Formed in 1992, Parex has seen off various crises to become Latvia’s second largest bank by selling itself as a channel into western Europe for Russian investors. Robert Anderson reports.

In a Baltic market that is dominated by Scandinavian banks, Parex stands out not just for being the last big independent bank but also as one that is taking serious steps to becoming a bridge between western Europe and the former Soviet Union.

Yet Parex, the second largest Latvian bank with assets of Lt650m ($1.39bn), faces a severe test this year as the country’s economy heads towards a possible hard landing, while international wholesale funding – on which the bank relies – becomes more expensive.

Given that gloomy outlook, it came as no surprise that negotiations collapsed late last year between Parex’s two founders, Valery Kargin and Viktor Krasovitsky, and potential buyers including Alfa Group of Russia.

Mr Kargin and Mr Krasovitsky have toyed with the idea of selling their bank several times since it was founded in 1992 but have never been able to achieve the price they believe it is worth, a goal made even more difficult in the current economic environment.

Potential buyers may also have been put off by the fact that the two founders are so dominant in the bank that there must be a question mark over how it would fare without them at the helm.

The two founders are Latvia’s richest men and leading representatives of the country’s dominant ethnic Russian and Jewish business elite. They still each own 43% of the bank and make all key decisions.

Mr Kargin, the president and chairman, represents the public face of the bank and manages its vital relationships with Latvia’s political elite. Mr Krasovitsky, the deputy chairman, avoids the limelight and acts more as a chief financial officer, managing the bank’s key financial transactions.

Mr Kargin, originally a journalist, and Mr Krasovitsky, a computer expert, made their start in business even before the collapse of the Soviet Union and the independence of Latvia in 1991. Owing to their strong Communist party connections – both members of Komsomol, the party’s youth wing – they were given the first private licence in the Soviet Union to trade in hard currency in 1990.

Quick profits

After Parex was granted a banking licence in 1992, the founders parlayed their successful east-west currency trading operation into a commercial bank. They made quick profits acting as a conduit for Russian flight capital – boasting “we are closer than Switzerland” in the bank’s advertising – and became the dominant local player in east-west shipping and trans-shipment.

In corporate banking – still a more profitable segment than retail banking in Latvia – Parex quickly became the Baltic states’ market leader in debt underwriting, mergers and acquisitons and stockbroking. It also built up a profitable corporate lending business, winning a reputation for ruthlessly seizing the assets of defaulting borrowers.

Parex boasts that it now serves nearly 30% of the top 300 Latvian companies and that it can make much quicker lending decisions than its Scandinavian branch rivals. “Our professional knowledge has enabled the bank to serve not just as a lender but also as a consultant to many companies,” says Jorens Raitums, vice-president for corporate clients.

Parex prospered as rivals folded in Latvia’s banking crises of 1993, 1995 and 1998 or sold out to Scandinavian buyers (four of the five largest Latvian banks are now foreign). Moreover, it showed its ambition by expanding outside of Latvia through the acquisition of a Lithuanian bank in 2000 and by opening a branch in Estonia in 2004, acquiring a Swiss subsidiary in the same year.

In the Baltics it now offers a full range of retail products, particularly mortgage lending, credit cards and asset management. “We jumped on the bandwagon to catch up with our rivals,” says Mr Raitums. “Now the main focus is on retail.”

In savings, Parex has been a leader rather than a follower, putting it into a strong position as Baltic people begin to shift away from borrowing. Already the Latvian market leader in deposits with a 19% share, Parex has started pension and life insurance operations and is now one of the largest asset managers in the Baltics, with more than 175,000 clients and $1bn under management.

Further expansion

Parex is now looking further east. It plans to draw on its existing links there, as well as drawing from its experience during the transition from Communism to a market economy. In Russia, Ukraine, Belarus and Azerbaijan it has established asset management subsidiaries, helping the region’s nouveaux riche to invest their wealth offshore, and has built up a strong car leasing business. The bank plans to double its lending there this year.

Parex would like to become a bridge to Europe for local corporates in the former Soviet Union and has already managed several bond issues and syndicated loans targeted at western Europe. “Your partner in the EU”, is the bank’s updated slogan. It also plans to become a bridge for western companies wanting to do business in the former Soviet Union. To achieve this and strengthen its deposit base, Parex opened a branch in Germany in 2005 and in Sweden in 2006, and it is now considering acquisitions in both countries.

“We like the idea and we have sufficient resources to buy banks in Sweden and Germany in addition to the branches we have in Berlin, Hamburg, Stockholm and Malmo. In my opinion, the overall financial business is undervalued in these countries and we are ready to grow by acquisitions if the right opportunities arise,” says Mr Kargin.

However, expanding the bank will be much more difficult at a time when wholesale funding has become more expensive. Refinancing a €385m Asian loan facility this month is likely to be a real test for the bank, which has a bare investment grade rating. By contrast, Parex’s main competitors, the subsidiaries of Swedish banks, can draw on cheap Nordic deposits.

To meet this challenge, Parex is trying to diversify its funding sources by increasing its deposit base – up 19% in the first three quarters of last year – and by seeking wholesale funding from a wider circle of lenders, particularly from Asia. Parex’s second big challenge will be to maintain earnings growth at home as the economies of the Baltic states slow down or suffer a hard landing – a danger that is making international lenders even more cautious.

The phenomenal growth of the Baltic states over the past few years has been built on cheap credit, particularly from Scandinavian banks such as Skandinaviska Enskilda Banken and Swedbank, which have made the region their second home. Latvian bank lending rose 30% in the first three quarters of last year, driven mainly by mortgage finance. After a domestic run on the lat last February, international attention has focused on Latvia’s huge current account deficit and gross foreign debt.

The US subprime mortgage turmoil has made things worse by tightening global credit conditions.

Now banks are rushing to turn off the lending tap as fears grow that the tiny Baltic economies are overheating and it could leave them with scalded fingers. At the same time, loan demand is falling as consumers begin to get more nervous and interest rates rise in line with the eurozone. “We’re getting more stringent definitely,” says Mr Raitums. “The market itself is in a state of uncertainty which psychologically puts a brake on borrowing.”

Lending slowdown

So far the lending slowdown has mainly had an impact on the housing market, with prices first in Tallinn and then in Riga falling this year, but banks are only experiencing a slight deterioration in loan quality. However, if economic growth were to plummet and Latvia felt forced to devalue its currency, many bank clients would have great difficulty repaying their loans because these are typically denominated in euros.

Parex, which has survived three banking crises in its short life, feels secure because it has always maintained conservative liquidity ratios. Moreover, it has focused on innovative lending products rather than competing on price. Even though it expanded lending by 26% in the first three quarters of last year, this was less than its rivals.

Parex – whose profit rose 80% in the first nine months of last year to Lt28.86m – also has a more diversified revenue profile, with a wider range of corporate clients than just the real estate sector and an equal split between net interest income and trading, commission and fee income. As competition and falling interest rates squeeze net interest margins while costs rise, it hopes to make up the earnings shortfall with fees and commissions.

Nevertheless, Parex still faces a much less helpful economic environment for the foreseeable future. This has inevitably fanned speculation about the bank’s future but Mr Kargin denies that the founders are in a hurry to sell or that they have missed their chance.

“The shareholders of the bank have sufficient resources for the further development of the bank,” he says. “We have not entered the subordinated debt market yet, while we have made several closed private placements, which received high levels of investor interest.

“Besides the possibility to increase shareholders capital by means of current shareholders, we have options to attract subordinated capital or tap equity market by issuing new shares.”

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