VTB, Russia's second largest bank is enjoying an acquisition spree

VTB, Russia's second largest bank is enjoying an acquisition spree

In the space of a few months, Russia’s second largest bank has engineered ground-breaking bond issues, a kick-start to the government’s privatisation programme, and two acquisitions. Philip Alexander reports.

When the Russian government designated Bank of America Merrill Lynch (BAML) in October 2010 as its sole agent to sell a 10% stake in Russia’s second largest bank VTB, the stakes were very high, says Riccardo Orcel, BAML’s head of Corporate and Investment Banking for Central and Eastern Europe, Middle East and Africa.

“This was the inaugural transaction of Russia's $60bn privatization programme kicked off with one of the prize assets, 85% state-controlled VTB,” he says.

Failure was not an option contemplated during the six months of work to prepare for the sale, but it was a very real possibility by the time the offering launched in February 2011. Instability in the Middle East was driving investors away from emerging market equities toward assets perceived as safer. Three major initial public offerings (IPOs) by Russian companies in the week before the VTB issue had to be postponed due to lack of demand.

In the six months before the secondary offering, VTB’s own share price had soared by around 80%, significantly outperforming the wider Russian share indices or its nearest rival Sberbank, and potentially leaving investors wondering about whether there would be further upside on the stock.

There was. The placement, in which BAML as sole agent was joined by VTB Capital as joint global coordinator and Deutsche Bank as bookrunner, was almost 1.6 times oversubscribed and raised $3.3bn for the Russian government. The share price climbed by more than 8% in the first month after the offering. This post-offer performance was a pleasing contrast to some transactions launched by the private sector in the past year that suffered steep declines in their first few months of trading. It leaves the door firmly open to further deals for state-owned assets in the ambitious new wave of privatisations.

“The government was keen to combine the short term merit of achieving the maximum price in the sale of state assets with the advantages of building a rapport with a top quality, stable, long-term investor base. The performance of VTB shares post-offering was important,” says Mr Orcel.

Rising oil prices reduce the budgetary need for further privatisation, but the government still has some attractive assets that should make straightforward deals. These include Sberbank, and gas transit shipping operator Sovcomflot – trained captains for gas transit ships are apparently rarer than trained astronauts. Herbert Moos, VTB’s chief financial officer (CFO), says he is confident that the government will push ahead with further deals, as the imperative is economic modernisation, not just fiscal revenues.

Going global

Building a high-quality investor base was also a vital step that can boost future divestments, and one which ties in with VTB’s aim of representing Russia in global markets. In particular, Mr Moos says management directly influenced the pool of investors to ensure that the deal helped to bridge the gap between Russian issuers and new sources of liquidity in addition to funds in the US and western Europe that are more familiar with the Russian investment story.

In total, only 25% of investors were domestic, and buyers came from 20 different countries. The major breakthrough investment was from the China Investment Corporation, which had not previously set a specific allocation for investing in Russia. Most of the other major sovereign wealth funds also participated, and strategic investors took 33% of the issue in total, including two significant stakes sold to Italian insurer Generali, and the US firm Texas Pacific Group, which is more usually associated with private rather than public equity.

The equity offering was able to build on VTB’s earlier efforts to broaden its fixed-income investor base. In 2010, it was the first Russian issuer to access both the Singapore dollar and Chinese renminbi bond markets. Mr Moos says these deals also generated new leads for its investment banking franchise VTB Capital, and possible issues in Brazil and other new markets are now under examination.

Competition hots up

VTB Capital became Russia’s largest player in both equity and debt capital markets in 2010, barely three years after its launch. The size of VTB’s balance sheet is undoubtedly an advantage relative to other Russian and some foreign-owned investment banks, and market participants say it is one the bank has used fairly liberally.

But that advantage may now be challenged, following the deal by the country’s largest bank, Sberbank, to purchase one of the largest independent investment banks, Troika Dialog. In addition to providing 30% of Russian corporate lending, Sberbank also has a market share of about 50% in retail deposits, giving it cheaper and more stable funding than any competitor.

