Graham Stack in Kyiv -

As if a looming financial crisis in Ukraine weren't enough to deal with, UniCredit Group is also having to deal with a dangerously escalating row between its Ukrainian subsidiary and a major debtor. The Italian bank is now looking increasingly likely to join other European banks that have left the country, licking their wounds.

Ukrsotsbank, Ukraine's sixth largest bank by assets, has accused the country's fraud squad of exceeding its powers during a raid on its Kyiv headquarters on September 20, which was carried out in connection with a court case brought by a major debtor of the bank. This is the first time a major European-owned bank has been raided by police in Ukraine and indicates that a wave of conflicts between international banks and debt welshers that have erupted since the economic crisis broke in 2008 shows few signs of abating

"The bank expressed readiness to provide all documents and information regarding the request, but the officers launched an active inspection and ensuing removal of documents and computers from all premises of the central bank offices, including those not on the court list," Ukrsotsbank said in a statement September 23. "The bank regards such behaviour during a search as an abuse of power... such precedents fundamentally spoil not only the image of the bank but also the business climate for European investors."

The root of the conflict is a whopping $190m lent by Ukrsotsbank to ISA Prime Development and a string of related companies to build office towers in 2005-2007 - in fact, before UniCredit purchased the bank in 2007. According to Ukrsotsbank, ISA Prime stopped servicing the debt after the crisis hit Ukraine in 2008, and it has since allegedly tried by hook or by crook to remove its properties that are under pledge to the bank. The court order backing the September 20 raid on Ukrsotsbank derives, ironically, from a criminal investigation into theft of Ukrsotsbank property that was prompted by a complaint from the bank itself.

In an escalation in the dispute, ISA Prime's founder and CEO, Oleksandr Bashenko, leaked police documents to the press that were published on September 24, which he claims prove wrongdoing by the bank, suggesting this criminal case could backfire on the bank.

The leaked documents contain the protocol of a police interrogation of an official employed in the state registry of deeds, who alleges he was forced under threat of physical violence to re-register disputed real estate assets built by Prime ISA to Ukrsotsbank, despite them having been frozen under court order at the time. This testimony could have served as the pretext for the police to search for documents believed hidden by the bank.

This is the version backed by ISA Prime's Bashenko. "The problem started not with us, but with the bank," Bashenko claimed in a statement on September 24. "It stopped its funding and started to seize our properties instead of a constructive dialogue. We finished construction of the objects with our money, spending over $170m to do so."

Ukrsotsbank disputes this, saying the "talks had been going on for over two years, but the negotiations period was used by ISA Prime management to strip leased real estate objects from under pledge and not to settle the debt situation." As a result, the bank's press service tells bne, Ukrsotsbank had no choice but to file a complaint in order to open a criminal case for property theft. The bank believes ISA Prime's annual income from leasing the properties to have been around $25m.

The dispute took a nasty turn last year. In April 2012, in what Ukrsotsbank representatives have suggested were attacks linked to the dispute, a yacht belonging to the bank's long-serving CEO Boris Timonkin went up in flames, and a number of cars owned by top managers followed suit. The parent bank UniCredit wrote a letter to Ukraine's president, Viktor Yanukovych, referring to physical threats made by ISA Prime against it, according to media reports. In a further twist, Timonkin, against whom most of Bashenko's wrath was targeted publicly, suddenly quit the bank in June of this year.

The big guys

In a lengthy interview in Forbes Ukraine in January, Bashenko portrayed himself as a self-made man who had been undone by Timonkin's overgenerous disbursal of credit pushed on his company during the pre-crisis lending boom.

Timonkin has acknowledged having had targets of 50% annual growth in the bank's credit book prior to 2008, but the huge volume of loans dispensed to ISA Prime Development between 2005 and 2007 - a volume even the Ukrainian state has difficulty attracting these days - points to weightier backers than Bashenko, whose only official position is deputy president of Ukraine's Federation of Cyclists.

Apparently, it was after two of Ukraine's richest families, chemicals oligarch Mykhailo Yankovsky and banking brothers Sergei and Oleksandr Buryak, became shareholders in ISA Prime in 2005 that loans from Ukrsotsbank really started to flow. According to the Spark Interfax database, there are two ISA Prime Developments - one private joint stock company (PrAT) where Bashenko is CEO and co-owner, and a limited liability company (TOV), which featured Bashenko as co-owner only until 2005. After that, Yankovsky and the Buryaks took parity stakes.

These men had not just financial but political clout: Yankovsky was a senior MP of the now governing Party of Regions, and Sergei Buryak is a founding member and MP in Yulia Tymoshenko's ByuT party, who also headed Ukraine's tax service from 2007 to 2010. He currently serves as first deputy chairman of the budget committee of Ukraine' Rada. Yankovsky could not be reached for comment, and Buryak was not answering his Rada office telephone.

According to the Interfax Spark database, the Buryak brothers sold out their stake in TOV ISA Prime to Donetsk-based Yankovsky in August 2012. In July this year, the Buryaks then sold 80% of their Brokbiznes Bank, a top-20 bank, to dark-horse fuel-trader Sergei Kurchenko, for around €200m, according to Forbes Ukraine. Intriguingly, Uksotsbank CEO Timonkin left Ukrsotsbank in July to oversee Kurchenko's banking business, including Brokbiznesbank, where the Buryaks have placed the funds from the sale.

The bank is keeping mum over whether oligarch shareholders are implicated in the conflict. In previous public conflicts with alleged major debt welshers, such as with diner chain Puzata Khata described here by bne in 2010, the bank has refrained from crossing swords directly with powerful shareholders of recalcitrant borrowers.

Mired in debt

European-owned banks have been devastated by loans going sour in Ukraine. In a series of negative reports about the Ukrainian economy and its banking sector this week, Moody's Investors Service said it reckons problem loans at Ukrainian banks will amount to 35% of all loans by the end of 2013.

The reasons cited why foreign banks have been particularly hard hit by bad loans is not just because they lent recklessly in the run-up to the crisis, but that - according to their debtors - they are not "flexible" enough when it comes to restructuring. Experts say they are also more vulnerable than Ukrainian-owned banks to skulduggery by borrowers hijacking state bodies and dodgy courts.

A leaked US diplomatic cable from 2009 entitled, "Extortion, bribes and threats: A Kyiv banker laments", detailed the full extent of the misery - the fact that borrowers perfectly capable of paying on debts were using the crisis as an excuse to renege on their debts. The cable, quoting an extensive interview with a top executive from Austrian-owned Raiffeisen Aval, Ukraine's second largest bank, detailed how "second-tier oligarchs and members of the Ukrainian parliament are extorting from the country's banks and threatening bankers."

"The powerful borrowers act with impunity, having paid off the court system to evade their debt obligations," the banker complained, detailing physical threats to bank personnel similar to "Russia in the 1990s" and saying the bank was crippled in disputes with debtors by refusing to bribe judges despite "a court system that exudes corruption".

The situation around Ukrsotsbank suggests little has changed in the years since.

The deteriorating circumstances in Ukraine have caused most of the European banks that rushed in during the pre-crisis boom to pull out, selling their banks to locals on the cheap. UniCredit and Raiffeisen Bank International (RBI) are two of the remaining bastions, though earlier this year local media reported that UniCredit was looking to sell its retail portfolio, which the bank has not commented on.

RBI's future in Ukraine also appears shakier following the departure of its emerging market champion Herbert Stepic following a scandal in July. His replacement, Karl Sevalda, in August announced a change of strategy, saying the bank would focus in the future on Central Europe, Romania and Russia. Ukraine was notably absent.