the default of ALB and assure full repayment and reimbursement of legal fees to investors. Almost more importantly, through its involvement in the creditors’ committee, ADB and its counsel were able to convince general creditors (non-DPR creditors) and ALB that the attempt to force the inclusion of the DPR transaction in the workout, apart from being futile legally, would at least delay, and possibly even derail, the restructuring of ALB’s debt. Far from reflecting badly on ADB within the lenders’ committee, ADB’s guidance on how best to treat the DPR product in the restructuring was valued by the committee.22

72. ADB’s role and contribution is thus rated excellent.

4. Overall ADB Work Quality

73. As discussed above, project screening, appraisal, and structuring, monitoring and supervision, and ADB’s role and contribution are all rated excellent. Overall work quality is also rated excellent. F. ADB Additionality

74. The evaluation of ADB additionality is based on whether (i) ADB finance was a necessary condition for the timely realization of the project, either directly or indirectly by providing sufficient comfort to attract private financiers; and (ii) ADB contribution to the project design and function improved the development impact. 75. ALB’s asset-backed securitization program of $200 million was well received by international investors and all the notes were placed successfully. ADB’s AAA rating enhanced the bond’s rating and provided comfort to bond investors who bought the series 2006A notes. 76. ADB’s additionality is thus rated excellent. G. Overall Evaluation

77. Overall the project is rated successful. Table 11 provides a summary of the individual category ratings.

22 PSOD considered the use of the DPR product as a risk hedge, which allowed PSOD to increase activity in

Kazakhstan while taking on risks that were lower than those it would have borne through direct lending. While it is true that ADB’s role in the DPR very marginally reduced its recoveries under the direct loan, ADB ended up with the highest recovery rate among all direct lenders because of this strategy.

15

Table 11: Summary Evaluation of the Project

Indicators/Ratings UnsatisfactoryPartly

Satisfactory Satisfactory Excellent Development Impact

Private sector development

Business success

) Economic sustainability Environmental, social, health,

and safety performance

ADB Investment Profitability

ADB Work Quality

ADB Additionality

Overall Rating Successful ADB = Asian Development Bank.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

78. From this project it is evident that securitization of assets is a good instrument to use when tapping longer-term funding. The robustness of this type of transaction is beneficial to the guarantor, the originator, and the investors. Securitization of assets, when packaged well, is a good source for borrowers seeking to tap funds in the capital markets and should therefore be encouraged. 79. A detailed analysis of lessons learned can be found in the Office of Risk Management memorandum.23 PSOD concurs with most of the findings contained in the memorandum. In particular, the task of assessing and controlling a borrower’s portfolio quality is vastly easier in a securitization transaction than in a general-purpose loan. While checking a sample of representative size from a borrower’s loan portfolio may be technically difficult, expensive, and often hard to negotiate, in securitization transactions it is not only accepted market practice but, because of the segregated nature of the securitized asset, also technically easier. Most DPR transactions, including this transaction, have the added advantage of lender security over the securitized assets (remittance cash flows in this case) besides full recourse to the borrower in the event of default. This combination of increased control for the lenders and funding advantages to the borrower makes this product ideal for emerging-market banks. This fact is recognized by a number of other development finance institutions, which are actively marketing the product. 80. Default by the borrower or issuer while a DPR transaction is still outstanding is a very rare event and the PSCM team is privileged to have had this experience because it will enable ADB to improve its future due diligence and enhance education provided to future borrowers. 24 While defaults are exceedingly rare, transaction structures are complicated and require a large 23 The memorandum of 13 October 2011 covers lessons learned from ADB’s experiences with ALB and BTA Bank. 24 In close to 200 rated DPR transactions, Fitch Ratings recorded only one default on the DPR bond itself, not due to

the quality of cash flows but caused by a legal error in setting up the issuer security position report for the bond. (Source: Conversation with Stefan Bund, head, of structured finance ratings, Fitch Ratings, London, 2010).

16

amount of legal and technical attention for correct unwinding in the event of default. Given the pressures on the borrower’s management in the event of default, assessing a borrower’s capacity to provide enough resources (or the capacity of the guarantor or the underwriter to make such resources available) should continue to be an important component of due diligence.

81. DPR investors’ preferential rights to remittance cash flows may lead, in extreme cases, to a shortage of liquidity at the borrower level and may put pressure on the borrower’s ability to pay out foreign remittance proceeds to its corporate, retail, or trade customers. This shortage of liquidity may exacerbate the already-strained liquidity of the borrower. While this fact is well known to arrangers and commonly understood by borrowers, the PSCM has taken care to explain these facts in detail to interested borrowers, as one lesson learned from the ALB securitization. B. Recommended Follow-Up Actions

82. No follow-up action is necessary, as the bond was fully repaid on 15 September 2010 and ADB’s obligation under the guarantee was terminated after that.

Appendix 1 17

OVERVIEW OF THE BANKING SECTOR IN KAZAKHSTAN

1. The key components of the financial system in Kazakhstan are the banking sector, the insurance sector, the securities market, the pension system, and a number of organizations engaged in specific types of banking operations, such as the financial subsidiaries of National Agricultural Holding, sovereign wealth fund Samruk-Kazyna,1 several mortgage organizations, Kazpost, the Central Securities Depository, the Kazakhstan Stock Exchange, and the interbank settlement center of the National Bank of Kazakhstan (NBK). 2. Kazakhstan has a two-tier banking system. The first tier is represented by NBK, which is responsible for the monetary and foreign exchange policies and is the lender of last resort. All other banks belong to the second tier—with the exception of the Development Bank of Kazakhstan,2 which is a government-controlled “policy” bank, has a special status, and belongs to neither tier. 3. There were 39 second-tier banks in January 2011, compared with 38 at the beginning of 2010. 3 Second-tier banks are primarily privately owned commercial banks. However, the financial crisis that started in 2008 forced the state to bail out three banks and make substantial equity investments in others through Samruk-Kazyna. As a result, Samruk-Kazyna holds controlling stakes in BTA Bank (81.5%)4, Temirbank (79.9%)5 and Alliance Bank (ALB, 67.0%)6 since their restructuring, and also owns 21.3% of Kazkommertsbank and 20.9% of Halyk Bank.

