Investors ask which Russian bank domino will be the next to topple

Investors ask which Russian bank domino will be the next to topple
Two of the Garden Ring banks have already collapsed.
By Ben Aris in Berlin September 24, 2017

Russia’s banking sector has been wracked by another mini-crisis after the collapse of two so-called Garden Ring banks – leading Moscow-based commercial banks that have been favoured by the Central Bank of Russia (CBR) –  costing the state trillions of rubles. The burning question now is: who is next? 

The collapse of Financial Corporate Otkritie and takeover by the CBR at the end of August led to a Rub1.1 trillion ($16bn) bailout, which is almost the size of the entire country’s federal budget deficit for this year. It was quickly followed by Binbank, which got caught in the flak and ran to the regulator on September 20.

The bank failures made Alfa Bank analyst Sergei Gavrilov's warning in the middle of August look prophetic. He named both Otkritie and Binbank as likely to be in trouble in a note sent to clients, and was castigated by the regulator for sowing discord that could undermine the sector. In his note, Gavrilov named two more leading commercial banks, Promsvyazbank (PSB) and Credit Bank of Moscow (CBOM),  as being in danger. 

The cost of bailing out Otkritie and Binbank is already so astronomically high that  the last thing the CBR wants to see is another Garden Ring bank go bust. These banks  – so called as they all have offices inside the ring road that encircles Moscow’s centre –  all share several characteristics.

They have all been used by the CBR to rescue failed smaller banks, which they have all done badly. They have all become increasingly exposed to state-owned enterprises (SOE), which are large and lucrative clients until they are leave. They have all snapped up pension funds, using the cash flow of premiums to fund their own businesses. They have all broadened their businesses to buy up other companies and so have, to an increasing extent, recreated the financial-industrial groups, or FIGs, that dominated the economy in the 1990s. They have all grown very fast, too fast to be able to manage their businesses effectively. And they even share some of the same shareholders.

The EBRD holds a 11.7% stake in PSB, giving it a sheen of respectability. But also in its shareholding are two of the other Garden Ring banks – Binbank group and Credit Bank of Moscow –with about 10% each.

In addition the O1 property group pension fund has owned another 10% since 2015. 01 is owned by Boris Mints and his son Dmitri sits on PSB’s board of directors (who bne IntelliNews profiled in its September magazine cover story on the collapse of Otkritie). Mints was one of the founders of Otkritie, but quit the bank in 2013 for reasons that are not clear and moved to PSB.

Alfa Bank is the only one of the five Garden Ring banks that doesn't participate in this incestuous circle, and it is the most robust.

In a precautionary move the CBR added CBOM to the list of strategically important banks shortly after Gavrilov’s note as a simple way of shoring up confidence in the bank and preventing life threatening outflows of depositors’ funds. A highly profitable bank that specialises in catering to private enterprise and cash collections, the bank is thought by analysts to be the most solid of the four banks named. 

Attention is therefore focussing on PSB, which seems to be the most likely to get into trouble next. Ironically, as the collywobbles in the sector grew in August, state-owned enterprises moved their accounts to PSB, which saw its deposits from these companies jump 79% m/m to RUB98bn. PSB also moved to consolidate its business by announcing a merger with sister bank Vozrozhdenie that PSB’s owners had bought in 2014, which makes it “too bigger to fail” than before.

Banking brothers

PSB was set up in the 90s by Alexei and Dmitry Ananyev, the legendary banking brothers. Both are big bears of men and deeply religious, sporting the long full beards of a Russian Orthodox believer.

They made their first money in imported computers and building digital overlay telecoms networks in the 1990s, at a time when the phones didn't work and everyone with some spare cash set up a bank.

In the boom years PSB flourished by catering to the needs of mid-sized commercial enterprises, the bank told bne IntelliNews in multiple interviews. It bucked the trend by focusing on private enterprise, at a time when the other oligarch-owned banks were focusing on state and SOE accounts. 

In the middle of September PSB announced that it would merge with Vozrozhdenie (which means “revival” or “renaissance” in Russia, but often the name is shortened to V-bank). Both banks belong to one controlling shareholder, Promsvyaz Capital, and it was simply a matter of time before they were merged. V-bank has a very similar profile to PSB and despite being a lot smaller, is better run and more profitable: the banks' return on assets were 1% and 0.5% respectively as of the middle of this year.

