Ben Aris in Moscow -
ED: this is the second part of a two-part interview with Herbert Moos, CFO of VTB Group.
Russia's second biggest banking group VTB Group is on the march and is halfway to transforming itself into the country's first true multinational financial services company.
The root of the change began in swinging London in the 1960s. Andrei Kostin was a young Soviet diplomat assigned to the sought-after posting to the UK. He shared his stint with Viktor Gerashchenko, the official representative of Gosbank, the central and only bank in the Soviet Union until the late 1980s.
But the decadence of Carnaby Street and the hippie revolution passed the two young men by (or rather they had to ignore it if they were to survive under the communist regime) and they returned home to climb the rungs of the Soviet financial system. Gerashchenko eventually ended up as governor of Russia's central bank for most of the 1990s, while Kostin moved into the hard-to-pronounce Vnesheconombank (VEB), the Soviet debt agency that owes its existence to presidential decree rather than a bank license.
I interviewed Kostin in the mid-1990s when he was still at VEB, during which he boasted of having built up a significant commercial business at the debt agency catering to the needs of the country's biggest blue chips. But in 2003, Kostin moved over to the equally unpronounceable Vneshtorgbank (later renamed VTB), the Soviet external trade bank, and began a makeover that has created a financial powerhouse.
Uncharacteristically, the first thing Kostin did was to reach for outside help; he brought in western consultants McKinsey & Co. and asked them to draw up a strategy. He liked the strategy so much and it has worked so well that the person responsible for putting it together, Ekaterina Petelina, was hired away from McKinsey to run corporate strategy for VTB.
Russian banks are typically dwarfed by their corporate clients, which number amongst the largest companies in the world, so the first task was to build up the balance sheet and make the bank big. The bank's state origins made this task relatively easy. When Kostin took over, VTB had $4bn in assets; today it has $160bn. Sberbank was preoccupied with retail clients and many of the other large state-owned banks are captives of one of the leading companies. VTB slotted into the role of "leading independent state-owned bank", if that's not an oxymoron. "It was not unusual to see the balance sheet double in a year," Herbert Moos, deputy president, chairman of the management board and chief financial officer of VTB, tells bne in an exclusive interview. "But the problem was always with funding: today we have two-thirds coming from deposits - both retail and corporate - with the rest funded by borrowing - both domestic and international. Opposite picture to what we had historically."
Relying on retail
The second step was the bank needed a retail arm to collect more deposits. The trick was to attract depositors, but at the same time not to encroach on Sberbank's franchise and end up competing head-to-head with the retail behemoth. The answer was to focus on the emerging middle class and leave the hoi polloi to Sberbank. "We started our retail operation in 2005 and six years later we are the second biggest retail bank in Russia," says Moos. "Sberbank was handed a significant natural monopoly and to avoid direct competition we focused on the 'mass affluent', upper middle class and high net worth individuals."
A golden opportunity to ramp up the retail soon presented itself. A mini-banking crisis in 2004 nearly sparked a systemic meltdown as rumours of "a black list" of nearly bust banks swirled and oligarchs used the fear to take pot shots at each other in the press, nearly wrecking the financial system in the process. The real victim of the otherwise artificial crisis was Guta Bank, which failed. VTB gleefully stepped in with the backing of the Central Bank of Russia to take over the bank - a de facto state-backed bailout that left VTB with Guta's extensive branch network in prime locations throughout the capital.
More recently, VTB has bought the captive banks of the state-owned railway monopoly, TransCreditBank (TCB), followed by the controversial takeover the Bank of Moscow, that together have added 8.5m new customers and made VTB24, the group's retail arm, the second biggest retail bank in the country.
However, the surprise was the blistering growth of VTB24 Private Banking, which was set up two years ago and targets the mega-wealthy. Moos says private bank accounts already hold a quarter of the group's entire retail deposits. VTB24 Private Banking has collected some $10bn of Russian money returning from overseas in the last two years after interest rates turned positive due to the crisis and the average deposit in its vaults is $1m. "Wealthy Russians naturally want to keep their money at home in rubles, as that is where most of their business is," says Moos. "But with negative real interest rates, the natural hedge is to put the money in deposit offshore in another currency. However, now Russian interest rates are positive, the return on [London Interbank Offered Rate] in the West is next to nothing and the outlook for currencies like the dollar and euro is poor, they have been returning their money home."
Competition in the retail segment is hotting up, but VTB is being aggressive and offers a premium service, which means that its deposit growth is rising faster than the sectoral average. Having a de facto state guarantee for deposits above and beyond that offered by the deposit insurance agency helps; few Russians believe the state will ever let VTB go under, no matter how bad any future crisis.