4. The Kazakhstani banking system is characterized by a high degree of concentration. As at the end of 2010, the three leading banks accounted for 53.6% of total assets—Kazkommertsbank (20.2%), Halyk Bank (16.8%), and BTA Bank (16.6%). The top five banks (the above institutions as well as Bank CenterCredit and ATF Bank) accounted for 71.8% of total assets, 74.8% of total loans, and 69.8% of total deposits.7

5. Second-tier bank assets totaled $81.6 billion as at end of 2010, 4.1% more than a year earlier (footnote 7). Total asset growth suffered a major slowdown—from 96.6% in 2006 to 31.7% in 2007, 1.8% in 2008, and –2.8% in 2009, indicating the vulnerability of the foreign borrowing-based growth model of the banking sector.

6. Domestic credit began collapsing in the second half of 2007 as the combined result of a bursting real estate bubble, the forced and substantial deleveraging of the banking sector when

1 Samruk-Kazyna plays an important role in the country’s economy, controlling several national development

institutions, national companies, and other legal entities, including holding majority stakes in three bailed-out banks. As of June 2010, the assets of Samruk-Kazyna accounted for 71.2% of 2009 gross domestic product.

2 The Development Bank of Kazakhstan is a specialized government institution that finances underdeveloped priority sectors of the economy not connected with natural resources.

3 Agency of the Republic of Kazakhstan for Regulation and Supervision of the Financial Market and Financial Organizations (FSA), 2011: List of Second-Tier Banks as of February 1, 2011. http://www.FSA.kz/attachments/35/245/publish245-1007975381.doc

4 Silk Road Intelligencer (2010). “BTA completes debt restructuring.” http://silkroadintelligencer.com/2010/09/03/bta-bank-completes-debt-restructuring/

5 Fitch Ratings (2010). “Fitch upgraded rating of Temirbank to level «B-» after restructuring.“ http://www.fitchratings.ru/financial/banks/news/newsrelease/news.wbp?article-id=0478C4A8-E6F3-4C65-9F78-

9B93B05E0FCA 6 Bloomberg (2010). “Kazakh Alliance Bank Completes Debt Restructuring (Update1).”

http://www.businessweek.com/news/2010-03-30/kazakh-alliance-bank-completes-debt-restructuring-update1-.html 7 Calculated based on data from FSA, 2011: Two tier banks' financial indicators on 01.01.2011.

http://www.FSA.kz/attachments/143/267/publish267-1768299547..xls

18 Appendix 1

the international capital markets became closed to Kazakhstani banks, and the global economic slowdown. Annual growth of total gross loans plummeted from 95.7% in pre-crisis 2006 to 48.0% in 2007, 4.2% in 2008, and 4.3% in 2009. In 2010, they decreased by 5.9% after write-offs of 10.6% of the average gross loans.8 Despite strong liquidity inflows from government support programs and other sources, banks remain reluctant to expand lending to the real sector. Total loans accounted for 75.4% of total assets as at the end of 2010, a significant decrease from 83.4% a year earlier.

7. Islamic banking is present in the Kazakhstani banking sector since March 2010, when Al-Hilal Islamic Bank was set up as a 100% subsidiary of the Abu Dhabi government-owned Al-Hilal Bank. The Malaysian government-owned trustee company Amanah Raya Bhd is planning to establish the second Islamic bank in the country in 2011–2012, as a joint venture with the Development Bank of Kazakhstan and the local brokerage company Fattah Finance.9

8. Loan portfolio structure and quality. As of the end of 2010, 72.1% of total loans were to legal entities and 27.9% to individuals; 57.7% were in national currency and 42.3% in foreign currency; 16.4% were short-term and 83.6% long-term. The exposure per sector was largest to trade at 24.0%, followed by construction at 18.1% and industry at 9.4%.10 The exposure to the troubled construction sector represents a significant concentration risk.

9. The substantial concentration of the banks’ loan portfolios by customer and among related parties considerably increases the credit risk.

10. The severe loan portfolio deterioration caused by the global financial crisis has not been reversed yet. As at the end of 2010, the sector-wide nonperforming loan (NPL) ratio11 stood at 32.6%, which is lower than the 36.5% in 2009; however, in absolute terms NPLs increased by 12.3% if the massive write-offs are included in the calculation. At the end of 2009 and 2008, the NPL ratio had been at 8.1% and 1.3% respectively. As at the end of 2010, the NPL ratios of the large banks that underwent restructuring were even higher—66.1% for BTA Bank (down from 78.7% a year earlier mainly as a result of the massive write-offs) and 63.5% for ALB.12

11. International rating agencies believe that the officially reported NPL indicator does not fully reflect the scope of the problem, given the insufficient transparency of the banks' reporting and their inclination to restructure bad loans rather than writing them off or selling them. Fitch estimates that bad loans, including restructured ones, accounted for over 50% of total loans at YE2010. 13 According to Standard & Poor’s, publicly underreported single-name, economic sector, and related-party exposure concentration implies a higher level of impaired loans.14 8 Calculated based on data from FSA: Information about owned capital, liabilities and assets of financial institutions

in the Republic of Kazakhstan]: http://www.FSA.kz/ru/information-for-entities-of-financial-market/banks-sektor/2009-11-09-11-41-37/2009-11-12-05-55-10/2009-11-12-06-04-15 . BTA Bank alone accounts for 79.4% of total write-offs.

9 Kamarul Yunus (2011): “AmanahRaya plans to set up Islamic bank in Kazakhstan.“ http://www.btimes.com.my/articles/amazakh/Article/

10 Calculated based on data from the National Bank of Kazakhstan: Loans of banks by economy branches for January 1, 2011 http://www.nationalbank.kz/cont/publish734494_6520.pdf

11 FSA defines nonperforming loans as “loans classified as doubtful 5th category plus loss loans plus the actual provisions for homogenous loans.”

12 http://www.afn.kz/en/information-for-entities-of-financial-market/banks-sektor/2009-11-09-11-41-37/2009-11-12-05-55-10/2009-11-12-06-14-08

13 Astana.kz (December 21, 2010): Fitch changed its outlook on Kazakhstan's "positive". http://www.astana.kz/en/node/21201 and Fitch Ratings (June 28, 2010). Kazakh Banks: Return to Health Lags Stronger Macroeconomy. Kazakhstan Special Report.

