Where the beer garden serves as a warm-weather crossroads for Moscow’s financial community. Even through the acrid smoke that blanketed Russia’s capital from peat fires caused by this summer’s epic heat wave, bankers and fund managers could see brighter prospects than would have seemed possible when financial crisis tore through the country two years ago.
The Russian stock market, which lost three quarters of its value in six months starting in July 2008, has nearly tripled since then. A credit freeze that pushed some of Russia’s biggest companies to the verge of bankruptcy has given way to a record boom in ruble-denominated bond issuance, with more expected to come thanks to plans for a sustained government borrowing program. The economy, which suffered a massive 8 percent contraction in 2009, is on track to grow by more than 4 percent this year.
All this is music to the ears of Moscow’s bankers. Investment banks that just two years ago were flirting with extinction are hiring again, backed by deep-pocketed investors. Renaissance Capital, which slashed head count by 40 percent after September 2008, was rescued by a $500 million investment from Russian metals billionaire Mikhail Prokhorov, who now owns half the bank. Troika Dialog, which fired one quarter of its staff in the dark days of the crisis, is back on the growth track after selling a 33 percent stake to South Africa’s Standard Bank in March 2009, in a deal valued at $300 million.
Renaissance and Troika are hardly alone. State-owned VTB Capital has been hiring actively in a bold bid for local supremacy. Global banks are beefing up their Moscow presence too. Deutsche Bank, a dominant Russian force before mass staff defections to VTB Capital in 2008, is rebuilding its ranks. Barclays Capital is looking to hire hundreds of bankers and brokers under the command of a former top Renaissance executive, American Robert Foresman. Morgan Stanley and Bank of America Merrill Lynch are also hiring, albeit more selectively.
“The market woke up in May 2009, and now the number of deals is close to the precrisis level,” says Andrei Sharonov, chief of investment banking at Troika.
The climate is not quite back to those heady days, however. The Russian stock market stalled along with the rest of the world’s this April, leaving the benchmark Russian Trading System index 40 percent below its April 2008 high-water mark. Hopes for a revival of the initial public offering market, sparked by a $2.2 billion IPO from aluminum giant Rusal in January, remain unfulfilled as other potential issuers, such as fertilizer maker Uralchem and coal miner SUEK, have decided to wait for better times. Even with those caveats, though, the outlook is surprisingly bright for a market that some had written off as the lost BRIC.
Two factors have invigorated the competitive landscape. One is the emergence of VTB Capital, reflecting the Kremlin’s strategy of having a state-owned champion in the capital markets. Under the direction of co-CEOs Vladimir Soloviev and Alexei Yakovitsky, both Deutsche Bank veterans, VTB has been building a team of bankers and traders to go along with Russia’s second-biggest balance sheet and a seemingly blank check from the government.
The second driver of change is the rapid expansion abroad by a number of local investment banks. VTB is the latest to enter world financial centers, with 200 employees in London and growing offices in Singapore and Dubai seeking to sell Russian securities to foreign buyers and to plant the flag for potential cross-border mergers and acquisitions. More ambitious still is Renaissance, which is seeking to transform itself from a Russian house into an institution spanning emerging and frontier markets around the world, from Nigeria to Mongolia. “If a majority of our revenues are still coming from Russia in 12 to 18 months’ time, we will be missing a massive opportunity,” says Nick Andrews, the chief of equities, who joined Renaissance earlier this year from JP Morgan in Hong Kong. Countries outside the former Soviet Union already generate at least 30 percent of banking income, Renaissance says.
VTB Bank, Russia’s second-largest lender, which is 85.5 percent owned by the state, launched VTB Capital in April 2008. The new firm was just a third of the way into its hiring plan when world markets collapsed five months later, but VTB’s Kremlin paymasters decided to treat the crisis as an opportunity to bulk up more cheaply than planned and guarantee dominance when Russian capitalism rebounded.
While competitors shed staff, VTB Capital has raised its professional head count to 750, and aims to reach 1,000 soon. The expansion has cost at least $850 million, according to Alexander Danilov, a bank analyst with Fitch Ratings in Moscow. By comparison, Renaissance has about 700 employees in Russia, and Troika, which operates the country’s largest brokerage, has 1,200.
