The times of “plateau of prospering” when international finance and credit groups were willing to buy Russian banks, paying a premium of 3, 4 or even 5 times the capital, have passed. The expectations that the acquired assets will bring the shareholders fantastic profits each year did not come true. In some cases, parent companies manifested their disappointment by selling such subsidiaries, partially or completely, or by making obvious hints that a beloved daughter company may one day turn into Cinderella doing all the dirty work of its step-parent. However, experts believe that such cases will not occur often - the Russian banking market remains too attractive and promising to leave it.

THE PRICE OF AFFECTION

The memories about the years of plenty, when foreign strategic investors were spendthrifts at buying Russian banks, are still fresh. Experts believe that 2005-2008 were years when Russia was "in fashion", when international finance and credit groups literally fought to grab another attractive Russian asset from each other. A very illustrative example is the sale of Investtorgbank, which was sought by six or seven buyers, as Troyka-Dialog investment bank claimed (it has played the role of the financial advisor). Thus, it is no surprise that the premium was 3.7 times the capital of the bank - not a record, but still a high premium.

“There was probably no TOP 100 bank in the world that has not seriously considered some form of presence in Russia”, says Georgy Piskov, Chairman of the Board of Directors, Uniastrum Bank. Mikhail Matovnikov, General Director of Interfax-CEA, also admits that foreigners were highly interested in Russia in 2000-2008, but he believes the “pre-crisis boom” of demand for Russian banks should not be overestimated. “You have to understand that the number of foreign strategic investors who are prepared to invest into the Russian banking system is limited. If we take finance and banking groups that are actively investing into Central and Eastern Europe - not only Russia, but other countries in the region as well - there are about 80 of them. Of these 80 players, around sixty came to Russia”, Matovnikov said.

Still, 60, 80 or 100 are considerable numbers, especially if they include some of the largest financial groups with enormous assets and a complex network of subsidiary banks in the whole world. They had huge purchasing power and their interest in Russia seemed perpetual. It was not surprising, considering the growth demonstrated by the national banking sector. “Before the crisis, the Russian market has been one of the fastest-growing in the world: in 2001-2008, the assets of the banking system have grown by an average of 36% per year. The credit market has grown even faster, especially retail credit, with average annual growth at over 75%. And that was in addition to high interest rates, impressive economic growth rates and generally healthy basic indexes. All of this could not but attract foreign investors”, says Valery Ilyushin, head of the strategic analysis department of UniCredit Bank. Mikhail Matovnikov agrees: “For almost 10 years before the crisis, Russia seemed to be an “Eldorado of banking”: high interest rates, low risks, some of the biggest profitability rates in the world".

In human relationships, love, or rather affection, often drives people mad. The same seemed to be the case when foreign strategic investors became passionate about Russian banks - many buyers failed to make an adequate estimate of the investment risks. However, besides the affection with Russia there was another factor to this: excessive liquidity. “Numerous mergers and acquisitions of Russian banks in 2007-2008 were rather caused by the general rush in absolutely all markets in the world - both geographic and industry-specific markets. A typical feature of such growth period is high competition for assets, which means that the buyer is sometimes unable to perform a careful analysis within a short time", says Sergey Monin, head of the Treasury Administration, member of the board of Reiffeisenbank.

The crisis that has broken out in 2008 has done exactly what all perturbations usually do - it has shown to investors all disadvantages of the assets they have acquired and Russian economy in general. Everyone, of course, knew about these disadvantages, such as dependency on exports of raw materials, undeveloped financial market etc., even before the crisis, but they preferred to ignore them when all macroeconomic indexes were growing. In late 2008 and especially in 2009, they became obvious. Similarly, it was also obvious that, according to Georgy Piskov, some foreign banks had a wrong impression of the risk profile of Russian assets: some have overestimated the investment capabilities, and some have realized that Russia is not the number one priority in business development.

“The 2008 crisis has shown that everything is not that simple, and there are not so many quality customers in the country”, says Dmitry Miroshnichenko, leading expert of the Development Center. “Moreover, it has shown this in the most cruel way - through considerable growth of overdue debt under both personal and corporate credits. This lesson was especially cruel since parent companies themselves experiences major difficulties".

LEAVE OR STAY?

As a result, foreigners in Russia faced the eternal Russian problem: what do we do? Some, if not all subsidiaries had negatives results in 2009, and some still cannot recover and show results which are far from satisfactory for the owners. Observers state that parent companies are most irritated about the banks purchased in 2007-2008: they have been bought with a large premium, but have not brought any significant profits to their owners.

