A financial BoM in Russia

By bne IntelliNews October 24, 2011

Ben Aris in Moscow -

Russia escaped the worst of the meltdown that destroyed large chunks of the US and European banking sectors. The Kremlin spent a total of $66bn in 2009 to prop up wobbly banks and only one biggish bank actually reached the point where the state had to step in and rescue it from collapse. So imagine the shock when two years after the eye of the storm had passed, state-owned VTB had to negotiate a $5bn bailout to save Bank of Moscow (BoM).

BoM is the fifth largest bank in Russia and has a clientele to die for. Moscow is like a country in its own right: with 15m-17m inhabitants (including the illegals), it is bigger than most Central European countries and the average income is five to six times higher in the capital than in the rest of the country. No wonder that VTB wanted to take the bank over when the Moscow's new mayor, Sergei Sobyanin, put it up for sale on December 10, 2010.

For over a decade and half, BoM had been the captive bank of former mayor Yuri Luzhkov, who was sacked by Russian President Dmitry Medvedev in September 2010. Most of BoM's 6.5m retail customers are from the prosperous middle classes and thanks to its City Hall connections the bank is home to some 100,000 municipal businesses. VTB Bank consolidated control of 75% over BoM in September. "The branch network and the municipal accounts would be both extremely difficult to reproduce in a competitor bank. In this sense, the BoM's business is unique," Herbert Moos, Deputy President and Chairman of the Management Board and CFO of VTB, tells bne in an exclusive interview.

VTB Bank has also taken over TransCreditBank (TCB) this year, a well-run and profitable operation that was formerly a captive bank of the state-owned Russian Railway monopoly. Together, these two acquisitions have catapulted VTB's retail arm, VTB24, into the big league, making it at a stroke the second biggest retail bank in Russia.

More interestingly, VTB also now services the accounts of almost all the municipal businesses in the Russian capital. "BoM has over 100,000 municipal companies that serve the needs of the city," says Moos, sitting in his corner office of the VTB building in Moscow City, the capital's financial district, which looks out over the city spread 26 floors below. "Moscow is a huge business in its own right and City Hall's annual budget is about the same size as that of New York - $45bn a year - one of the largest in the world.

Missing words

But the BoM deal didn't go smoothly. The bank was among the very first asset to go into the city's privatisation programme after Sobyanin began to clean out the hubris of the Luzhkov-era. VTB immediately asked the bank's management for the details of its top 400 borrowers - and that's when the games began. BoM sent over the files, but once they started digging into the detail, they found many were missing. "We had selective loan files provided to us," says Moos, who as a German is the first foreign national ever to serve on the bank's board of directors.

Things quickly got nasty. The takeover should have been a friendly acquisition, as the main shareholder, the City of Moscow, was happy to sell. But when VTB turned up at the BoM offices, the management of the bank had locked them out. "The management only owned about 10% of the bank, but they treated BoM like it was their personal bank," says Moos.

It is easy to see why. Luzhkov plucked the BoM president Andrei Borodin from relatively obscurity to run the bank when he was only 25 years old, who then ran it like it was his own personal fiefdom: Borodin insisted that all the staff empty the corridors whenever he walked through the building, according to Moos.

It quickly transpired there were two banks at BoM: the public one that reported to the Central Bank of Russia (CBR), issued IFRS accounts, had credit and risk committees that vetted deals, and all the normal trappings of a successful commercial bank. But on one of the upper floors was the "Department of Investment Assets," the other bank. Some 15 people worked in these rooms, according to Moos, who fed a money chute that ran straight out the front door. "It was a bank within the bank," says Moos. "The credit decisions it made were not approved by the committees, but signed directly by Borodin and senior managers and the cash would leave the door with no questions asked."

The Department of Investment Assets made it as hard as possible to see the millions of un-scrutinised loans that the bank was making, chopping them up into thousands of small pieces so they wouldn't show up in the bank's reports to the CBR and cause awkward questions.

Much of this lending was not stealing per se, but simply poor credit decisions where loans were made to companies close to the City that couldn't repay them, so they were simply rolled over. However, after Luzhkov was ousted, things changed rapidly. "The lending picked up six months before VTB acquired the stake and about RUB150bn ($5bn) was lent, mostly to special purpose vehicles (SPVs) based in the Cayman Islands, British Virgin Islands and other offshore havens," says Moos. "There was nothing behind these SPVs but more SPVs."

After the ropey state of the bank was revealed, the problems started to get serious. BoM was near collapse and if it went down, not only would 6m Muscovites lose their savings and the city's economy be brought to a halt, but the bank was big enough to spark a systemic collapse.

The solution that the CBR came up with was pretty elegant. First, the CBR conceded that the problems at BoM were nothing to do with VTB's ownership of the bank and so its shareholders should be protected from taking any losses associated with the takeover. In return, the CBR insisted that VTB consolidate at least 75% control over the bank - something it was delaying doing all that summer, much to its shareholders' chagrin - so that if the state did bail out BoM, it could be sure that the money would remain in BoM.

Then the CBR drew down a 10-year loan via the deposit insurance agency to the tune of RUB295bn at 0.51% (the 0.01% was the administrative fee the DIA charged for the transaction). On exactly the same day, the Ministry of Finance issued a 10-year bond for exactly the same amount, but at an interest rate of 8.3%. The value of the spread between the loan and the bond is exactly RUB150bn at current prices, which will be used to plug the hole in BoM's books. "At the end of September, Bank of Moscow's accounts will show an accounting gain of RUB150bn, which will immediately be used to create a reserve against the SPV portfolio so the net P&L effect for the BoM will be zero," says Moos. "The upshot is we will have sufficient reserves to deal with all the problems caused by the BoM management, but it will not cost VTB shareholders one kopek nor is this taxpayers' money."

The whole BoM fiasco has had several consequences. The Central Bank of Russia has already sponsored a new law that gives it the power to sack a bank's management if it's doing a bad job (or stealing). And Gennady Melikyan, deputy chairman of the CBR's bank oversight committed, was sacked and replaced by Alexei Simanovsky in September as part of the central bank's efforts to beef up supervision in the wake of the debacle.

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