Ru En

You aren’t protected in Russia

That’s the reality in Russia. The crisis hasn’t changed it. You’ve got to accept it or not accept it, and see all the risks: while earning a large margin, it’s possible to lose even more, says Ruben Vardanyan.

Ruben Vardanyan Troika Dialog Manager

Date: 29 October 2009

Source: Vedomosti

That’s the reality in Russia. The crisis hasn’t changed it. You’ve got to accept it or not accept it, and see all the risks: while earning a large margin, it’s possible to lose even more, says Ruben Vardanyan.

The global financial system collapsed in 2008: two of the oldest investment banks – Bear Sterns and Lehman Brothers – suffered a crash, while their peers had no choice but to become commercial banks. One year ago, at the height of the crisis, Ruben Vardanyan said in an interview with Vedomosti that Troika Dialog had withstood the crisis and wouldn’t even sell a minority stake. However, it was announced in March that South Africa’s Standard Bank had acquired a 33% stake in Troika Dialog Group. Vardanyan spoke with Vedomosti about the other scenarios for business development reviewed by Troika, how the investment bank is faring in the new situation, and his various other projects at the moment.


Troika Dialog’s 2009 financial year ended on September 30, meaning the year’s results are a reflection of the crisis. How did it go?

The final quarter of 2008 was the first quarter of our financial year, so our situation is a bit unusual. The first quarter was very difficult in terms of results, volumes and overvaluations; we also reduced our staff. But the following three quarters – despite the financial crisis – were profitable and successful. Overall, it was quite a god year for Troika: we managed to get through the crisis without losing our independence. We also preserved our capital and client base, and signed a deal with a major international institute – Standard Bank – under a unique format and in short time. We managed to secure long money from the EBRD ($150 mln for five years – Vedomosti) at market cost. In December, simultaneous with the total collapse, we agreed to sell a stake in KAMAZ at a good price. In January we closed the year and underwent two due diligences – we were examined by Standard Bank and the EBRD as well as other ratings agencies. Simultaneously, we examined a large commercial bank that we wanted to purchase, reduced personnel, and sorted out the ruins with problem assets. The workload was considerable.

What are the initial financial results?

You wouldn’t mark this year with a plus sign for profits. We expect to finish the year with a positive result (the 2008 results after bonus payments was $10 mln – Vedomosti). Nevertheless, Troika had quite a good year. We fulfilled all our obligations, preserved the strongest team of analysts on the market, and continue making deals. Clients appreciate how you perform on a down market. So I repeat, this was a good year, even though return on equity (ROE) will be minimal. However, on the other hand, we received $300 mln of new capital by securing a new partner. The capital base now exceeds $800 mln, allowing us to enter the top 10 commercial banks by proprietary capital. We always believed that 35% ROE was average, but now a 15% result is top performance in our industry. Overall ideas about good ROE have changed sharply – the same is true for margins. The euphoria of 2001-2008, when ROE under 50% was out of the question, has ended. Success in times of crisis is not measured in profits.

Will bonuses be paid for 2009?

This question will be decided by the Board of Directors, which now includes two Standard Bank representatives. I can’t mention specific figures right now in terms of profits.

Has staff pay been returned to pre-crisis levels?

Pay stayed the same for everyone receiving less than $3000. Mostly the top executives were affected by the reduction. Their pay hasn’t returned to former levels. I, for instance, hardly receive any pay, nor did I receive a bonus. Basically the same is true for all members of the Management Committee. This is because the top executives shoulder more responsibility, plus we save a considerable amount of money. But, on the whole, our staff receives more than the market rate, as evidenced by the large volume of job applications we receive.


Which business lines brought in the most profits?