In general, the time of acquisition of a Russian asset proved to be very important, as experts believe. Those who came to the market at the right time from the point of view of both market saturation and asset prices, have suffered less, since they paid more attention to the quality of the asset and the quality of strategy in the Russian market in general. Those who followed them - not everyone, but many of them - have made the typical mistakes and errors, says Valery Ilyushin: “Expensive purchases of Russian assets just before the crisis, unprofitable retail operation model with high market growth rates and specialization in narrow niches of corporate banking oriented only at major customers”. “Foreign banks who made such mistakes have certainly found themselves in a difficult situation. Those whose strategy and crisis management proved to be efficient are likely to strengthen their position in the Russian market”, he says.

So what do foreign strategic investors do if they, for some reason, have made any strategic mistakes when buying subsidiaries? Yury Amvrosimov, director of international business and financial institutes department of Binbank believes that their situation is further aggravated by the disappointment from their disillusionment and the fact that besides the Russian subsidiary (or even subsidiaries), the parent company has other assets to manage, and it has to support them all, helping ones and abandoning others, such as underperforming units.

The easiest possible way is to let the underperforming subsidiary float on its own: if it performs well - that's great, if not - whatever, no problem. However, experts believe that Western investors are not ready for such decisive action - even those who sometimes threaten to wind up their business in Russia. “During the crisis, some investors have indeed claimed that they will change their strategy in Russia. Thus, Dutch ING and Swedish Swedbank have announced complete scrapping of all operations in Russia, and Belgian KBC Group has acknowledged that the Eastern Europe market, including Russia, is not their strategic area of development. All of these companies currently continue to operate in Russia”, says Anton Ilyushenko, vice president, director for strategic development of Promsvyazbank.

“What can parent banks do if they are unhappy with the pace and results of development of their Russian subsidiaries?”, says Yury Amvrosiev, head of the department of international business and financial institutes at Binbank. “There are various options, but I believe that winding up a bank completely is not a viable solution - nobody needs it. Nobody wants to take 100% losses, and winding up a Russian subsidiary may lead to exactly this outcome. It is better to minimize losses by selling the unwanted bank to a competitor at least for half of its price”.

“It is a highly unlikely scenario that the parent structure decides to just abandon its subsidiary and let it operate on its own -thus leading it to imminent bankruptcy in certain situations”, says Pavel Samiev, deputy general director at Expert RA. We have seen such cases - for example, in late 90s in Argentina. In Russia, however, there has been no cases like this - some foreign shareholders reduced the business of their local subsidiaries and sustained it at the minimum level until they would see some signs of improvement in the economic situation of the country. Such signs are obvious now, as is the fact that the market will start growing again in the nearest future. Accordingly, the task of parent companies is not to abandon their subsidiaries but to support them, expecting that they will regain pace during the new market growth.

Georgy Piskov agrees: “It is obvious that it is impossible to just leave the capital of a subsidiary bank”, he explains. The entity should either be liquidated voluntarily, which leads to damaged reputation and acknowledgement of its failure, or the shares or stock should be sold to someone else. We have to admit that there is no demand for such acquisitions yet.

GET SOME OTHER PARENTS, OR A PARTICULAR CASE OF CMB

Despite the lack of demand that the chairman of the board of directors of Uniastrum Bank has pointed out, at least one parent was able to sell its subsidiary to another parent. On July 1, 2010, Eastern Express Bank has announced the acquisition of 100% of City Mortgage Bank (CMB) from Morgan Stanley. Observers were surprised by this decision: Morgan Stanley has acquired CMB in late 2006 at estimated 200 million dollars, or 5 times the bank's capital. The American financial group had big expectations about its Russian subsidiary: Morgan Stanley's executive director Maksim Ermilov has claimed that "any resale of CMB is out of the question, we have purchased it exactly to develop the sphere of mortgage loans”.

On the other hand, observers were not really surprised. First of all, rumours that Morgan Stanley was disappointed in the Russian mortgage market (and consequently, in its subsidiary) have circulated for some time. Secondly, experts point out that CMB is a niche bank that cannot be reshaped for another type of banking, at least not without considerable investment from the parent entity. That is why the market was not surprised to learn that CMB has been sold again, and the rumoured price has been three times less than Morgan Stanley has paid for it - only $64 million.