14 Standard & Poor’s (April 19, 2010). Banking industry country risk assessment: Kazakhstan

Appendix 1 19

12. Deposits and liquidity. Customer deposits reached $46.3 billion as at the end of 2010, 56.7% of total banking sector assets. They increased by 13.7% in 2010, after growing by 30.8% in 2009 in tenge terms—boosted by the February devaluation—and by 17.8% in 2008. Large deposits from Samruk-Kazyna and state-owned enterprises, which continued to have access to the international capital markets, substantially contributed to the improvement of the liquidity position of some major banks during the global financial crisis.

13. As at the end of 2010, deposits from legal entities accounted for 67% of total deposits, while deposits from individuals stood at 33%, approximately the same level as at the end of 2009 and 2008. The majority of deposits (57.3%) were denominated in tenge15. As a result of the very limited credit growth since the second half of 2007, the loan to deposit has significantly dropped from 2.3x as at the end of 2007 to 1.3x as at the end of 2010.

14. Despite the increase in customer deposits, total liabilities decreased by 14.5% in 2010, due mainly to the restructuring of the debt of the defaulted banks.

15. Liquid assets to total assets were at 21.2% as at the end of 2010, having increased by 2% in 2010 and by 7.6% over 2 years. The liquidity ratios exceeded their required minimums by 3–5 times.16 Liquid assets to deposits were at 37.4% compared with 37.0% in 2010 and 35.3% in 2009, reflecting the cautious policy of the banks toward issuing new loans.

16. Capital adequacy. Total equity of the banking sector stood at $8.9 billion as at the end of 2010, 10.9% of total assets, after registering a negative value of $6.6 billion as at the end of 2009 mainly as a result of the vast losses of the three defaulted banks (ALB,BTA Bank, and Temirbank).

17. Overall capital adequacy indicators are compliant with the required minimum as at the end, after the restructuring of the three banks: tier 1 capital to total assets (k1-1) was 11.6% (required minimum: 6%), tier 1 capital to risk-weighted assets (k1-2) was 13.5% (6% required) and total capital to risk-weighted assets (k2) was 17.9% (12% required). As at the end of 2009, the capital adequacy ratios of the banking sector excluding the two defaulted banks also complied with the regulatory requirements, standing at 10.6% (k1-1), 12.6% (k1-2), and 16.7% (k2).17

18. However, the reported levels of capital adequacy are possibly overstated by the large amount of accrued interest in the banks’ balance sheets.18

19. Profitability. Net income remained under pressure from high provisioning expenses and decreasing interest income from loans as a result of the fall in interest rates and the increase in non-accrual loans. In 2010, the sector demonstrated positive net income of $9.6 billion compared with net losses of $19.2 billion in 2009. However, excluding the three restructured banks that benefited from a vast extraordinary restructuring income, the banking sector suffered

15 Calculated based on National Bank of Kazakhstan. 2011. Deposits in banks (by regions) for January 1, 2011.

http://www.nationalbank.kz/cont/publish818404_6487.pdf 16 FSA. 2011. Current conditions of the banking sector of the Republic of Kazakhstan in tables and graphs as of

January 1, 2011. http://www.FSA.kz/attachments/105/267/publish267-1142014511..pdf 17 FSA. 2011. Current conditions of the banking sector of the Republic of Kazakhstan in tables and graphs as of

January 1, 2011. http://www.FSA.kz/attachments/105/261/publish261-821382963..pdf 18 Fitch Ratings (June 28, 2010). Kazakh Banks: Return to Health Lags Stronger Macroeconomy. Kazakhstan Special

Report.

20 Appendix 1

net losses of $0.8 billion in 2010, almost the same level as the previous year when excluding the three banks.

20. Excluding the three restructured banks, return on assets and return on equity before income tax were –1.2% and –10.6% in 2010, slightly less negative than –1.4% and –12.6% in 2009. In 2007, these indicators had been 1.4% and 10.9%.

21. Ratings. In 2010, the international rating agencies started revising their views on Kazakhstani banks, acknowledging improvements in the macroeconomic environment, liquidity, and capitalization as well as the successful restructuring of the three defaulted banks. However, all the rated banks remain in the highly speculative B category, except for the foreign-owned ATF (BBB), Sberbank (BBB-) and VTB Bank (BBB-), and there is very limited potential for significant further rating upgrades in the short term.

Issuer Last Available

Issuer Default Rating Outlook

Alliance Bank B- Stable

ATF BBB Positive

BCC B Stable

BTA Bank B- Stable

Eurasian Bank B- Stable

Halyk Bank B+ Stable

Kaspi Bank B- Stable

Kazkommertsbank B- Stable

Sberbank BBB- Stable

Temirbank B- Stable

VTB Bank (Kazakhstan) BBB- Stable Source: Fitch Ratings, Silk Road Intelligencer, Bank websites.

22. Regulatory update. The Deposit Insurance Fund currently guarantees deposits by natural persons of up to circa $33,800. From 1 January 2012, this amount will be reduced to circa $6,800.19 The Deposit Insurance Fund issues recommendations on the interest rates offered by banks on deposits to natural persons. In April 2010 the recommended rates were reduced from 11.5% to 10.0% for deposits in national currency and from 8.0% to 7.0% for deposits in foreign currency.20 23. Regulations for the development of Islamic banking in Kazakhstan were adopted in 2009.

24. On 2 September 2010, FSA proposed to introduce the following new requirements for banks: (i) limiting share ownership by individuals and legal entities to 25% of a bank’s capital except for shares owned through banking holdings; (ii) limiting a bank's investment in shares of financial organizations to 10%; (iii) restricting a bank's investment in shares of nonfinancial organizations except for those providing banking-related services (such as encashment,

19 Anna Melnikova. 2010. The state reduces compensation for guaranteed deposits.

http://profinance.kz/2010/05/19/iyolbyoe-yosbn-epinshhnsn-ibbsebx-lnpse.html 20 Kazakhstan Deposit Insurance Fund. Recommended deposit interest rates. http://kdif.kz/ru/recommended_rates

Appendix 1 21

securitization, etc.); (iv) limiting a bank's investment in the parent bank’s shares; (v) limiting the number of representatives of the parent bank on the boards of directors of its subsidiaries to one-third; (vi) restricting lending to related parties except for those who are participants in the banking conglomerate. The limitations on investments will be effective from 1 January 201321.

