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Banks merge to combat crisis

As Russia undergoes its own financial crisis, the country’s authorities appear to be encouraging consolidation to remove the weaker players. But buyers will be taking a close look at their assets. Writer Ben Aris.
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According to Uralisib’s chief finance officer Konstantin Vaysman: “Russia’s crisis is the mirror image of the American one.” Mr Vaysman told a group of Russian bankers gathered in ­London for the annual Russian banking conference: “[The crisis in the US] started with toxic debt and then turned to a liquidity crisis; ours started with a liquidity crisis in ­September and now the toxic debt is going to come.”

Russia’s banking sector was walloped by the international financial crisis that hit in September 2008 after the fall of Lehman Brothers, but thanks to fast action by the Central Bank of Russia (CBR) and the deep pockets of the Russian state, it managed to avoid a systemic banking sector collapse.

The US felt most of its pain in the first few weeks, but cut off from its main source of long-term cheap money, Russia’s immature and fragile banking system is going to feel most of the pain this year.

Analysts say the silver lining is that the slowdown will spur a badly needed consolidation of the sector, which was already well under way by December. But everything depends on how well banks cope with the rapidly decaying quality of their assets.

The collapse: phase one

The international crisis broke on Russia’s shores on September 17, 2008, when the fast-growing second-tier KIT Finance defaulted on its repo obligations. At the start of the year, the bank was held up as poster boy for the rapid progress of Russia’s financial sector, and hoped to be Russia’s first commercial bank to launch an initial public offering (IPO).

Russia has been through many financial crises and the state knows the routine well. Within less than 24 hours, asset management company Leader, owned by Gazfond, the pension fund of state-owned gas giant Gazprom, said it would buy the bank, going a long way towards restoring confidence.

Over the next few weeks, about half a dozen other banks got into trouble – and each time a state-owned bank or company quickly stepped in to bail out the victim. Vnesheconombank, the state’s debt agency, took over Svyaz Bank and Globex Bank in quick succession using a $2bn capital injection from the CBR. The central bank also put $500m into the little known Gazenergoprombank, a subsidiary of Gazprombank, to bail out commercial bank Sobinbank, and by December commercial banks were moving into the fray.

The next big shock was the announcement by leading investment bank Renaissance Capital that it would sell a 49% stake to billionaire Mikhail Prokhorov on September 22 for $500m. Stephen Jennings, chief executive of Renaissance Group, which owns the bank, denied that the move was a rescue package.

He described it as a “pre-emptive strike” to shore up the bank’s strength ahead of what was clearly going to be a rough patch for everyone. Still, commentators couldn’t help but point out that Jennings had turned down an offer to sell the bank in 2006 from state-owned bank giant the VTB Group, which carried a $4bn price tag.

The collapse: phase two

The $5.5bn the state spent on rescuing banks in September was timely and nipped any panic in the bud, but with the interbank lending market still closed, the crisis was far from over. In November, the crisis went into a second phase and commercial banks came into play as the lack of liquidity continued to cause casualties.

Russia’s richest man, Oleg Deripaska, and his Basic Element holding company were the biggest losers among Russia’s business elite. The crisis wiped out some $20bn of his estimated wealth in a matter of weeks. His entire group is in dire financial straits and Mr Deripaska announced in the middle of November that his bank, Soyuz, would sell a 71.87% stake it owned in regional bank Akcept to a consortium of investors, for just $10m. By January 2009, he had announced the planned sale of Soyuz itself to GazFinance, yet another of Gazprom’s multiplying subsidiaries.

Over the next two months, most of Russia’s leading commercial banks announced similar deals or plans to buy smaller banks. Alfa-Bank bought out Bank Severnaya Kazna, the second largest in the Sverdlovsk region, at the start of December and said it would buy more in 2009. BIN Bank acquired a 76% stake in Bashinvestbank in Tatarstan and also said it was looking at buying more banks. And frenetic negotiations are going on throughout the sector. Indeed, the CBR is actively pushing the top 200 commercial banks to buy smaller banks – and most are very interested.

“The turbulence has produced some very big opportunities,” says Kirill Dmitriev, the manager of Icon Private Equity, which has a $250m bank fund that he runs together with Russian banking ‘wunderkind’ Igor Kim, owner of Ursa Bank. “Currently we are getting calls from 10 banks a day that want to be bought. We are not going to acquire problems we can’t mend. You have to look at the liabilities and check the quality of the assets. Can the bank repay its obligations? If the answer is yes then we are interested.”

begin to flow

By far the biggest deal of this sort, announced on December 2, 2008, was the merger between leading commercial bank MDM Bank, owned by Sergei Popov, and leading regional bank Ursa, owned by Mr Kim. It will create the largest private lender in the country.

Mr Kim described the merger – expected to take between 12 and 18 months to complete – as “unprecedented” in size and importance. “We have the resources necessary: the liquidity of MDM Bank, which is close to $1.5bn, and Ursa Bank, approximately $1.3bn, to create a substantial reserve for further development together,” he said in a statement. However, some analysts speculate that Mr Kim was forced into the deal as his aggressive expansion over the past few years has been driven by access to foreign capital, which has now disappeared. MDM gives Ursa access to new markets but it also has much better access to international financing. One analyst even calls the deal “an acquisition in disguise”.