Mr Moos remains confident about VTB Capital, which has a head start and already has a comprehensive platform, whereas Troika has a more narrow product offering. Investors who hold long positions in VTB stock tend to agree. Hanna Loikannen, the head of the Moscow office for Sweden-based East Capital, which is one of the largest foreign portfolio investors in Russia, notes the long period from memorandum of understanding to closing the Sberbank/Troika deal.

“There is a serious risk of some key people leaving Troika, and of course there is no public information about how those people are tied to the bank until the final closing. Sberbank has a huge corporate client base that needs investment banking services, particularly fixed income, so there is a natural flow of business, but it is hard to see how it will develop in practical terms,” she says.

Buying bulk

At the same time, VTB is bulking up its own network and market share, via bolt-on acquisitions rather than organic growth. In late 2010, it purchased TransCreditBank (TKB), the captive bank for Russian Railways. This should provide VTB Capital with deal flow from the Russian rail sector, which has huge investment needs. It is planning to meet these partly by spinning off component companies such as rolling stock operators and logistics arm Transcontainer, which made an IPO in November 2010. VTB Capital was not a bookrunner on that deal, but the bank apparently purchased a large slice of the offering, and is roadshowing an upcoming Eurobond for the company. Mr Moos says TKB is also a good deal for VTB’s retail arm, VTB-24.

“TKB has added in one go about 3 million loyal retail customers who are the staff of Russian Railways and their families, with credit histories and payroll profiles for most of them, and a lower number of bank products per customer than VTB-24,” says Mr Moos.

However, VTB-24 will receive a much larger injection of about 8 million new customers in the Moscow region, effectively doubling its customer base, if it successfully completes the purchase of the country’s fifth largest bank by capital, Bank of Moscow. Following the dismissal of Moscow mayor Yuri Luzhkov by Russian president Dimitry Medvedev in mid-2010, the new mayor Sergei Sobyanin agreed to sell the city administration’s 46.48% direct stake in Bank of Moscow to VTB.

At present, some minority shareholders are still negotiating and may drive up the ultimate purchase price. The deal could yet fail to materialise, because VTB has only just started due diligence on the bank’s loan book, and might baulk if the price tag is pushed too high. And investors are divided over the significance of the deal. Dedicated eastern Europe investor Wermuth Asset Management prefers to invest in Sberbank rather than VTB, and the fund’s banking analyst Ursula Beyreuther says it is difficult to form a clear investment view on VTB.

“It is a kind of conglomerate of different units, it bought Promstroybank in 2005 and it required a long integration period, TKB is not integrated yet and already it is trying to buy Bank of Moscow. We also find Sberbank is more transparent in its communication with investors,” she says.

Avoiding indigestion

By contrast, Ms Loikkanen at East Capital has more confidence that Bank of Moscow can be successfully integrated by the renewed management team at VTB, embodied by Mr Moos himself. A former Lehman Brothers executive, he became CFO in September 2009. Since then, VTB and VTB Capital have brought in many highly regarded senior staff, prompting market participants to joke that the bank’s initials stand for “Vse Tam Budem” – Russian for “we will all be there”.

“The market largely sees the Bank of Moscow deal as positive, provided the negotiation does not drag on too long and VTB does not overpay. In general, there is upside in that acquisition as Bank of Moscow has a wide branch network and customer base in a region where VTB is keen to expand,” says Ms Loikkanen.

Mr Moos says the deal is potentially transformative for VTB, taking its assets to about two-thirds those of Sberbank, and providing an excellent deposit base in Moscow as well as potential investment bank deal flow as the new Moscow administration prepares to sell other assets. He is also frank about possible problems with the loan book at Bank of Moscow. The Russian authorities are investigating whether the bank made significant loans to real-estate developments owned by Mr Luzhkov’s wife, Yelena Baturina, prompting ratings agency Fitch to place the bank on RatingsWatch Negative. The bank’s published non-performing loan (NPL) ratio is just 4%, well below the national average, and Mr Moos acknowledges that this may be understating the risks.

“What made us more confident is that the coverage ratio of reserves to NPLs is over 200%. That tells me that there may indeed be a need to report higher NPLs, but the bank was prudent in forming reserves, which means that the P&L [profit and loss account] has most likely already absorbed the potential losses,” he says.

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