OREANDA-NEWS. July 6, 2011. In response to questions from one of our subscribers, RusRating has prepared the following comments on its recent Bank of Moscow report. We believe that other subscribers should also receive this information.

Questions to the agency about the recent change in Bank of Moscow’s rating outlook:

1) What do you mean by "possible application of radical regulatory measures"? We assume you are referring to the announced substantial rescue package for Bank of Moscow.

Agency comments: We meant financial rehabilitation proceedings plus the large-scale financial support required to maintain the Bank’s health. There is no question of the Bank’s license being suspended, but for an institution of this size and with semi-official status, in the absence of any serious problems just one month ago, any rehabilitation programme can be seen as radical.

According to the most recent available information, the Deposit Insurance Agency will extended the Bank a covered ten-year R295bn loan at 0.51% per annum. Over its full maturity the gap between the subsidized and market rates will generate R150bn in profits, offsetting the cost of setting aside reserves against problem assets and/or write-offs. According to Valeri Miroshnikov, the DIA’s First Deputy General Director, a portion of Bank of Moscow’s loan book will be pledged as collateral. The DIA will, in turn, take in an equivalent five-year loan from the Central Bank at 0.5%, with the option of re-extension.

Altogether the CBR audit has identified approx. R368bn in problem loans at Bank of Moscow. Most of this (close to R220bn) is owed by companies with links to Andrei Borodin, a further R80bn or so by Russian companies with no independent business (so-called “fictitious” firms) and R60bn by offshore structures. It has already been confirmed that the Bank faces a “hole” of at least R60bn in its loan book.

2) Why do you think these "radical regulatory measures" raise doubts about Bank of Moscow's status as a VTB subsidiary? As we understand, VTB itself will participate with an equity injection of R100bn which should take its stake in the Bank to the 75% threshold required to qualify for state aid.

We mean here its status as a state-sector institution in the widest sense. Bank of Moscow by its nature was in some sense a state-sector bank even before it was taken over by VTB due to its ties to the City of Moscow and its system-critical role in Russian banking. As a VTB subsidiary it is now explicitly a state-sector bank.

Such banks are not expected to operate “behind the scenes”, running a business hidden from the authorities. The current situation has made it clear, however, that Bank of Moscow faces fundamental financial problems on a massive scale: the support on offer is greater than the total sum of stabilization funding provided to the banking sector as a whole during the recent crisis.

The sudden appearance of such major problems suggests that neither VTB (which has been the Bank’s largest shareholder for some time), nor the regulatory authorities were until recently in a position to monitor its activities. This is particularly strange in the case of Bank of Moscow, which plays an important social role in the Russian capital and more generally is a system-critical player. In other words, it turns out that a supposedly state-sector bank was in practice an entirely private and non-transparent business that operated without any effective official monitoring; everything was left in the hands of the Bank’s own management. If nothing else Bank of Moscow’s membership in the deposit insurance programme should have ensured a more conservative approach.

Some more general questions:

3) When do you expect the regulatory bodies or VTB will publish details on Bank of Moscow's asset quality problems and expected losses?

Data on problem assets (see the answer to the first question above) have now been published in generally reputable Russian media sources, which in turn cite officials at the CBR, DIA and VTB.

In addition Bank of Moscow’s website published the following announcement today:

01.07.11. The Bank of Moscow fulfils its obligations in full

The Bank of Moscow confirms that, in accordance with resolutions approved by the Board of Directors of the Bank of Russia, the Bank is receiving a loan from the Deposit Insurance Agency to a sum of up to RUR 295 bln at a beneficial interest rate. The funds will be invested in reliable financial instruments, including state securities of the Russian Federation. In addition, VTB Group companies are to acquire a minimum of 75% of the Bank’s shares and will buy up a Bank of Moscow additional issue of shared in a sum of up to RUR 100 bln.

All the Bank of Moscow’s obligations to investors, creditors, clients and depositors are and will continue to be discharged in full and in a timely fashion.

The Bank of Moscow will apply all possible efforts to redeem the assistance received from the state ahead of time.

The Bank of Moscow states that the problem credits arose within the Bank as a result of the non-conscientious actions of the Bank’s previous management. The Bank of Moscow stresses that it will apply all possible efforts to recover the loans issued previously and the interest thereon from the owners of the relevant companies and the previous management of the Bank.