VTB Capital’s rapid buildup, combined with its parent’s lending relationships and cash pile, makes the upstart outfit a potent force, co-head Yakovitsky tells Institutional Investor. “Our difference is in the scope and depth of what we do,” he says. “Renaissance and Troika are basically equities houses that succeeded because they had a nonstop bull market.” Yakovitsky, who holds the title of CEO Moscow, was chief of research at Deutsche Bank in Russia before jumping ship and bringing most of his team with him in early 2008. Global CEO Soloviev was deputy chairman of Deutsche’s Russia unit.
Market conditions since Russia’s economic recovery started in mid-2009 have been favorable for fulfilling Yakovitsky’s boast. Equity issuance has been trifling except for Rusal’s IPO, which was led by BNP Paribas and Credit Suisse, two multinational banks with long histories in Russia. The ruble bond market, meanwhile, exploded in the second half of last year. Russian companies, many of them threatened with bankruptcy from hard-currency debt when the ruble slid by 30 percent against the dollar during the crisis, scrambled to refinance locally. Banks, shored up with liquidity by the Central Bank of Russia but wary of direct lending relationships, happily bought corporate debt.
Domestic bond issuance hit 1.1 trillion rubles ($37 billion) in 2009, surpassing Russian Eurobond issues for the first time and lifting outstanding volume to about $90 billion. The pace of new issues slowed to 346 billion rubles in the first half of this year, but volume is expected to pick up again this autumn, says Dmitri Dudkin, fixed-income analyst for Uralsib Bank in Moscow. The quality of issuers has greatly improved as about 100 weaker companies defaulted on bonds during the crisis, to be replaced by relative blue-chip borrowers like oil company Gazprom Neft, which raised 10 billion rubles ($327 million) in April 2009, and mobile telephone operator Vimpelcom, which floated 10 billion rubles in July 2009 and registered for another 20 billion-ruble issue this spring. Average borrowing costs for top-rated companies have plunged from the 16.75 percent that Gazprom Neft paid last year to about 9 percent now, says Troika’s Sharonov.
The bond boom plays heavily to VTB Capital’s balance-sheet strength as issuers look for underwriters who can buy up paper themselves in case market demand falters, Dudkin says. The bank outdistanced all competitors by arranging 277 billion rubles’ worth of domestic bonds in 2009, and again in the first half of this year with 58.5 billion, according to Russia’s Cbonds Web site. Two other state-owned giants, Gazprombank and Sberbank, finished second and third in 2009 despite having only embryonic investment banking franchises.
VTB Capital has also climbed quickly up the equity rankings, placing second in share underwriting in both 2009 (behind Morgan Stanley) and the first half of 2010 (behind Renaissance), according to data provider Dealogic. But its main focus remains fixed income for the moment. “This is obviously not the era of equities,” Yakovitsky says. “That has to wait until at least the middle of the business cycle.”
Meanwhile, VTB Capital has taken over the largest lending clients of its parent bank, aiming to spruce up their finances and squeeze more profit out of them for the VTB group.
Rivals are impressed by VTB Capital’s rapid march to market power. “We see VTB as a competitor across the board,” says Batubay Ozkan, head of global markets for Deutsche Bank in Moscow. But they question how much of its 16.4 billion rubles in pretax profits last year represented new business. “It’s impossible to tell how much of this really came from capital markets and how much is related to corporate banking,” says Natalya Orlova, chief economist at Alfa Bank, Russia’s top privately owned lender.
It also remains to be seen whether the firm, which has grown domestically on the strength of its state-owned parent, can develop business ties outside Russia as Renaissance and Troika have over the past 15 years. While VTB Capital spends heavily in a bid to become Russia’s investment banking flagship, Renaissance Capital is going resolutely global. Andrews and other senior managers brim with enthusiasm about the miles they are logging to Johannesburg and Hong Kong, or the pipeline of deals they plan to tap into in Mongolia. “Russia is still very important, but we like to think of ourselves as a company without a headquarters,” deputy CEO Andrew Cornthwaite tells II.
