Yeltsin-era oligarch business collapses amid first Eurobond default since 1998

By bne IntelliNews July 8, 2010

bne -

And then there were two...

Convention wisdom has it that seven oligarchs carved up Russia under former president Boris Yeltsin - the so-called seven boyers - but actually there were eight, with Sergei Pugachev a late addition to the club. Pugachev's empire collapsed this week, leaving only two of the original oligarchs who came to prominence in the 1990s still in the game.

Pugachev wasn't invited to Yeltsin's first oligarch meeting that ended with the now notorious loans-for-shares deal, which handed over to the seven Russia's industrial crown jewels. But he was present at the very last oligarch meeting Yeltsin held shortly before the 1998 financial crisis that should have propelled him to riches and notoriety had not the economy collapsed a few months later.

However, he sort of made up for it since. An old friend of current Prime Minister Vladimir Putin's from St Petersburg, Pugachev escaped the anti-oligarch pogrom at the start of the last decade and thrived in the first part of Putin's first term as president.

In classic style he made his first money with his International Industrial Bank (IIB, or Mezhprombank in Russian) and also was a big player in shipping, owning two important shipyards in the northern capital. Unlike the other oligarchs who backed off from making business out of close ties to the government, for many years Pugachev seemed to be the only oligarch doing business in the old school fashion; using his close contacts within government to boost his commercial activities. Richard Hainsworth, CEO of RusRatings, told bne previously: "Mezhprom remains a bank of many mirrors. It is still doing what it always did: takes the state's money and then lends it back to them."

However, it has just emerged that on July 6, IIB defaulted on its two Eurobonds - the first default on an external debt by any Russian entity since 1998. The fact the bank was allowed to default signals an end to state bailouts for troubled Russian banks and shows that Pugachev, who represents Siberia's Tuva Republic in parliament's upper house, has clearly fallen out of favour with the Kremlin and Putin in particular. The bank's future hangs in the balance and the state has already seized the shipyards as collateral, which will almost certainly be taken to form the core of yet another new national champion, this time in the shipbuilding business.

The fall of Pugachev means that out of the original Yeltsin-era oligarchs, the only survivors are Mikhail Fridman of Alfa group and Vladimir Potanin of Norilsk Nickel.

One of the largest banks in Russia, IIB's star began to wane from Putin's second term as president began and Pugachev looked increasingly out of step with the way Russia was developing. In 2005 when the entire banking sector was re-licensed as part of the introduction of the deposit insurance scheme (following the mini-banking crisis of 2004), the then-deputy head of the Central Bank of Russia, Andrei Kozlov (who was later murdered by another disgruntled banker), tried to block the inclusion of Mezhprombank in the scheme. Pugachev finally managed to dodge the ban by setting up a retail operation called M+ Bank that ensured him a full banking license.

On July 7, Prime-Tass reported analysts at VTB Capital as saying that IIB is ready "to repay the coupon on the Eurobond issue, but only after bondholders agree to restructure the issue." The analysts were reported as saying that the bank's management may offer bondholders to restructure the issue by increasing its maturity by one year while keeping the coupon rate at 9%. The Prime-Tass report only seemed to talk about one Eurobond.

Whatever the outcome for IIB, Pugachev is hardly going to be driven into penury and rags. At worst he will retire to Monaco where he owns the luxury chain of stores of the Hediard Group, which he bought from Monaco-based business man Michel Pastor in October 2007 for a reported $1bn. Pastor is a close friend and together with Pugachev under his LuxAdvor holding the two have gone into the luxury interior design business with Viscount David Linley, the Queen's nephew and 12th in line to the British throne. Linley produces top-end luxury interiors for the rich and famous with his over-the-top use of expensive materials and heavy handed exotic finishes - just the sort of stuff crass Russian oligarchs love. Pugachev owns a chateau near Nice and two villas in the jet-set playground of St Jean Cap Ferrat. Linley owns a nearby property with 600 acres and has taken Pugachev on pheasant shoots at Windsor Castle, the Queen's residence, while Pugachev has reciprocated with invitations to functions at the Elysée Palace in Paris.

Below is a note from Renaissance Capital on the details of the default on the bonds and the impact on Pugachev's business:

International Industrial Bank defaults, press reveals preliminary restructuring terms

Maxim Raskosnov, Renaissance Capital

Yesterday (6 July), International Industrial Bank (IIB) publicly announced defaults on its two Eurobond issues. The press (including Reuters and Vedomosti) has reported some preliminary terms of a restructuring offer the bank will propose. In our view, the terms do not seem very favourable to shareholders, and we believe investors should demand better treatment, although this might prove difficult, given the bank's current financial position. Our key takeaways from the reports are:

Reasons for the default. IIB cited its litigation with Bashneft and the court rulings allowing the oil company to block IIB's access to its correspondent account as the primary reasons for its liquidity issues, which were followed by the Central Bank of Russia's (CBR) decision not to restructure its loans to IIB. In our view, the core reasons of IIB's liquidity problems are 1) its inability to boost its deposits base (which contradicts the general market situation in Russia) and 2) IIB's decision to grow its loan book by using rather short-term CBR resources.

Current status. The bank reported it has settled the litigation with Bashneft (claims amounted to $67m) and has reached an agreement with the CBR on extending the maturities on the bank's liabilities until Jan 2011 (six months from now).

According to numerous press reports (including Reuters and Vedomosti), the CBR has taken shipbuilding assets from the bank and its shareholder (OPK) as collateral.

Still, the bank continues to be in breach of regulatory liquidity ratios. Press reports also indicate that VTB is considering providing financing ($400-600m) to OPK, against its coal assets (accepting its coal assets as collateral).

Default on both issues. According to a recent IIB press release, the bank has notified the trustee of a default event on both of its Eurobond issues, based on a number of factors (breach of CBR regulations, restructuring of CBR loans and the bank's inability to service its obligations).

IIB's forecasts. The bank has stated it plans to improve its liquidity position by significantly boosting its retail deposit base. In our view, this is unrealistic for an institution that has publicly defaulted on a number of its obligations.

No official restructuring terms. So far, we have not seen any restructuring terms to noteholders from the bank. However, according to press reports (including Reuters and Vedomosti), the terms will not include any down payments and will ask creditors to approve a one-year extension of the bonds' maturities. This effectively will put bondholders in a subordinated position to the CBR (given that the regulator becomes a secured lender and has extended maturities of its claims for only 6 months). Moreover, if a sale of coal assets goes forward, we think the absence of any prepayment will also restrict the position of bondholders regarding claims on IIB's and OPK's assets.

If, in fact, the final restructuring terms are similar to those highlighted by the press, we believe bondholders will be put in a very weak position, giving way to very significant risk of non-payment under restructured notes. Despite what seems to an absence of a haircut on the notional, we believe that a pure extension without any prepayment reflects very poor treatment of bondholders' rights. In our view, the most beneficial development would be if the bank was put under the umbrella of a state-related entity (eg VEB), but so far this option has not been discussed. We reiterate that the IIB situation is materially different from that of all of Russia's major privately-owned banks, which are currently experiencing a liquidity surplus on the back of continuing deposit inflows and thus we do not expect it to have any material impact on the broader market of banking sector bonds.

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