The great survivor of Russian banking

Alfa-Bank has emerged largely unscathed from Russia's financial crisis. And it wants to return to the capital markets. But it faces a big test — it must show that it can pay back a large Eurobond, ??n Aris in Moscow talks to Mikhail Fridman, Alfa Group chairman.

IN THE MIDST of the rouble devaluation in the summer of 1998, an advertisement was broadcast on Moscow radio: “Trouble with your bank? Call Alfa.” While crowds were fighting to withdraw their savings from the likes of Most Bank, SBS Agro and Inkombank, Alfa-Bank's doors remained open, deposits could be withdrawn and settlements were made.

Alfa is one of only two banks of the seven belonging to the so-called oligarchs to survive the 1998 rouble devaluation and ensuing financial crisis virtually intact (Most Bank is the other). Today, it is seen as one of Russia's strongest privately owned banks. “We are going to try and keep Alfa-Bank's position as strong as possible. We were lucky to emerge from the crisis of August 17, 1998 in a stronger position than we went into it,” says Mikhail Fridman, chairman of the Alfa Group, which owns Alfa-Bank in an interview with EMI. “The crisis allowed us to strengthen our reputation, while it destroyed those of our competitors, because we took pains to treat our creditors well, We were quite careful with everyone.”

At the beginning of the year, Alfa-Bank launched a major publicity campaign to pave the way for a return to the international capital markets. Advertisements in the Russian press boast its achievements over the past 12 months: best bank in Russia (according to one Western financial publications-largest private bank in Russia (Russian Ratings, a Moscow-based agency), best outlook of all the rated banks (Standard & Poor's), corporate client base up by 50%, 22 new branches in nine zones, largest issuer of credit cards in Russia; and manager of the largest mutual fund in Russia.

Fridman sits at his desk in a modern split-level office on Prospekt Sakharov in a huge, white Soviet building that is home to several other big Russian banks — both new commercial entities and former Soviet banks. Rather chubby and speaking fluent English, Fridman doesn't look intimidating. But this is one of the seven oligarchs who between them have proved able to manipulate the Kremlin and control a big chunk of Russia's economy. Fridman dismisses the oligarch term with a wave of the hand, blaming the minority shareholders rights abuses and endemic corruption of the past years on the weakness of the state since the collapse of the Soviet Union in 1991. “The state is inexperienced,” says Fridman, who was born in the Ukrainian town of Lvov 35 years ago, the son of Russian parents (his father was an electrical engineer). “In a short space of time since Russia became a market economy the state hasn't been able to recruit professional people who can support the workings of a market in a civilised fashion,” Fridman argues.

It was the weakness of the state that allowed Fridman to become one of Russia's most powerful businessmen, and is at the root of the periodic wars between the powerful oligarchs. Within two years of leaving the Moscow University of Alloys and Steel with a degree in engineering, Fridman went into business in 1988, setting up the trading company Alfa Eko. Unlike nearly all the other oligarchs, Fridman began his career with no political connections, making his money from the most lucrative business at the time — Alfa Eko imported alcohol, later adding food, electronics and oil to the mix.

Alfa-Bank was set up in 1990, as the financial arm of the group, but when the rouble went into free-fall in 1991, anyone with hard currency could make a fortune speculating against inflation. The mid 90s was a period of “wildcat” banking when thousands of pocket banks were set up, many of which were Mafia fronts for money laundering. Early on, Alfa-Bank established itself as one of the strongest of the new banks, and as a “real” bank. In 1993, the Central Bank of Russia (CBR) awarded it a general banking licence (which allowed forex deals), and by 1994, Alfa-Bank was one of the top 100 banks in Russia by assets. By 1996, it was running programmes sponsored by the World Bank and other international financial initiations.

As inflation came under control and yields on state treasury bills (GKOs) began to fall after the re-election of Boris Yeltsin as president in 1996, nearly all the oligarchs refocused attention from banking to industry. Using the cash they had made between 1991 and 1995, they bought Russia's industrial jewels in the notorious loans-for-shares deal. Having somewhat weaker political connections and being the more junior of the seven oligarchs, Fridman hardly benefited from these loans-for-shares deals. He won none of the major companies on offer at the time. When his group did finally acquire the oil major Tyumen Oil (TNK) at a privatisation auction in 1996, it was the only one of the so-called financial-industrial groups (FIGs) to pay close to a market rate for a major industrial asset. Largely left out of the state sell-off, Alfa Group concentrated on smaller businesses.

Today the group includes Altex Group, which owns two hotels; Alfa Estate Group, a real estate company; Kubansugar, with two sugar factories; the Nikitin Tea House, with two tea factories; Alfa Cement, with a third of Russia's production; as well as Alfa Eko and a few other smaller interests in other sectors.

The modest size of Alfa Group's companies (compared with the oil and metal companies of the other FIGs) and the more rational structure of the group has worked to its advantage during the crisis of 1998. All these companies are cash-rich businesses, and needed little in the way of investment to put them into profit. While some of the other FIGs concentrated on diverting the cashflows of their holdings into the GKO market (or simply whisking money offshore), Alfa Group always put the emphasis on building up profitable businesses.