Renaissance believes its future lies in serving companies and investors in the oil, gas, metals and agribusiness sectors across emerging markets. The firm advised African Minerals, a London-listed company that mines iron ore in Sierra Leone, on the $247 million sale of a 12.5 percent stake to China Railway Materials in June.
Renaissance began expanding into sub-Saharan Africa before the 2008 global crisis. It has continued building there, reflecting the conviction of chief executive Stephen Jennings that Africa will be the world’s fastest-growing region over the next two decades.
In May, the firm bought South African brokerage Barnard Jacobs Mellet Securities for $28 million, gaining 63 staff in Johannesburg. In June it opened a 15-employee Hong Kong office to sell Russian and African securities to Asian investors and establish a beachhead for an expected wave of emerging-markets resources companies staging IPOs in China, as Rusal did in January. The bank also intends to develop a presence in Egypt and North Africa, and in Eastern Europe, particularly Poland and Turkey. “There is no textbook for what we are doing, and that’s what makes it exciting,” Cornthwaite says.
The rebuilding at Renaissance follows a tough period of upheaval. Jennings was long known for keeping bonuses low and retaining staff through an equity-sharing scheme that promised a fat payout when they left or the bank was sold. In 2007, he rejected a reported $4 billion buyout offer from VTB Bank; the following year, Renaissance’s worth plummeted to $1 billion at best, sparking a wave of defections. Foresman, who was Renaissance’s deputy chairman, left in September 2009 to head Barclays’ charge into Russia. Gordon McCulloch, a deputy CEO, resigned in August of last year. Ruben Aganbegyan, Renaissance’s president, left this June to head up the Moscow Interbank Currency Exchange (MICEX), RTS’s crosstown rival.
Yet Renaissance has fought back with a series of high-profile hires. In February the bank poached global equities chief Andrews from JP Morgan, where he had headed the equities business for Asian emerging markets. Yonatan Gozdanker left his post as Citigroup’s head equity trader for emerging Europe, Middle East and Africa to join Renaissance in July as global head of cash equities, based in London. The firm’s new head of equity derivatives is Christopher Carter, who formerly held that post globally for Credit Suisse.
Jennings, who founded Renaissance in 1995 with four others from Credit Suisse’s Moscow office, has brought the firm back from the brink once before, when it was all but wiped out by Russia’s default in 1998. He had eased into a chairman’s role by 2008, but returned as CEO following the latest meltdown. “After a near-death experience you need a dictator, not a chairman,” Cornthwaite explains.
Troika Dialog is also well on the road to recovering from the crisis. Troika led Russian private banks in debt underwriting last year, and rose to second place overall in the first half of 2010, behind VTB Capital, with 57.5 billion rubles. The bank failed to reach the top 10 in the 2009–10 Russian equity league tables, but remains a market leader in trading and asset management. It is dominant among internationally oriented Moscow brokers, with $32 billion in trading volume during the first half of 2010, compared with $7.5 billion for Renaissance and $4.7 billion for VTB Capital, according to research firm RosBusinessConsulting. Troika has maintained its position as a leading asset manager and Russia’s biggest mutual fund operator, though the crisis has taken its toll. The firm manages $2.8 billion in assets (of which $550 million is in mutual funds), down from close to $5 billion before the crisis.
These days Troika is the object of no little suspense, centered on Ruben Vardanian, the company’s CEO and controlling shareholder. In July he confirmed reports that he intends to sell his 40 percent stake and retire in the next few years. Standard Bank, which is building a global emerging-markets business and already owns one-third of Troika, would seem the most logical buyer. But speculation in Moscow is focusing on Sberbank, the state-owned savings colossus that is Russia’s biggest bank by far. If it decided to make a big push into investment banking, a purchase of Troika would give it instant scale and credibility.
The future of Troika Dialog, poised between potential private- and public-sector buyers, is a metaphor for the broader clash of economic visions taking place in Russia. Prime Minister Vladimir Putin has championed a return to state control of key sectors of the economy over the past decade, but his restive protégé, President Dmitri Medvedev, is a reformer who has said that large state companies “have no future in the long term.”