25. To facilitate the write-off of NPLs, the government intends to amend the tax code that exempts provision income from taxation. Other rules that make it challenging to manage NPLs are: (i) Kazakhstani laws do not allow banks to establish special-purpose vehicles to manage NPLs efficiently and (ii) banks are prohibited from taking an equity position in nonbanks, which makes it impossible for them to convert their NPLs into equity.

26. FSA plans to introduce several new requirements for banks in line with the Basel III global standard from 2013: (i) “core capital” will include issued common shares and reserves; (ii) perpetual financial instruments and preference shares will be excluded from tier 1 capital; (iii) the limitation that tier 2 capital cannot exceed tier 1 capital will be removed; (iv) tier 2 capital will include dynamic reserves of up to 1.25% of risk-weighted assets, perpetual financial instruments, preference shares, and subordinated debt; and (v) tier 3 capital will disappear.22 27. Effective 12 April 2011 by a decree of the President of the Republic of Kazakhstan, the powers and functions of FSA and of the Agency for Regulation of Activities of the Regional Financial Center for Almaty were transferred to the central bank. Pursuant to the decree, NBK is now responsible for functions previously performed by FSA, such as licensing and regulation of financial organizations (banks, insurance companies, pension funds, etc.), oversight of joint stock companies, and regulation of the securities market. NBK will also be responsible for the development and regulation of the Regional Financial Center of Almaty. In addition, NBK continues to be the country’s central bank.

28. Industry outlook. The banking sector is expected to gradually continue its recovery from the crisis, though more slowly than the real economy.23 NBK does not expect growth in lending before 2012. According to NBK, new loans issued in 2011 will be offset by current loan repayments and write-offs. In 2012–2013, loans are expected to grow by 10% per annum. In the medium term, profitability is expected to be constrained by higher interest expenses, operating costs, and provisions compared with pre-crisis levels. NBK expects overall deposits to increase by 19.5% in 2011, 13.1% in 2012 and 11.9% in 2013. The official refinancing rate will probably increase from 7% in 2010 to 8% in 2011–2013.

21 Kazkommertsbank. Kazakhstan Financial Review, August 2010.

http://en.kkb.kz/attach/KazakhstanInBrief/Kaz_Fin_Review_Aug_2010.pdf 22 Kazkommertsbank. Kazakhstan Financial Review, December 2010.

http://en.kkb.kz/attach/KazakhstanInBrief/Kaz_Fin_Review_Dec_10.pdf 23 Standard & Poor’s (April 19, 2010). Banking Industry Country Risk Assessment: Kazakhstan.

22 Appendix 2

KAZAKHSTAN PRIVATE SECTOR DEVELOPMENT INDICATORS

AND RATINGS: FINANCIAL INTERMEDIARIES

Indicator Rating Justification

1. Beyond Intermediary and Sub-borrower Impact

1.1 Private sector expansion and institutional impact 1.1.1. Contributes to an increased private sector share and role in the economy and to sustainable jobs 1.1.2. Contributes to expanded SME lending 1.1.3. Contributes to institutional change by improving supply and access generally to formal credit and banking service to SMEs 1.1.4 Contributes to the growth of viable financial institutions and financial market development.

Satisfactory As a result of the deleveraging of the economy, the banking sector has shrunk. ALB’s total assets have decreased from its height in 2007 at KZT1,160,931 million to KZT427,584 million in 2010, and total loans decreased from KZT819,194 million in 2007 to KZT251,827 million in 2010. However, going forward, ALB is on track to achieve its target growth rates. Under ALB’s strategic goals, it aimed to achieve by 2013 the following: (i) a market share of 11.2% in retail lending and 10.7% in SME lending; (ii) a market share of 9.3% in retail deposits and 4% in corporate deposits; and (iii) a return on assets (ROA) of 4%, a return on equity (ROE) of 19%, and net interest margin of 7% and a cost-to-income ratio of 41%. Loans made to the SME sector have increased from KZT25 billion in 2009 to KZT30 billion in 2010. The target of SME sector financing for 2011 is KZT52,000 million. Through its network of branches, ATMs, and cash offices, ALB is able to deliver its services across Kazakhstan. The securitization program provided an alternative source of funding to ALB and allowed it to tap the international market for much-longer-term funding, which was not available onshore. It also helped in the development of the financial market to broaden and deepen access to funding.

1.2. Competition. Contributes to new competition for SME business among local banks (including new product and service offerings, local currency products).

Satisfactory ALB’s development strategy is to increase its share of the SME market to 10.7% by 2013. As at April 2011, ALB had an 8% market share in the SME sector of Kazakhstan with a portfolio size of KZT108,007 million. ALB is currently ranked no. 5 in financing for the SME sector, the other top four being Kazkommertsbank, AFT Bank, BTA Bank, and Bank CenterCredit.

Appendix 2 23

Indicator Rating Justification

1.3. Innovation. Contributes to new ways of offering effective banking services to SMEs (including new products, services, and technologies) in ways that are replicated by other banks and in the financial system.

Satisfactory The products offered to SMEs are overdrafts and working capital and short-term loans. To increase its market share, ALB has reduced the interest rates on these products and increased the size of the overdraft or loan in order to attract more SME customers. In addition, ALB participates in government programs to increase economic activities and growth. So far, ALB has participated in Damu I, II, and III tranches, Damu Ondyrys, and Damu Region II. Damu I, II, and III are targeted solely at companies in the SME sector.

1.4. Linkages. Contributes to local savings and deposits mobilization via the network of branches, and contributes to notable upstream or downstream link effects to sub-borrowers’ businesses in their industries or the economy.

Satisfactory Depositors’ confidence in ALB has returned since the restructuring. Customer deposits, which dipped in 2008–2009, have increased. At the end of 2010, customer deposits stood at KZT208,798 million, an increase of 36% over the 2009 figures.

1.5. Catalytic element. Contributes to mobilization of other local or international financing for SMEs, and to positive demonstration to market providers of debt and risk capital to SMEs.

Satisfactory ALB tapped the proceeds of the bond, which was placed with international investors for long-term funding. This source of funding enabled ALB to extend longer-tenor loans to its customers in the SME sector.

1.6. Affected laws, frameworks, regulation. Contributes to improved laws, regulation, and inspection affecting formal SME banks and banking services for SMEs in the local financial system.

