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VTB’s Acquisition of the Bank of Moscow

The situation around VTB and the Bank of Moscow is becoming more and more complicated every day, following VTB’s acquisition of a major shareholding in the Bank at the end of February. The State bank’s actions and statements have become increasingly contradictory. The position may seem impenetrable from a commercial point of view, but that reflects the fact that the principle motivation behind the change of control of Bank of Moscow was political.

This view is reflected in the latest media coverage which reports that analysts from international banks are finding it increasingly difficult to provide a meaningful analysis of Bank of Moscow because the deal with VTB has taken it into “a misty area of Russian politics”.

What we all know about the Bank of Moscow

Bank of Moscow started from very small beginnings.  It began in March 1995 when the Moscow City Government established a join stock company known as “Moscow Municipal Bank – Bank of Moscow” in which the City held a 51% stake and which only employed 6 people.  Over the next 16 years, thanks to strong management under the Presidency of Andrei Borodin and a clear commercial vision, Bank of Moscow was built into a major financial institution and a major universal commercial bank in Russia, offering its clients the full range of banking products, and employing in the region of 9000 people.

Between 1996 and 2003, Bank of Moscow rose from 47th to 8th place in the list of top-equity Russian banks. Under Borodin’s leadership, Bank of Moscow was, from 2007, one of only a handful of banks in the country with an investment grade rating, such that in August 2006, J. P. Morgan International Finance Limited, part of JPMorganChase, became a minority shareholder in the Bank of Moscow, and in 2010, Goldman Sachs and Credit Suisse Group AG similarly acquired 3.88 percent and 2.77 percent stakes respectively.

The increase in the Bank of Moscow’s independence

Bank of Moscow grew by progressively becoming independent from the City Government’s control and developing services which were characteristic of a universal commercial bank, many of which the City of Moscow did not need or use. In 2008 the City Government’s stake was reduced from 51% to 44%, and the number of the City’s representatives on the Bank of Moscow’s Board of Directors was reduced from nine to seven, out of 13 in total. The Bank’s management were also given substantial additional powers, to reflect their increased responsibilities and independence. As a result, the Bank was given more freedom to follow a disciplined, independent and commercial business strategy.

The success of Bank of Moscow can be attributed in particular to adopting best banking practice, and especially the strict, open and transparent internal procedures that were applied to all loans over US$10Mio.  Every such loan was subject to a decision of the loan committee following a meeting in which the appointed risk-officer gave his view of the possible risks and the opinions of other departments of the bank were aired.  A loan only passed the loan committee stage following a majority vote from the members of that committee and at all times, Mr Borodin, as President, retained the right to block (but not to advance) any loan if he considered that it was not in the commercial interests of the bank.

Political ‘all change’ in Moscow

For these reasons, Bank of Moscow was commercially successful and attractive, as the participation of foreign topflight investment banks confirms. However, the recent changes in management, ownership and, above all, sentiment are due to political, rather than commercial, factors.

First, when Mayor Luzhkov was replaced it was asserted that the City of Moscow wanted to re-establish management and majority control over Bank of Moscow. This was not a commercial response, but a political attempt to reverse the growing independence which had been the basis for the Bank of Moscow’s success.

Then, in November 2010, the Kremlin made a move: Alexei Kudrin, the deputy prime minister and finance minister, announced that VTB was interested in buying the bank. It was proposed that the City of Moscow’s shareholding was to be sold to VTB and that VTB would acquire control and consolidate the bank. While VTB is a bank, rather than the administration, as is well known, VTB is no ordinary bank, but rather ‘the Kremlin’s bank’: again, this proposal was plainly a political initiative, rather than having a commercial explanation.

The State owns 75.5% of the shares in VTB. The Supervisory Board of eleven was chaired by Mr Kudrin, the Deputy Prime Minister and Minister of Finance, supported by prominent Government figures such as Ms Popova, the Deputy Chief of Staff of the Government Executive Office, directly subordinate to the Prime Minister and his Deputies. As VTB recognized in its prospectus for the issue of GDRs in both 2007 and 2011, ‘the Russian Federation is able to exercise significant control over [VTB] Group’s activities and may from time to time take actions in relation to the business of the Group.. that may not be in the best interests of the Group or its minority share holders’.

The way that VTB acquired the City of Moscow’s shares in Bank of Moscow confirms that this was no commercial transaction. The City of Moscow was plainly not concerned to achieve the highest price from State owned VTB. It refused to conduct a tender for the sale of its shares (as the Law on Privatisation would require). That was despite the declared interest of Alfa Group in bidding for them, which would surely have improved the price received. VTB, as a 75% state owned entity, was equally an unusual participant in a privatization of the City’s shares in Bank of Moscow in the first place.

Since VTB acquired the City of Moscow’s shares, its ‘strategy’ has changed again from acquiring 100% of Bank of Moscow, to operating the bank with the support of other shareholders. Once again, the change is inexplicable on a commercial basis, but it is notable that VTB had the political clout to gain that useful shareholder support, which the City of Moscow had been unable to deploy: the VTB Board certainly have some useful friends.

As a result, from the moment it acquired the City of Moscow’s 46.6% stake, and the former management were squeezed out, VTB has installed its own management and treated Bank of Moscow as a wholly owned subsidiary in practice, without the bother, or the cost, of acquiring a majority stake, still less all the shares. One key feature of having ‘control without control’ was the ‘acquisition’, or possibly ‘facilitated purchase’, of Mr Borodin’s 20.3% shareholding. Obviously, this could not be achieved with a purely commercial approach, but again reflects the desired political goal.

The State to the rescue?

Perhaps a political, rather than a commercial analysis may also help to explain the mysterious problems which VTB management have now discovered since they took over management control of Bank of Moscow…

Afterall, when Mr Kostin announced that the Bank of Moscow was ‘a mess’ and the VTB management has referred to supposed problems in the loan book and the need for huge State aid, exceeding the price paid for those shares in Bank of Moscow by VTB, it has come as a stark contrast to the evaluation of the Bank of Moscow not merely by its auditors and former management, but also by the prominent foreign investment banks which held Bank of Moscow shares.

Applying a commercial view, it is therefore doubly surprising that VTB nevertheless resisted the temptation to sell that VTB shareholding on to Mr Borodin, at the same price as VTB paid for it, an offer which Mr Borodin made on 22 March 2011 and had not withdrawn until it expired on 8 April 2011.

It seems that, for VTB, and whoever controls the shares which help them run the Bank of Moscow, it is more expedient to seek State aid, with all the adverse publicity that brings to both the Bank of Moscow and VTB itself, than to adopt the commercial solution of selling on the ‘suddenly risky’ Bank of Moscow shares, at the price they paid for them.

Apparently, economics works differently for the ‘the Kremlin’s bank’