The brothers acquired V-bank following the death of its founder Dmitry Orlov in December 2014, and paid a reported $200mn for control.  Promsvyazbank is ranked the 10th largest bank in Russia, with assets of RUB1.21 trillion ($20.18bn) as of the end of the second quarter, and Vozrozhdenie 32nd, with assets of RUB238.2bn ($4.1bn). 

Like their Garden Ring peers the Ananyev brothers have been actively building up the banking business through buying or rescues. And this has been done with the encouragement of the CBR that has pressed the leading commercial banks into service as part of its clean up of the entire sector. By supplying large cheap loans, the CBR has in effect been outsourcing the restructuring of failed banks to the best and biggest commercial banks – making them bigger in the process.

PSB’s merger with V-bank mirrors the takeovers that Otkritie and Binbank carried out at the CBR’s behest of Trust bank and Rostbank respectively, which in retrospect contributed to their problems.

And V-Bank is only the latest in a string of acquisitions: the Promsyvaz group acquired a 100% stake in Samara Pervobank in summer 2015, buying it from independent gas producer Novatek's Leonid Mikhelson, one of the richest men in Russia, in exchange for a 5% stake in PSB. In the same year PSB took on the rescue and rehabilitation of AvtoVAZbank, the financial arm of the iconic automotive plant and the maker of the Lada, after having received RUB18.2bn ($313mn) from the central bank and the Deposit Insurance Agency (DIA) to fund the take over.

It was exactly these sorts of deals that got Otkritie into trouble and PSB was weakened in the process too. The bank’s capital adequacy fell to close to the mandatory minimum, and the bank had to deal with this problem by issuing a $500mn perpetual bond in August. The bank also managed to successfully support its capital though secondary public offerings, too. In 2016 the bank offered 40.57mn shares (about 3.6% of the charter capital).

Investors are now worried enough to have dumped PSB’s shares and the price of its $250mn of Eurobonds bonds due in October 2019 fell to a record low in the middle of September after the Binbank news, pushing the yield up 28 basis points to 6.57%. CBOM bonds have been mullered too. In his prophetic note, Alfa Capital’s Gavrilov said a clean-up at the four lenders may result in their subordinated bonds losing between 40% and 60% of their value.

While a full blown banking crisis is not expected, the main outcome from this autumn’s mini-crisis will be that Russia’s state-owned banks will increase their market shares again; they now control just under two thirds of banking sector assets but could end up with 80% if the other two Garden Ring banks go under. 

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One of the causes of the current problems of the Garden Ring banks is that their owners have moved out of banking and have been actively building up financial-industrial groups or FIGs.

The 2008 crisis has worked in favour of the leading companies in each sector as the strongest survive and consolidate their sectors by taking over their weaker competitors. The Promsyvaz Group got into a number of new sectors such as high-end real estate, retailing and agriculture and food processing among many other sectors. 

Dmitry Ananyev saw the crisis as a boon, as the strong will eat the weak. "For those private banks that will cope with these challenges, it will be a Klondike. We will do everything to stay among private banks that will continue to work and provide services,” he said in an interview with Vedomosti on September 7. “Over the past three years we have carried out several deals: the purchase of V-bank, the rehabilitation of AvtoVAZ Bank, and the merger with Pervobank. As a result of the last deal, we have a strong shareholder, Leonid Mikhelson, and clients such as Novatek and [petrochemical company] Sibur. Novatek is now one of the 20 largest depositors with Promsvyazbank."

Part of this process has been to set up investment vehicles, especially in Cyprus, that have been used aggressively to take over companies. Otkritie took over RCB bank in Cyprus from VTB, which appears to have been used for both banks’ “black ops”.

PSB’s ambitions in Cyprus are grander. In November 2016 it registered the PSB Asset Management company in Cyprus, which the brothers intend to turn into a major investment vehicle, according to reports. The plan is to invest $100mn into the business and the brothers have already approached several former Deutsche Bank employees (which has massively scaled back its Russian operation) to manage it. The documentation for this venture is reportedly with the Cypriot authorities now.