Satisfactory ALB is in constant dialogue with the National Bank of Kazakhstan (NBK) and it provides feedback and opinions on laws and regulations to be introduced or promulgated by NBK. For example, ALB has given positive feedback to NBK and other government agencies on improvements in the tax regime and changes in the current legislature to allow more efficient management of nonperforming loans.

1.7. Wider demonstration of new standards. Contributes to higher standards in corporate governance, transparency, and stakeholder relations.

Partly satisfactory

Since the restructuring, ALB has taken positive steps to overhaul its corporate governance standards and make them more transparent, and has raised accountability standards among its board of directors and management board.

2. Direct Participant Bank and Sub-borrower Impact with Wider Potential

2.1. Skills with wider impact potential. Contributes (i) to improved SME credit approach at all stages in the participant bank(s) in ways that will be replicated by

Partly satisfactory Since the restructuring, ALB has made major changes in its risk management system to be in line with international practices. A system of checks and balances are now in place at all levels.

24 Appendix 2

Indicator Rating Justification

other providers of SME finance and banking service; and (ii) via the participating bank(s) to improved sub-borrower skills in the operation of their businesses, e.g., via good appraisal, and monitoring by the bank(s).

2.2. Demonstration and new standards-setting potential. Demonstrates potential through improved and achieved standards in corporate governance and transparency, stakeholder relations, and ESHS spheres

Partly satisfactory

Post restructuring, major improvement in corporate governance and stakeholder relations were made with the installation of new management team. In the ESHS spheres, there is currently no environmental management system in place. However, there is no breach by ALB of any ESHS and ALB confirmed compliance with the local Kazakhstani environmental law. Market practice dictated that capital market instruments such as the bonds issued by ALB in this project did not contain ESHS requirements.

Overall PSD Rating Satisfactory

ALB = Alliance Bank JSC; ESHS = environmental, social, health, and safety; PSD = private sector development; SMEs = small and medium-sized enterprises. Note on the rating scale: Excellent, satisfactory, partly unsatisfactory, and unsatisfactory. The rating is not an arithmetic mean of the individual indicator ratings, and these have no fixed weights. It considers already manifest actual impact (positive or negative) and the potential for impact as well as risk to its realization.

Appendix 3 25

PROJECT-RELATED DATA

A. Introduction 1. Alliance Bank (ALB) was established in 1993 as IrtyshBusinessBank. It was a regional commercial bank in Pavlodar, Northern Kazakhstan. In 1999 it merged with Semipalatinsk Municipal Joint Stock Bank. In 2001, Seimar Investment Group purchased a 37% stake in the bank and the bank was renamed Alliance Bank. 2. Under Seimar’s leadership ALB experienced impressive growth and in 2007 became the fourth-largest bank in Kazakhstan by total assets. Its assets stood at $9.7 billion in 2007. In July 2007, ALB conducted an initial public offering and listed its shares both in Kazakhstan and on the London Stock Exchange. 3. In April 2009, ALB entered into debt restructuring negotiations with its creditors after failure to fulfill its loans repayment obligations. Many factors contributed to the payment default, chief among them the poor asset quality and fraudulent transactions involving US Treasury bonds.1 The poor asset quality was due to the lack of good credit policy and assessment. The majority of corporate loans were made to parties related to shareholders, and there was overconcentration in lending to the real estate and construction sectors. These sectors collapsed during the global economic crisis that began in late 2008. Many of the loans were also made to speculative projects. Hence, nonperforming loans (NPLs) ballooned to 54% in 2009. 4. In March 2010, ALB concluded its debt restructuring with the support and assistance of the Government of Kazakhstan and all its creditors. Samruk-Kazyna, the sovereign wealth fund, became the largest shareholder after injecting T24 billion for 67% of the common shares and T105 billion for 67% of the preference shares. ALB's external debt was reduced by 77.8% from $4.5 billion to $1.08 billion, and financing terms were extended from 7 to 20 years. ALB's capital adequacy ratio is now within Kazakhstani regulatory requirements. Samruk-Kazyna has committed to continue to support ALB until a strategic investor is found. B. Business Strategy and Operations after Restructuring 5. ALB provides products and services of a commercial bank, including loans, deposits, settlement, guarantees, and foreign currency exchange to corporate and retail customers. Its services are delivered through a network of branches, cash offices, and ATMs across 53 cities in Kazakhstan. Since restructuring, the network has been optimized to deliver better service at less cost. The number of branches was reduced from 21 to 19, cash offices from 176 to 108, and ATMs from 1,125 to 929. The number of employees has been trimmed from 5,536 in 2008 to 3,553 (as at 1 July 2011) as part of ALB’s overall operational efficiency exercise. The bank has two 100%-owned subsidiaries, one in the Netherlands, the other in the Russian Federation, both with the sole objective of raising funds for ALB in capital markets internationally and in Russia. 6. In March 2010, the board of ALB approved the bank's development strategy for 2010–2013, which clearly defines the business goals. These include development in three core areas: (i) sustainable assets and deposit growth; (ii) improvement and strengthening of risk management and corporate governance; and (iii) efficient management of NPLs.

1 ALB pledged United States Treasury securities for guarantees issued to companies related to a former shareholder.

These guarantees were provided by offshore banks. These transactions which amounted to $1.1 billion were neither recorded in ALB’s books nor authorized by the board of directors.