“The main problem with the financial-industrial groups in Russia is the existence of a single centre of executive control where all decisions are made,” says Fridman. He explains that in his group, the operational decisions of the individual companies are delegated to the managers of those companies. They are expected to run their businesses for profit, rather than as sources of cash for the bank at the heart of the FIG. One bonus has been that all these businesses are low profile, attracting little political interference by the state. The other oligarchs' industrial holdings remain, at worst, under the threat of renationalisation and, at best, heavily taxed, as they are all major revenue earners for the country. None of Alfa Group's businesses have much political significance, with the exception of TNK.

Fridman's good reputation is in part deserved as he, more than any of the other oligarchs, has struggled to build up a Western-style operation. The other banks at the core of the FIGs have been little more than treasuries for their industrial holdings. By the beginning of 1997, all the FIG banks were attempting to improve their banking skills, but were still heavily exposed to their group's companies. Uneximbank, for example, was once a top-ten Russian bank, but the bulk of its loan portfolio was to only 50 companies under its control, whereas Alfa-Bank had 11,000 corporate clients by August 1998. Today its loan portfolio is $500 million, of which 10% of loans are to the group's own companies.

It has also concentrated on building up one of the strongest teams in the country. For example, Alexander Knaster, the president of Alfa-Bank, an American-born Russian, was hired from the Russian branch of Credit Suisse First Boston in 1998. Foreigners also head Alfa-Bank's risk management, finance, treasury and IT departments.

Fridman says that Alfa-Bank's more conservative policies and rational structure, “as well as the small exposure to GKOs and dollar forward contracts — which converted the GKOs into hard currency — are the reasons why Alfa-Bank came through the crisis while our competitors collapsed”. Over the past year, the bank has increased the number of its regional branches fivefold to 25, and added another 10 branches to their Moscow network of 20 existing branches. The new branches are mainly aimed at corporate clients, as retail banking is dominated by the state-controlled Sberbank, which holds four-fifths of all retail accounts. The average Russian is still too poor to tempt the private banks to compete for their business.

Corporate and investment banking were growing quickly in Russia until the rouble was devalued. Fridman expects both businesses to begin growing again soon — although little is happening at the moment — and is positioning his bank to be in a leading position when they do. Alfa-Bank's reputation is their most important asset, according to Fridman. With some $77 million in an outstanding syndicated loan as the rouble went into a tailspin, Alfa-Bank immediately paid off about $20 million in cash and restructured the rest into tranches to be repaid over three years. Other banks such as SBS Agro, Uneximbank and Menatep set up parallel banks and transferred their best assets out of their struggling flagships.

“The main problem of our customers is to be able to trust their partners,” says Fridman. With the rule of law weak in Russia, there is little a company can do to partners who renege on deals. This means that Russians still put more emphasis on personal — rather than contractual — relations in choosing with whom they do business. “The informal relationship between the customer and their bank has a big impact,” says Fridman.

Alfa-Bank's reputation will receive its next big test this summer. A $175 million corporate Eurobond issue in 1997 matures in July Analysts will be watching closely to see if the bank can come up with the money At the end of 1998, the bank's capital was a paltry $12 million. By the end of 1999, Fridman says it had grown to more than $200 million. Much of the growth in capital has come from reassessment of the group's assets as the Russian economy begins to recover.

“We were very pessimistic in 1998, so we made a lot of provisions for our investments and loans. But the situation has not turned out as bad as we had predicted,” says Fridman. “We are 100% certain that we will be able to repay the whole debt according to our agreement.” Even so, the repayment of the bond would take most of the bank's capital (the bond is a liability of the bank, not the group as a whole). Fridman won't say exactly where the money will come from, but analysts believe that it will arrange an inter-company loan to raise the capital and then go back to the international capital markets in the following year to raise fresh capital.

“It is not impossible that Alfa-Bank will be able to pay off its Eurobond,”says Margot Jacobs, a bank analyst with United Financial Group in Moscow. “I think that they are going to do some sort of short-term bridge loan within the group, knowing that they are going back to the market shortly afterwards. The question is: how liquid are their assets? They are more liquid than they were — but are they liquid enough?” High oil prices mean that the group's oil company TNK is earning money hand over fist, and TNK's oil revenues would be a possible source of financing.

Fridman intends to pay off the Eurobond if he can, as he wants to maintain Alfa-Bank's reputation as one of the best-behaved banks in Russia. He is hoping that, should they manage this, the bank will be rewarded with lower interest rates. “The trouble is that you don't get brownie points for good behaviour in Russia,” says Kirn Iskyan, a bank analyst with Renaissance Capital in Moscow. “You have to prove that you are creditworthy and the market is suspending judgement. Alfa has done a lot of good PR, but investors are not naive.”

Fridman counters by saying the group is playing for the long term. He tells an anecdote about a post-devaluation conversation he had with another oligarch and leading Russian banker, who defaulted on hundreds of millions of dollars of international debt. “He told me: 'you kept your reputation. I kept my money Let's see who wins in the long run.”