The third plank of the strategy is to expand VTB's international reach. This part was made easy after the government decided to close down the central bank's Soviet-era international daughter banks scattered around the globe - some of them, like Moscow Narodny bank in London, with pedigrees stretching back to tsarist times. Today, VTB has 20 international branches with the latest additions being Beijing, Shanghai, Singapore, Hong Kong and New York, all of which have opened or are opening this year. "The strategy is to try and facilitate all the inbound and outbound flows of money to and from Russia," says Moos.
VTB's new Bloomberg advertising intones: "VTB the global bank", omitting the word "Russia." And that's the point. VTB has its eye on the likes of JP Morgan and Morgan Stanley, taking over the dream of Renaissance Capital's Stephen Jennings to build Russia's first true international bank. However, no-one expects VTB to manage this overnight, though in a few areas VTB has more than a competitive advantage.
All the major international banks are in Russia and servicing its largest companies, but Moos argues that VTB is the only big bank that specialises in Russia - and Russia is already a world-beater in some sectors, especially raw materials. "We want to leverage what we are good at and the strengths of Russian companies," says Moos. "It is our focus on certain sectors where we already work with the biggest companies in the world where we can add the value. We don't just provide financing for Russian multinationals, but say a company wants to buy a steel company in the USA, we can not only advise on the transaction - as we have very strong analysts covering that sector - but we can also go to the client and offer them alternative investments from around the world."
The fourth and final plank of the McKinsey strategy was to build an investment bank to better serve those large corporate clients. VTB Capital (VTBC) was launched in 2008 in the midst of the international meltdown, as bne was the first to report.
At first glance, launching an investment bank in the midst of a crisis might seem a little crazy, but with capital available it is actually an ideal time to set up shop, argues Moos. "The 2008 crisis helped a lot, as the other banks were bleeding their best people and were unable to keep their top guys." VTBC hired away almost the entire Deutsche Bank investment banking team and cherry-picked amongst the other banks based in Moscow to build up sales and marketing.
Going forward, the investment bank is increasingly hiring foreigners (Moos is German and the first foreigner to join the VTB board) and has make London the hub for the investment banking operations. The CEO, CFO, risk committee, compliance, legal and the trading floor are all based in London to better access the international capital markets. There are also hubs in Dubai and Hong Kong to serve those regional markets, with another office about to open in New York before the end of the year that will close the global circle. "Many foreign banks have been working in Russia for many years, but have never been able to build up a strong corporate bank here. However, investment banking in Russia has always been dominated by foreign banks. The local banks have never been able to compete on size or in the breadth and depth of products. But we are already number one in investment banking, [equity and debt capital markets] since 2009," says Moos.
Phase two: from muscle to margins
VBT has more-or-less finished its rapid growth phase and put all the pieces of the McKinsey plan in place. From here on in, the group is going to shift its emphasis from expansion to profits. For example, Moos has told the heads of all the foreign subsidiaries they have to generate a return on equity of at least 15% by 2013 - or face closure.
An integral part of this change is to completely privatise the bank. President Dmitry Medvedev re-launched Russia's privatisation programme last year, but the companies on the list fall into two camps: those that welcome cutting their ties to the state and those that will fight tooth and nail to remain under the aegis of the Russian budget. VTB is perhaps the best example of a state-owned company that longs for freedom and the management are actively working to push its sale through as fast as possible.
VTB already carried out an IPO in May 2007, well before the privatisation programme got going, and followed this up in February with a second sale of 10% during the brief window of enthusiasm for the Russian story that closed so decisively in August this year. Moos says the plan is to continue selling 10% a year until the bank is 100% privately owned; in theory, the bank will be fully private inside seven years. Another 10% stake is due to be offered next year, provided Sberbank can get a mooted sale of 7.6% away first, as these deals are too big for the market to absord more than two a year.
But Moos says the new shareholders that came in during February's sale - such as the sovereign wealth funds of China, Singapore and several Middle Eastern countries, as well as leading private equity funds - have already brought tangible benefits. "Now these funds are shareholders in the bank, they are more willing to co-invest with us," says Moos. "For example, we have just finished the 'White Gardens' real estate project, a huge business and hotel complex in central Moscow where the Chinese invested more than $500m - China's biggest ever investment into Russia."
VTB is a perfect vehicle for the sovereign wealth funds, as most of the alternative large investments would link them to an oligarch. Such a scenario is politically uncomfortable, as most government's don't want to be seen playing favourites in a domestic economy.
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