26 Appendix 3

7. ALB aims to achieve a well-balanced and profitable loan portfolio of 51% retail, 28% SME, and 20% corporate loans, and to become a leading lender in the retail and SME sectors. 8. Under the bank’s development plan, the major strategic goals to be achieved by 2013 are: (i) market share of 11.2% in retail lending and 10.7% in SME lending; (ii) market share of 9.3% in retail deposits and 4% in corporate deposits; (iii) return on assets of 4%, return on equity of 19%, 7% net interest margin, and 41% cost–income ratio. 9. ALB is trying to regain market share and has stepped up its marketing efforts to attract customers, both in loan lending and deposit taking. It has launched seven secured and two unsecured loan products to meet the demands of retail customers. In the SME sector, ALB is participating in government programs targeted at SME customers. Boosted by the confidence of Samruk-Kazyna as a major shareholder, customer deposits have increased since restructuring. In the first quarter of 2010, customer deposits totaled $509 million, which has risen by 82% to $929 million in the second quarter of 2011. 10. Efficient management of NPLs is also one of the strategic goals of ALB. The loan portfolio is segregated into “Good Bank” and “Bad Bank”. As of 1 July 2011, the “Bad Bank” loan portfolio was 64% of the total portfolio and had a 96% provision level. The “Bad Bank” is managed by a workout team comprising 113 dedicated specialists in the corporate department and 260 dedicated specialists in the retail department. 11. In terms of risk management and corporate governance, the system was substantially overhauled after lessons learned from the restructuring. The changes are explained in detail in the following paragraphs. C. Ownership and Shareholding Structure

12. Until February 2009, the major shareholder in ALB was Seimar Alliance Financial Corporation, which owned 76%. On 30 December 2009, the FSA forced the transfer of all outstanding shares of ALB to Samruk-Kazyna, which became a 100% shareholder. On 30 March 2010, Samruk-Kazyna converted T105 billion of the debt owed to it by ALB into convertible preference shares and recapitalized ALB by subscribing to additional common shares with a T24 billion cash injection. At the close of the restructuring, Samruk-Kazyna had become a 67% shareholder and creditors received the remaining 33% of shares. D. Organizational Structure

13. Please refer to Appendix 4, Table A4.1 for ALB’s organizational structure. The structure has undergone substantial changes since Samruk-Kazyna became the major shareholder. 14. The board of directors comprises 6 directors, of which 3 are appointees from Samruk-Kazyna, 2 are independent, and 1 represents the bank. The board is responsible for issues relating to strategy, risk management and control, funding, staffing, and internal audit. The board meets every month, and three specialized committees report directly to it: audit, risk and debt committee; strategic planning and corporate governance committee; and personnel and remuneration committee. The committees meet monthly. 15. The management board performs the executive functions of the bank and reports to the board of directors. It is headed by the chairman, who is also a member of the board of directors and is assisted by three deputy chairmen, a chief financial officer, two vice-presidents, three managing directors, and two advisors, each in charge of an ALB department.

Appendix 3 27

E. Corporate Governance

16. In March 2010, ALB adopted a new corporate governance code that set out the role and responsibilities of the board of directors, the establishment of committees, the principles of risks and control, the system of internal control and risk management, the requirement for financial reporting and capital management, the quality of the management information system, and rules on providing information and reporting to shareholders. 17. Based on the corporate governance code, ALB undertook a major overhaul of its internal systems to ensure transparency with built-in checks and balances in all aspects of operations. F. Risk Management

18. The risk management system in ALB has been substantially overhauled since Samruk-Kazyna became the major shareholder and also draws on the experience and lessons learned when going through the debt restructuring. 19. The major risks for ALB relate to market risk, credit risk, and liquidity risk. 20. Risk management policies and procedures. The risk management policies aim to recognize, analyze, and manage the risks for ALB by setting adequate risk limits and controls. These are constantly monitored to ensure adherence and compliance. 21. The board of directors has overall responsibility for the oversight of the risk management framework, supervising the management of key risks and reviewing risk management policies and procedures as well as approving significant exposures. 22. The management board is responsible for monitoring and implementing risk mitigation measures and making sure that ALB operates within the established risk parameters. The head of risk service (Risk Department and Collateral Department) is responsible for the overall risk management and compliance functions, ensuring the implementation of common principles and methods of identifying, measuring, managing, and reporting both financial and nonfinancial risks. He or she reports directly to the chairman of the management board and indirectly to the board of directors. 23. Credit, market, and liquidity risks at portfolio and transactional levels are managed and controlled through a system of credit committees and an asset and liability management committee (ALCO). To engender efficient decision making, ALB established a hierarchy of credit committees depending on the type and amount of the exposure. 24. Both external and internal risk factors are determined and managed throughout the organization. Particular attention is given to developing risk maps that are used to define the full range of risk factors and serve as a basis for determining the level of assurance over the current risk mitigation procedures. Apart from the standard credit and market risk analysis, the Risk Department monitors other financial and operational risks by holding regular meetings with operational units to obtain expert judgments in their areas of expertise. 25. Market risk. Market risk refers to the risk where movements in market prices (which include foreign exchange rates, interest rates, credit spreads, and equity prices) will have an effect on the income or value of portfolios. Market risk comprises currency risk, interest rate risk, and other price risks. Market risk arises from open positions in interest rate, currency, and equity financial instruments. These open positions are subjected and exposed to general and specific market movements and changes in market prices.

28 Appendix 3

26. The objective of market risk management is to manage and control market risk exposure within acceptable parameters while optimizing the return on risk. 27. Overall authority on market risk is vested in ALCO, which is chaired by the Chief Financial Officer. Market risk limits are approved by ALCO based on recommendations of the Risk Department (Market Risk Management Division) and subsequently agreed by the board of directors. 28. ALB manages its market risk by setting open position limits in relation to financial instruments, interest rate maturity, and currency positions and stop-loss limits. These are monitored on a regular basis and reviewed and approved by the two boards. 29. In addition, ALB uses a wide range of stress tests to model the financial impact of a variety of exceptional market scenarios on individual trading portfolios and the overall position. 30. Credit risk. The risk of a financial loss to the bank if a customer or counterparty to a financial instrument fails to meet its contractual obligations is classified as credit risk. ALB has policies and procedures for the management of credit exposures, including guidelines to limit portfolio concentration. The responsible credit committee actively monitors the credit risk. 31. The bank’s credit policy is reviewed and approved by the Board of Directors and establishes (i) procedures for review and approval of loan credit applications, (ii) methodology for credit assessment of both individual and corporate borrowers, (iii) methodology for credit assessment of counterparties, issuers, and insurance companies, (iv) methodology for the evaluation of collateral, (v) credit documentation requirements, and (vi) procedures for the ongoing monitoring of loans and other credit exposures. 32. Corporate loan credit applications are originated by the relevant client managers and are then passed on to the Department of Corporate Business. Analysis reports are based on structured analysis focusing on the customer’s business and financial performance. The loan credit application and the report are then independently reviewed by the Risk Department (Credit Risk Management Division) and a second opinion is given accompanied by a check that credit policy requirements are met. The credit committee reviews the loan credit application based on submissions by the loan and the risk departments, the legal opinion, the conclusion of the Security Department., the Collateral Department’s evaluation, collateral report and independent assessment of the company / credit applicant. Individual transactions are also reviewed by the legal, accounting, and tax departments depending on the specific risks. 33. ALB continuously monitors the loan portfolio by conducting credit reviews of the borrowers and updating the value of the collaterals through appraisal done by independent companies or internal specialists. In the event of a drop in market prices, the borrower is usually requested to come up with additional security. 34. The Retail Lending Division reviews the retail loan credit applications via scoring models and application data-verification procedures developed with the Risk Department. 35. Liquidity risk. Liquidity risks refer to the risk for the bank in the event of not being able to raise funds to meet its commitments and exist when the maturities of assets and liabilities do not match. 36. ALB aims to ensure that funds will be available at all times to honor all cash-flow obligations as they become due. The management board reviews and approves the liquidity policy.