The bank is already active in Cyprus and used vehicles registered there to aggressively take over food processing and meat producers last year. PSB’s Cypriot vehicle has, like RCB, been running “black ops” for the bank but is now caught up in a legal battle for control of the Ramfood Group of companies, a major Russian meat producer, which includes a big pig farm and pork processing plant in the Saratov region, as well as a chain of butchers.

Largely financed by debt, Ramfood ran into financial trouble in 2014 following the devaluation of the ruble. The company had built up debts equivalent to $67mn, backed by the assets and the personal guarantee of its owner Mikhail Kerstein, according to press reports. Unable to pay, the company was eventually forced into liquidation the next year, thanks to a spike in the cost of borrowing. PSB stepped in and acquired more than 80% of the company’s debt and all of its collateral. The enterprise was transferred to the management of the White Bird Company, with the Ananyev brother as the ultimate beneficial owners.

But things then got complicated. Kerstein held his Ramfood assets through a Dutch holding entity called United Investors Company BV (UI). In July 2015 in an effort to rescue the group, Kerstein sold 80% in UI to the Russian entrepreneur Alexei Pavlov in exchange for an obligation to cover the group’s debts and invest in new production. Pavlov invested some $25mn into the group to buy out the debt and built another pig farm. The plan was to double the groups profit via a restructuring over five years and eventually sell for an estimated $100mn.

Despite Pavlov’s rescue attempt the company’s debt still belonged to PSB. In September 2015 Pavlov met with Dmirty Ananyev, who said he wanted to buy the business, but only offered him a price equal to the amount Pavlov had already invested. Pavlov refused but continued negotiations, asking for a better return on his investment.

At the same time and unbeknownst to Pavlov, the Ananyevs opened secret negotiations with Kerstein, according to court documents seen by bne. A deal was struck where Kerstein used a power of attorney secretly drawn up by UI lawyers just before he did his deal with Pavlov to dilute Pavlov’s shares and sell a super majority to a Cypriot shell company called Maxaton controlled by the Ananyev brothers, according to the court documents.

As the sole executive of UI, Kerstein passed a resolution, using the power of attorney, and, “the company’s authorised capital was increased from RUB 24,685,503 to RUB 74,804,555; the [UI] share was reduced from 100% to 33%; a new shareholder was listed as a company shareholder: Maxoton Holding Limited, with a share of RUB 50,119,052, constituting 67% of the company’s authorised capital; and a new version of the company charter was approved”, according to evidence submitted to a Moscow count in the dispute, seen by bne IntelliNews. In other words Pavlov’s stake was diulted and Maxaton was given de facto control of the the company and its assets.

In December 2015 the deal was closed and PSB provided the funding to pay up the shareholders capital of the company to effectively take control of the Ramfood group, according to the court documents.

Once Pavlov found out what had happened he took Maxaton and the Ananyev to court to try and recover control of the company, claiming that Kerstein has no right to dilute the shares as he was no longer the majority shareholder. In July the ninth commercial court of appeal in Moscow found in favour of Pavlov that the share dilution and entry of Maxaton were in fact illegal. The enforcement of this decision is now subject to appeal by Maxaton and Kerstein.

This case is not entirely clear cut. Pavlov had invested significant money into the company, but not enough to clear its debts, most of which are owned by PSB. However, the use of the power of attorney by Kerstein and the dilution of the shares in UI by PSB affiliated companies is playing rough to say the least.

The case is the latest in a long line of debt-fuelled take overs, using the bankruptcy laws. Russian companies that get into debt are very vulnerable to attack and often it is the bank they owe the money to that attacks them. In the 1990s Alfa Bank’s use of the bankruptcy laws to snatch assets was so egregious – oligarchs Vladimir Potanin lost the Sidanko oil company and Oleg Deripaska lost Avtobank to this ruse by Alfa – that the state had to defang the law to stop the raiding. Potanin lost control of his oil company when an unknown entity called Beta Ekho bought a mere $1,000 of the company’s debt and used it to foreclose on Sidanko. The Alfa Group has a takeover company called Alfa Ekho and owner Mikhail Fridman later admitted to bne IntelliNews in an interview that the attack was driven by revenge after Potanin excluded Fridman from the Svyazinvest telecoms privatisation in the 1990s.  PSB's takeover of the Ramfood group looks very old school in this context.

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