The VTB website contains the following statement, dated 1 July 2011:

VTB supports Bank of Moscow

VTB Group today announced details of the Bank of Moscow financial rehabilitation plan approved earlier by the Central Bank of Russia and by the Deposit Insurance Agency and the effect of this process on the Bank of Moscow and VTB Group.

Yesterday the Central Bank of the Russian Federation and the Audit Chamber of the Russian Federation confirmed that fraudulent lending activities of the previous management in 2010 and earlier have resulted in the need for provisioning of the loan portfolio against potential losses to the extent that prudential ratios of the Bank of Moscow cannot be maintained above minimum levels required by law and Central Bank instructions. This caused the Central Bank to recommend and the Deposit Insurance Agency to agree to a financial rehabilitation plan for Bank of Moscow.

The plan adopted includes:

1) The Deposit Insurance Agency named VTB Pension Administrator and VTB Debt Center as administrators for Bank of Moscow during the financial rehabilitation period. The administrators will acquire minimum 75% of the share capital of Bank of Moscow.

2) The Deposit Insurance Agency grants a 10 year loan of up to RUB 295 billion to Bank of Moscow at a below market interest rate. The proceeds of the loan will be invested into government securities of the Russian Federation. Bank of Moscow is able to book a profit with an economic effect of RUB 150 billion.

3) VTB Group commits to provide Bank of Moscow with additional capital in the amount up to RUB 100 billion by yearend 2012.

These measures allow adequate provisioning to be made against the problem portfolio of Bank of Moscow and maintain strong capital level at Bank of Moscow for future development.

Bank of Moscow will become a fully consolidated subsidiary of VTB Group and will thus enjoy the full support of VTB Group.

The actions above will effectively deal with any potential problems arising from the uncovered fraudulent activities while simultaneously having no negative effect on the financial results of VTB Group and the Group’s capital position will remain strong.

Bank of Moscow 2010 results, VTB Group Q1’11 results and further effects of Bank of Moscow consolidation into VTB Group will be announced by end of July, 2011.

[Note: The Russian version of VTB’s statement differs somewhat from the English one, most notably in its references to the “improper actions” of the Bank’s former managers and in a final paragraph citing statements by VTB President and Management Chairman Andrei Kostin that underlined the serious threat to Bank of Moscow’s stability, commented favourably on the official response, noted that the VTB Group would make every effort to recover problem assets and expressed confidence in the Bank’s potential and ability to overcome its current difficulties.]

4) What do you think is the origin of these substantial asset quality problems (so far unknown and unexpected to the market)?

As described above, the situation verges on the fantastic. Of course, many assets in the Russian banking sector are far from ideal, which reflects the Russian economy’s level of development. Even so, the loan book at Bank of Moscow (as at most major Russian banks) consists mainly of financing for the country’s most attractive borrowers, although this is naturally supplemented by credit for friendly parties. This latter group likely accounts for the “hole” or R60bn (or slightly more) that was mentioned earlier. All other borrowers – even firms affiliated with Andrei Borodin, Yuri Luzhkov, Luzhkov’s wife Elena Baturina, etc. – are more or less public companies whose obligations can most likely be brought under control. Furthermore, most borrowers are doubtless served by other banks and also draw on the debt markets. If they were experiencing problems this should have become apparent elsewhere as well.

Based on currently available information (statements from official sources and the parties involved), only one of two possibilities seem plausible:

1. If low quality (i.e. all but unrecoverable) assets really do approach R400bn (more than 40% of the Bank’s assets under Russian-standard accounts, or virtually the entire corporate loan book) then the problems could not have emerged in the course of a single month in a stable macroeconomic environment. That raises questions about earlier CBR reviews, including regular audits; about the Bank’s accounts in general (including IFRS figures audited by ZAO BDO); and about banking supervision in Russia in general. Furthermore, it remains an open question how a bank with such problems managed to survive the recent crisis and why VTB would walk into a take-over “with its eyes closed”.

2. If the above figures for “bad” loans represent nothing more than provocative assertions by the Bank’s previous owners and actual loan quality is in line with earlier assessments, then such rapid official confirmation of the supposed problem creates the appearance that the Russian authorities have in effect allowed Mr. Borodin and his associates to walk away with R400bn at the state’s expense.

5) When do you expect Bank of Moscow to issue its 2010 financials as the bank is required to publish them until end-July at the latest, in order to avoid triggering an Event of Default on most of its bond and loan obligations.

We believe that the Bank may well publish accounts by the second half of July. We also expect it to meet all financial obligations, since any failure to do so would have a major impact on the investment climate in Russia and the country’s international reputation.