Appendix 3 29

37. ALB seeks to support a diversified and stable funding base comprising debt securities in issue, long-term and short-term loans from banks, core corporate and retail customer deposits, and a diversified portfolio of highly liquid assets so as to respond quickly and smoothly to unforeseen liquidity requirements. 38. The Treasury Department receives information from the business units on the liquidity profile of their financial assets and liabilities, and details of projected cash flows arising from the projected future business. Based on this information, the Treasury Department will ensure that sufficient liquidity is maintained at all times. 39. The Risk Management Department monitors the daily liquidity position and performs regular liquidity stress tests. Under normal market conditions, liquidity reports are presented to senior management on a weekly basis. Decisions on liquidity management are made by ALCO and implemented by the Treasury Department. 40. ALB also calculates mandatory liquidity ratios on a daily basis in accordance with the requirement of the central bank. It was in compliance with these ratios as at 31 December 2010. G. Anti-Money-Laundering Policies

41. ALB has a manual on combating money laundering and the financing of terrorism. These policies and procedures are applied across all branches and subsidiaries. Essentially, the manual covers (i) customer identification, i.e., Know Your Customer rules; (ii) prevention, detection, and reporting of suspicious transactions; and (iii) record keeping and the relationship with politically exposed persons. 42. Reports on cash deposits and withdrawals exceeding $40,000 and offshore transfers above $13,000 are automatically generated and submitted to the Financial Monitoring Committee of the Ministry of Finance. In addition, suspicious transactions are reported within 24 hours. Specialized anti-money-laundering software has been integrated in the Athena core banking system. Customers are cross-checked against blacklists received on a regular basis from Dow Jones and the central bank. The compliance controller reports directly to the board of directors. 43. Since the anti-money-laundering law came into force in March 2010, all staff concerned have had requisite training and new staff receive an introduction to anti-money-laundering rules and the combating of terrorist financing. No money-laundering cases have been detected so far.

30 A

ppendix 4

ORGANIZATION STRUCTURE OF ALLIANCE BANK JSC

A

ppendix 4 31

Source: ALB

32 Appendix 5

Appendix 5 33

34 Appendix 5

Appendix 5 35

36 A

ppendix 6

FINANCIAL STATEMENTS, ALLIANCE BANK JSC, 2005–2010

Table A6.1: Balance Sheet

Year ended : December 31 (in KAZAKHSTAN TENGE, Million)

2010 2009 2008 2007 2006 2005

Loans

Customer Loans

622,238.00

697,882.00

703,265.00

862,721.00

640,913.00

187,652.00

(Loan Loss Reserves)

(370,411.00)

(454,175.00)

(269,790.00)

(43,527.00)

(21,113.00)

(7,555.00)

Customer Loans, Net

251,827.00

243,707.00

433,475.00

819,194.00

619,800.00

180,097.00

Other Earning Assets

Deposit with the Central Bank

56,663.00

20,563.00

Interest-bearing Deposits & Placements with Other Banks

700.00

2,702.00

6,450.00

37,079.00

14,984.00

24,104.00

Government Securities

100,880.00

67,276.00

Trading Securities

10,368.00

11,247.00

3,658.00

155,620.00

48,748.00

16,045.00

Investment Securities

57,208.00

97,131.00

1,422.00

3,057.00

5,219.00

8,896.00

Derivatives Financial Instrument

-

32,272.00

22,487.00

2,216.00

Investment in Unconsolidated Subs and Affiliates

Pledged Assets (earning assets)

56,339.00

5,648.00

167,362.00

1,513.00

2,676.00

Other earning assets

TOTAL EARNING ASSETS

376,442.00

360,435.00

644,639.00

1,038,950.00

848,510.00

319,657.00

Fixed Assets, net

21,912.00

23,750.00

32,665.00

29,613.00

12,520.00

1,999.00

Other Non-earning Assets

Cash and Non-interest Bearing Deposits

10,874.00

9,160.00

52,571.00

20,698.00

48,546.00

7,842.00

Pledged assets (non-earning assets)

-

Foreclosed Properties

-

264.00

225.00

3,539.00

Appendix 6 37

Year ended : December 31 (in KAZAKHSTAN TENGE, Million)

2010 2009 2008 2007 2006 2005

Intangible Assets, Net

1,188.00

1,262.00

1,532.00

1,436.00

262.00

182.00

Deferred Income Tax Assets

468.00

Other Assets

17,168.00

24,487.00

16,637.00

70,009.00

7,373.00

2,610.00

TOTAL ASSETS

427,584.00

419,094.00

748,308.00

1,160,931.00

920,750.00

332,758.00

Deposits & Money Market Funding

Local Currency Customer Deposits

189,545.00

135,794.00

140,353.00

197,397.00

194,312.00

138,083.00

Foreign Currency Customer Deposits

19,253.00

17,982.00

48,691.00

44,420.00

50,949.00

Due to Banks

32,770.00

10,807.00

Other Money Market Funds

TOTAL DEPOSITS & MONEY MARKET FUNDING

208,798.00

153,776.00

189,044.00

241,817.00

278,031.00

148,890.00

Other Liabilities

Derivative Financial Instruments

332.00

19.00

50,168.00

6,280.00

18.00

-

Deferred Income Tax Liabilities

1,554.00

1,100.00

-

Non-interest Bearing Payables

8,239.00

13,017.00

143,934.00

5,167.00

4,766.00

889.00

Other Money-Market Funding

Domestic Short-term Borrowings

67,660.00

155,610.00

102,574.00

88,767.00

23,102.00

6,291.00

Foreign Short-term Borrowings

551,636.00

448,008.00

154,634.00

28,575.00

957.00

Long-term borrowings:

