The Second Will be the First

In ten years from now, Vneshtorgbank will become the largest Russian bank with capitalization of USD 40 to 50 billion, a global network of branch offices, and at least one subsidiary in Western Europe – these are the plans set by the bank’s management.

Vneshtorgbank (VTB) is the largest Russian commercial bank in terms of charter capital, and one of the quickest growing ones in Russia. According to its published reports as of July 1, 2006, Vneshtorgbank’ s equity was RUR 118 billion, and its assets were RUR 752 billion.

The main shareholder of Vneshtorgbank is the Government of the Russian Federation, which holds 99.9% of shares. The other shareholders are OOO Gazexport, Sberbank (Savings Bank of the Russian Federation), ZAO Energomashexport, OAO Ingosstrakh, and the Russian Chamber of Commerce and Industry.

In 2005, after a series of major acquisitions, Vneshtorgbank became the owner of an impressive group of banks, including seven banks in Western Europe (in London, Paris, Zurich, Frankfurt on Main, Limassol, Vienna, and Luxembourg), four banks in CIS countries (Ukraine, Georgia, Armenia, and Belarus), and offices in Milan, Beijing, Delhi and Singapore. The group also includes Promstroibank (Saint Petersburg), Vneshtorgbank Retail Services (operating under the brand Vneshtorgbank-24) and a number of Russian regional banks.

The main challenge facing the bank today is restructuring these assets and working out the most efficient strategy for future development. The management of VTB has already defined the main outline of that future strategy: it announced that the group will have three main business units dealing with corporate, retail and investment services. How that is going to be achieved in practical terms, remains unclear.

Vneshtorgbank-24 will clearly form the core of the new retail unit, and VTB is going to preserve and build on that brand. Vneshtorgbank-24 will handle all operations with private clients (VTB is second in Russia after Sberbank in terms of private deposits - the gap is still large, but is narrowing), loans to small businesses (companies whose annual revenue does not exceed USD 3 million), and consumer loans, including car loans and mortgages. What remains unclear is how specific businesses will be transferred to VTB-24, for example, the current mortgage business. Now a powerful business unit, its specialists blazed the trail in Russia for mortgage loan portfolio securitization this July, where they placed mortgage-backed 29 year Eurobonds on the Irish Stock Exchange. Building on the success of that deal, the management of VTB plans, first, to extend the scope of mortgage-backed loans, and, second, act as an intermediary for other banks in their mortgage securitization deals in Western markets. It plans to set up a special conduit company, which will pool together mortgage loans of Russian individuals with the purpose of later securitization.

Considering the scale of those plans, the concern is that the current Vneshtorgbank-24 capabilities do not match the challenge. On the other hand, if the workload in the mortgage business is split between two units, the retail and investment ones, that may complicate internal procedures and make a negative impact on the overall efficiency of the bank.

There is more clarity on the unit dealing with large corporate clients. The core of the unit will be built on current Vneshtorgbank operations, which will preserve its current clientele, including all major Russian companies: Gazprom, Rosneft and others. One point which remains unclear is what to do with foreign banks within the VTB group. According to announced plans of Vneshtorgbank management, they would be brought together under a common VTB brand and unified management system. But would they become part of the corporate unit or transferred to the investment unit to focus on international capital markets?

The investment unit as such is under construction right now, and its business priorities have not been clearly announced yet. Apparently, one of the areas of business would be serving M&A activity between Russian companies. To manage that part of the business, VTB hired a strong professional team that has experience of completing fifteen such transactions to a total value of more than USD 3 billion. To be fair, a major part of that amount has been contributed by two transactions: Alisher Usmanov’s group acquiring Mikhailovski iron ore concentration plant (total value of the deal, USD 1.6 billion, of which VTB loan contributed one billion), and Renova-Capital acquiring Corbina-Telecom (total value USD 145 million, 90 million provided by Vneshtorgbank).

Real estate is becoming another important area of VTB investment activity, as Vneshtorgbank invested USD 250 million in the construction of the Federation tower in Moscow City. When construction completes in 2008, a considerable proportion of the premises there will be owned by VTB that also wants to move its main office there.

This past September Vneshtorgbank opened a credit line of RUR 3.2 billion to finance the construction of the first stage of the New City project in Chuvashiya, located between the capital Cheboksary and Novocheboksarsk, one of the pilot projects in the federal program for the construction of low-rise residential housing. In addition to that, VTB finances the construction of an elite housing neighborhood in Moscow, although the bank itself keeps a low profile on the project.

Whatever the scale and ambition of their plans, the main focus of attention of VTB management right now is completing the merger with Promstroibank in Saint Petersburg. Two years ago, the owners of Promstroibank agreed to sell 76% of the shares of VTB. In March last year, VTB acquired 25% for USD 97 million, and later increased its holding to 75% plus three shares. Now the banks are preparing for a merger using common shares. To facilitate that process, the shareholders of VTB made a decision in September to split Vneshtorgbank shares, reducing the par value of a share from RUR 1000 to one kopeck. The process would result in each registered share of VTB in the shareholders’ register being replaced with 100,000 new shares.

The first reason for the split was a considerable difference in the nominal value between Vneshtorgbank and Promstroibank shares, which was RUR 1000 and RUR 1, respectively. The second reason is the upcoming public placement of VTB stock planned early in 2007. It seems that the bank’s management and the government want to offer the shares to private Russian investors and reduced the nominal value to make them affordable for the broad masses of the Russian public. The retail sale of the shares will most likely be done through VTB-24 retail banking network. The domestic placement will be followed by Vneshtorgbank’s IPO on the London Stock Exchange.

In mid-September, prime-minister Mikhail Fradkov submitted a draft resolution to the president to take out Vneshtorgbank from the list of strategic domestic companies, to open the way for its privatization. By all indications, the Kremlin is not going to create problems for the bill. The management of the bank seems to have succeeded in persuading everybody that a public placement was the most efficient way of improving the capitalization of the bank. The management has set the following targets to help improve capitalization. In next five years, the bank’s retail business should have assets in excess of USD 10 billion, and gain more than 10% of the Russian retail market. In ten years, Vneshtorgbank should become the largest Russian bank, its capitalization should reach USD 40 to 50 billion, it should have branches throughout the world and have at least one subsidiary in Western Europe. Considering today’s level of activity of VTB in the market, those ambitious plans seem quite realistic.