A lot more deals of this sort are expected in 2009 as the equation for bank owners has changed dramatically. While assets were growing strongly, few were keen to sell. Now that asset growth has either stalled or is going backwards, the majority of smaller bank owners are happy to cash out. At the same time, prices were already falling.

A study by Russian investment bank Uralsib found that the average price-to-book value ratio for bank mergers and acquisitions in all of central and eastern Europe (CEE) done in 2006 rose to a high of 4.7x but was falling in 2007 when it reached an average of 3.6x. Banks in Ukraine and Kazakhstan were still going for heady prices in the range of 4.7x to 6.2x that year, but the bottom dropped out of the market in 2008 as the subprime financial storm gathered pace. The average ratio for the region fell to 2.9x in 2008 and by the end of the year, the only deals being done were the rescue operations ordered by central banks.

There were too many banks before the international financial crisis struck, but no one wanted to sell. Now there are too many banks – but the vast majority of owners want to sell. The question is: who is going to buy all these little banks?

Second chance for CBR

Mr Dmitriev says the CBR believes it missed a trick when it failed to consolidate the banking sector during the 2004 mini-bank crisis, but commentators on all sides say it is not going to make the same mistake this time.

Russia currently has just over 1200 banks, but at a banking conference of top Russian bankers in December 2008, the consensus was that there will be about 800 banks left by the end of 2009. Mr Dmitriev says the CBR would actually like to go further and have 300 to 400 banks standing in two or three years’ time.

To get to this point, the state has to get the commercial banks on board with the restructuring of the sector. A key element of the rescue effort being co-ordinated by the beefed-up Deposit Insurance Agency (DIA) – which is emerging as a central player in the restructuring effort – is that the state has singled out a list of 200 banks that are “too big to fail”.

Allowed to fail

As many as two-thirds of the remaining 1000-odd banks will either be bought or allowed to fail. As these banks only account for about 8% of the total sector’s assets, their demise should not make much difference to the functioning of the sector. Nonetheless, just how these banks are removed will be important if the CBR is not to trigger a panic as it did by fumbling the closure of Sodbiznessbank and causing the mini-crisis in 2004.

The CBR has already rushed through changes to make bank mergers and acquisitions easier. And Mr Dmitriev says that the CBR has told Icon that if it takes over any bank it can expect fast-track approval for the deal and access to liquidity injections from the CBR coffers to make sure the buy-out target is in good health after the deal. That will not be easy as many smaller banks are expected to go bust this year.

“We have no illusions that we can save all the banks with state support in this crisis,” says Bella Zlatkis, a former governor of the CBR, deputy chairman of the board and member of the supervisory board at ­Sberbank.

“[Deputy prime minister Igor] Shuvalov and the top Kremlin officials have realised the reserves are big but not limitless, and they will not last long if we keep spending money at this rate. We need to stimulate the economy with the budget resources, through public works, construction, roads, etc,” adds Ms Zlatkis.

Bad debts set to rise

Russia’s toxic debt is only just starting to appear. Retail borrowers were surprised in September 2008 when the government went out of its way to suppress reports of the financial crisis until it was well under way. Now that economic growth and industrial production have crashed, the proportion of non-performing loans (NPLs) is expected to soar.

“People had no idea of what was going on and were spending as freely as ever. The job cuts and freeze on lending has come as a complete surprise for many,” says Ivan Svitek, CEO of Home Credit Finance Bank (HCFB) Russia. “We have made provisions, of course, but whatever your level of NPLs was in 2008, you can expect it to double now.”

Between October and November, some 80,000 Russians lost their jobs, according to the Russian Ministry of Health, and analysts predict that the jobless total will rise from 6.1% to 7% of the population by the end of the year. Bad debt among consumers was already soaring and corporate loans were starting to sour at the end of 2008. Overdue corporate loans also rose sharply in October 2008, up by RUB51bn ($1.54bn) to 1.6% of gross loans against RUB20bn in September, according to the most recent CBR data.

“The banks were pretending they were offering one-year loans that they could choose not to renew. This is very well while the economy is growing, but now they need to call in the loan they have discovered the loans were really five-year loans as the borrowers have no money,” says Mr Dmitriev. “If a bank calls in a loan, what is the company going to do? Say ‘here, come and take my tractor’? Banks cannot get their money back even if they wanted to.”

Rescue criteria

On November 20, the DIA set quantitative criteria for a bank to be rescued. The agency is to rescue a troubled bank if its retail deposit base is more than $4bn for a federal, or $1bn for a regional, bank (although there could be exceptions). UniCredit estimates that about 200 to 300 banks meet this criteria, but the agency only has enough capital to cover 5% of the total Russian deposit base – enough to save only a small proportion of the top 300 banks, which account for at least 90% of deposits.

No one knows how far NPLs will rise, but analysts guess mortgages will be the least affected, with NPLs in the order of 1% to 2%. Banks with a strong retail focus will see NPLs rise to the red line level of 5% or more. And the banks in most danger are the consumer finance specialists, which will see NPLs rising to more than 10% of their portfolio, says David Nangle, senior bank analyst at Renaissance Capital.

“A few weeks ago I was telling people that the Russian economy was fundamentally strong and the bank sector sound. Now I have had to eat my words,” Mr Nangle said at the start of December 2008. “The outlook for the next three to 12 months is now very vague. Visibility is poor and the asset quality of the banks is deteriorating fast.”

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Read more about:  Central & Eastern Europe , Russia