Bank Borrowings

17,357.00

22,613.00

-

163,293.00

308,356.00

88,862.00

Debt Issues / Bonds

145,806.00

-

305,646.00

164,150.00

53,488.00

Other Borrowings (sub-debt, hybrid capital)

22,152.00

48,194.00

35,140.00

27,913.00

14,253.00

5,349.00

TOTAL LIABILITIES

470,344.00

944,865.00

968,868.00

995,071.00

822,351.00

304,726.00

38 A

ppendix 6

Year ended : December 31 (in KAZAKHSTAN TENGE, Million)

2010 2009 2008 2007 2006 2005

Subordinated Debt

62,275.00

-

6,620.00

6,885.00

18,361.00

-

Hybrid Capital

-

-

-

-

-

-

Common Stock (including capital surplus)

121,597.00

97,602.00

97,602.00

97,602.00

61,235.00

24,904.00

Perpetual Non-cumulative Preferred Stock

152,715.00

Retained Earnings

(290,570.00)

(625,099.00)

(326,776.00)

59,297.00

16,468.00

2,433.00

Less: Treasury shares

Reserves

Disclosed Reserves

(84,955.00)

Revaluation Reserves

(3,822.00)

1,726.00

1,994.00

2,076.00

2,335.00

695.00

Minority Interests

Others

TOTAL EQUITY

(105,035.00)

(525,771.00)

(227,180.00)

158,975.00

80,038.00

28,032.00

TOTAL LIABILITIES and CAPITAL

427,584.00

419,094.00

748,308.00

1,160,931.00

920,750.00

332,758.00

Exchange Rate

147.43

148.38

120.79

120.30

127.00

133.77 Source: ALB

Appendix 6 39

Table A6.2: Income Statement

Year ended : December 31 (in KAZAKHSTAN TENGE, Million)

2010 2009 2008 2007 2006 2005

Interest Income 44,381.00

85,189.00

166,086.00

181,768.00

80,193.00

17,858.00

Interest Expense (39,990.00)

(81,548.00)

(100,677.00)

(92,889.00)

(40,350.00)

(11,604.00)

Net interest income 4,391.00

3,641.00

65,409.00

88,879.00

39,843.00

6,254.00

Fee and commission income 4,531.00

7,452.00

12,817.00

12,629.00

6,019.00

2,942.00

Fee and commission expense (409.00)

(518.00)

(24,584.00)

(10,508.00)

(3,390.00)

(440.00)

Net fee and commission income 4,122.00

6,934.00

(11,767.00)

2,121.00

2,629.00

2,502.00

FX Income, Net 16,202.00

(52,417.00)

13,989.00

(10,748.00)

(1,138.00)

(36.00)

Trading Income, Net 2,460.00

(63,779.00)

(31,307.00)

16,066.00

3,114.00

922.00

Dividend Income

Other Operating Income (1,337.00)

(1,027.00)

1,717.00

108.00

853.00

846.00

TOTAL OPERATING INCOME 25,838.00

(106,648.00)

38,041.00

96,426.00

45,301.00

10,488.00

Less Operating Expenses:

General and Administrative Expenses (9,011.00)

(8,658.00)

(8,035.00)

(10,185.00)

(5,403.00)

(2,063.00)

Personnel Expenses (7,724.00)

(8,438.00)

(10,055.00)

(9,252.00)

(4,443.00)

(1,581.00)

Depreciation (2,678.00)

(3,253.00)

(3,033.00)

(2,238.00)

(696.00)

(271.00)

Other Operating Expenses

(759.00)

(273.00)

PRE-PROVISION INCOME 6,425.00

(126,997.00)

16,918.00

74,751.00

34,000.00

6,300.00

Loan Loss Provision 4,973.00

(166,461.00)

(242,273.00)

(25,571.00)

(14,032.00)

(4,921.00)

INCOME AFTER LOAN LOSS PROVISIONS 11,398.00

(293,458.00)

(225,355.00)

49,180.00

19,968.00

1,379.00

Other Provisions (496.00)

40 A

ppendix 6

Year ended : December 31 (in KAZAKHSTAN TENGE, Million)

2010 2009 2008 2007 2006 2005

(8,381.00) (164,147.00) 79.00 (356.00) (139.00)

Other Non-operating Income 326,842.00

3,967.00

3,712.00

8,056.00

-

-

Share of Earnings of Associate

Other Non-operating Expense (3,310.00)

(543.00)

(766.00)

(726.00)

PRE-TAX INCOME 334,434.00

(298,415.00)

(386,556.00)

56,589.00

19,612.00

1,240.00

Taxes

(25.00)

346.00

(13,906.00)

(5,602.00)

356.00

Extraordinary Items, net

Minority interest

NET INCOME 334,434.00

(298,440.00)

(386,210.00)

42,683.00

14,010.00

1,596.00

Income Distribution

Adjustments

Cash Dividends:

Common Shares (declared)

-

-

-

Preferred Shares

1,280.00

49.00

To Retained Earnings 334,434.00

(298,440.00)

(386,210.00)

42,683.00

12,730.00

1,547.00

Additional Capital Reconciliation Items

Exchange Rate 147.43

148.38

120.79

120.30

127.00

133.77 Source: ALB

Appendix 7 41

SUPPORTING COMPUTATIONS

A. Cost of Equity The cost of equity used in the computations is 16.50%. This is the cost of equity for Kazakhstan (KAZ) as indicated in the Cost of Equity Memo from the Office of Risk Management dated 18 August 2010. B. Weighted Average Cost of Capital

Market value of equity ( KZT million) 251a

Market value of debt ( KZT million) 261,546

Cost of equity 16.5%

Cost of debt 5.23%

Effective tax rate 0.00%

Weighted average cost of capital 5.24% a Market value of equity is based on price per share (in KZT) as at 31 August 2011. MVD = market value of debt, MVE = market value of equity.

Formula

MVE MVD x (1 - Tax) MVE +MVD MVE +MVD

x Cost of Equity + x

Cost of Debt