Larger banks with a diverse business structure, extended network of branches and a considerably larger share in the banking market, have little chances for an outcome like this. “As for the large-scale outflow of foreign investors from Russian banking assets, it is not happening”, says Aleksey Ilyushchenko. “The situation of 1998, when banks such as Lehman Brothers, JP Morgan, Goldman Sachs, Merrill Lynch and Nomura have reduced their Russian subsidiaries, is far from being repeated. Despite the difficult situation, Western investors are optimistic about the potential of Russian banks”. To prove his point, Ilyushchenko gives examples of foreign investment into the financial sector of Russia during the crisis. In 2009, Nordea Bank has brought its share in Orgresbank up to 100%; in the same year, Standard Bank has finalized the deal with Troyka Dialog, and EBRD has purchased 11.74% of Promsvyazbank shares.

“Foreign owners do not generally sell their banks so that they do not have to pay twice to return to the market, and also due to the absence of real demand for Russian assets. I think that some banks became like a suitcase without a handle for their owners: hard to hold, but they do not want to lose it either. In a situation like this, the prevailing type of behaviour is to optimize the business and look for a suitable format. A good example is the decision of Barclays Bank to abandon the plans of retail development and provide services mainly for wealthy customers and only in Moscow and Saint-Petersburg", says Dmitry Miroshnichenko.

On the other hand, experts do not rule out the chances that some parent companies experiencing difficulties with cash assets (the crisis has hit everyone, after all), will decide to split the subsidiaries by selling their share to a third-party investor. Such deals will hardly be super-profitable, considering the current market conditions and low demand from potential buyers. But on the other hand, this will allow parent companies to receive a partial compensation for the losses and focus on developing the business of other subsidiaries. In some cases, Russian assets may be sold completely - not because it was disappointing, but because other markets seem more prospective for strategic investors. “For example, a group with presence in Poland and Russia may try to develop its Polish asset by exchanging its Russian bank for somebody else's Polish bank with subsequent merger of the two Polish assets", says Georgy Piskov, Chairman of the board of directors of Uniastrum Bank. He does not rule out the possibility of an interesting phenomenon in the market - the so-called management buy-out (MBO), when senior managers of the bank buy its shares or stock. "In this case they get a good price and probably financial assistance of the seller itself who wants to convert equity to debt as soon as possible", says Georgy Piskov.

SOMETIMES THEY DO NOT RETURN

Are there going to be "normal" acquisitions of Russian banks, and if so, with what average premiums? Experts are unanimous: yes, the acquisitions will continue, but we will not see the pre-crisis premiums anymore. Not in the nearest future, and maybe not even at any time later, says Yury Amvrosiev. “Even before the crisis premiums of 4 times the capital have been exceptions. A fair price for Russian banks, in my opinion, is 2-2.5 times the capital”. (Experts believe that currently Russian banking institutions are being sold with the ratio of 1 or less, or 1-1.5 according to other experts).

“The ratios, of course, will not return to the pre-crisis levels, and not just because foreign strategic investors are less optimistic about Russian banks, but mainly because the global financial system had excess liquidity before the crisis, and it was a completely different situation on the global financial market”, says Pavel Samiev. “All banking groups and financial corporations have aimed for permanent expansions and constantly entering new regional markets, niches and segments. A lot of time will pass and the global economy in general should be in the same situation as before the crisis so that this phenomenon could reappear

Mikhail Matovnikov from Interfax CEA also believes that it is highly unlikely that Russian banks will attract the same record-breaking premium ratios. However, he cites different reasons for this. "As I have already said, there are about 80 financial groups that invest in Russia and other Eastern European countries. Around 60 of them have entered the Russian market. Thus, in the best-case scenario, there can be about twenty more acquisitions of Russian assets by foreign strategic investors. Considering that many of these twenty remaining banks invest only in banks of EU countries or Baltic States, the actual number of potential buyers is about ten, and not tens or hundreds". And since there will be less buyers, there will be nobody out there to inflate the premiums to pre-crisis levels (even though large Russian players may become active in bank mergers and acquisitions).

However, the small number of buyers is not the only reason for the absence of record premiums. “In all key parameters of penetration of banking services into the economy, Russia has almost reached the Eastern European levels. For example, the ratio of total loans to the GDP in Russia is about 50%, and 60% in Eastern Europe. Thus, there is potential for growth, but it is not tremendously large. And so the situation is drastically different from the situation when loans to GDP was at 25%. For this reason, we cannot expect another credit boom and 60% annual growth of credit portfolios, says Mikhail Matovnikov. "The period of exponential growth in Russia is over, strategic investors have to accept that our market is not an Eldorado of banking anymore, it is not an easy market with high growth rates, high error margins and extremely high profitability that used to absorb all shocks. Now it is not a market where you could use mediocre effort to achieve the best results”.