The financial crisis appears to have given Putin the upper hand. The country’s economy was hammered by the seizing up of global credit markets and the plunge in commodity prices following the September 2008 collapse of Lehman Brothers Holdings. Many heavily leveraged business oligarchs tottered on the verge of bankruptcy, threatening to bring much of the banking system down with them.
Russia’s rulers, who saved hundreds of billions of dollars in excess reserves and created two sovereign wealth funds during the boom years, reacted energetically. The central bank kept commercial banks afloat by cutting interest rates in half, to 7.5 percent, and accepting depressed securities as collateral for loans. “No one lost a dollar in Russian banks during this crisis,” Uralsib’s Dudkin observes.
State banks stepped in to refinance short-term credit for the overdrawn corporate sector. VTB bailed out Arctic metals giant Norilsk Nickel, controlled by Vladimir Potanin, with a $3.2 billion loan in January 2009. Another state entity, Vnesheconombank, saved Oleg Deripaska’s Rusal with a $4.5 billion loan. Sberbank became Russia’s biggest property owner by foreclosing on delinquent corporate borrowers. The government intervened directly with a $50 billion fund for soft loans to strategic companies, and bolstered welfare spending by drawing $100 billion from its Reserve Fund.
The stimulus worked. Russia began to grow again in the middle of last year, and is on track to expand by 4.25 percent in 2010, according to the International Monetary Fund. Unemployment, which doubled to 10 percent during the collapse, is back down to 6.8 percent. “The thing I’ve been amazed by in Russia is the resilience of the place, how quickly the whole thing blew over,” says Renaissance’s Cornthwaite.
Thanks to a doubling of oil prices during 2009 to their current level around $80 a barrel, Russia looks like it can afford its largesse. Veteran Finance minister Alexei Kudrin says the budget gap will fall to 5.5 percent of gross domestic product this year from 5.9 percent in 2009. The deficit for the first half was just 1.9 percent of GDP as both oil and general tax revenues exceeded ministry assumptions.
Russia planned to borrow $18 billion on the Eurobond market this year, but so far it has had to raise only $5.5 billion, issuing five-year bonds in April at a spread of just 125 basis points over U.S. Treasuries. The Finance Ministry planned to increase domestic borrowing to 934 billion rubles this year from 267 billion in 2009, but with the deficit undershooting, the ministry had borrowed only 130 billion rubles as of July, according to Uralsib.
Notwithstanding Russia’s improved finances, Medvedev has been sounding an increasingly strident alarm about his country’s longer-term problems. In September 2009, he published a major essay titled “Forward Russia!” asking his electorate: “Must we keep dragging ourselves into the future with a primitive natural-resources economy, chronic corruption and the outworn habit of depending on anything and anybody but ourselves?” Last year Russia languished in 146th place out of 180 countries in Transparency International’s Corruption Perceptions Index, tied with Kenya, Sierra Leone and Ukraine. Oil, coal and metals accounted for 87 percent of 2009 exports outside the former Soviet Union.
In the year since his broadside, Medvedev has focused on a range of modernizing initiatives, including a plan to cut the country’s bureaucracy by 20 percent, a draft law to rein in police powers, a project to create a would-be Silicon Valley in the Moscow suburb of Skolkovo and a plan to transform the capital into an international financial center. Russian financiers are skeptical that those projects can succeed without sweeping structural reform. “Russia needs to overhaul its court system and ensure fair competition that is not dominated by politically connected companies,” Troika’s Sharonov says.
Bankers, however, are hopeful the president will curtail the expansion of state enterprise and shift momentum back to the private sector. Exhibit A is the Kremlin’s nursing giant debt-ridden private companies like Rusal and Norilsk Nickel through the crisis, when it could easily have renationalized them through bankruptcy.
Kudrin this summer unveiled a plan to raise $29 billion from privatization over the next few years. This would not represent a wholesale retreat by the state. The minister plans to offer or expand minority stakes in key companies, such as oil giant Rosneft and water-power producer RusHydro, rather than unload them altogether. The Ministry of Economic Development quickly pulled the largest proposed privatization target, Russian Railways, off the list.
Still, the principle that more private investment is better seems to be regaining ground. Russia’s swaggering investment bankers will be only too happy to oblige.