The brokerage business creates almost all the profits right now. Trading volumes started rebounding in April, while the primary debt markets opened in June. Excluding from discussion the proprietary securities issues that several banks have performed, we enter the top-three arrangers of bonded loans. But the debt market is only getting started, while the market for stock offerings is still basically closed. Some people thought there would be a large number of debt restructurings, but the new bank-mediators aren’t participating in many deals – the deals are happening one-on-one – and not much business was created. There weren’t any closed M&A deals like the KAMAZ-Daimler deal, but this is true not only for us, but the market in general. Asset management suffered most of all following the strong drop late last year. Many people lost a lot of money and spent a long time coming to grips. Recovery began after 6-7 months, and there is a bit of new money flowing in, however little. Private equity was hit especially hard as money had been invested with growing companies in the financial and consumer sectors – where the crisis wreaked its greatest havoc. Some of our partners behaved appropriately, while others – inappropriately and out of line (the case of Eurocommerce is most indicative). We had to let go of team members who weren’t prepared for the new realities. We revalued core investments, and assets now amount to several tens of millions of dollars. This also had an impact on financial results. However, of the seven companies we invested in, five are alive and actively operating.

What were the proceeds from the Standard Bank share purchase put toward? Why did Troika secure the EBRD loan?

We considered four possibilities regarding development in crisis conditions: an additional release by Troika Dialog Bank for 10 billion rubles, a loan from the EBRD, the deal with Standard Bank, while simultaneously considering the purchase of a commercial bank. In crisis conditions, every opportunity must be exercised. We were already prepared to buy a commercial bank, but then we entered into the deal with Standard Bank. As for the EBRD loan, our thinking was, given the dearth of long money in the five-year horizon, it was necessary to go all the way. Now we’re over-capitalized, but we aim to develop the commercial banking project.

Can you describe that project?

Private banking for wealthy clients on the base of Standard Bank. The bank, which will operate under the Troika brand, will require approximately $100 mln to develop. Troika Dialog is one of the largest retail financial companies servicing clients at the middle-upper level. We are present in all major cities in Russia, and over 70,000 clients have purchased shares in our mutual funds. New services such as deposits and credit cards will be offered to these clients. The project will be launched next spring; we have to finish the fine tuning first.

So all $300 mln will go toward the banking project?

Not only that. We are developing new business lines. Together with Standard Bank and ICBC, we intend to create an equity trading platform in South Africa and Asia. We are building commodities trading. We are launching derivative products for hedging interest rates and currency risks. There’s another idea about working together with Standard Bank in other countries and creating alliances with local champions.

We’ve already seen this with one investment bank.

We have a different idea. I don’t believe that a local champion in Russia could become one in Africa as well. But I have a partner-local champion in Africa, a partner-local champion in China, and a partner-local champion in Brazil. This is an entirely different model. I don’t feel like I could be successful in, say, Indonesia, because I don’t have the necessary people and knowledge. Maybe someone else does.


The deal with Standard Bank was closed in September. What can you say about it?

This is a successful deal. We received a commercial bank in Russia and created a unique model for interacting with a leader from another emerging market. Now we’re discussing it with consultants. The question is whether we believe that cash flows between emerging markets will increase over the coming five years. We believe that, for example, money traveling from Brazil to Russia won’t go through the U.S. And we believe the opportunity exists to develop a new model. Global banks are represented everywhere, but they didn’t make a strong case for themselves during the crisis. Now they are more strictly regulated, have problems with capital and mandates from shareholders to invest in emerging markets. But the local markets that earlier were smaller in size have grown bigger, and the leaders from these markets – Russia, India, Africa – will be capable of competing with the global banks.

What did Troika Dialog receive from the partnership with Standard Bank?

At the most basic level, we are currently discussing a commercial bank, people from Standard Bank traveled here and described their operations in South Africa and Nigeria, and I received more knowledge than I would if I specially studied this myself. In terms of commodities, Standard Bank is the largest gold trader. And, of course, they understand many things. For that reason, for example, several employees from South Africa will work on the commercial banking project.

Have any particular deals already occurred? Generally speaking, do Russian businessmen want to buy anything in Africa, or Chinese businessmen – invest in Russia?

Sure, such deals are happening, but they haven’t been closed yet. For certain deals we will use Standard Bank’s balance, since they are bigger. But you’re going too fast – we only started working with Standard Bank in June, while we received approval from the regulators just this past September.

Will Standard Bank increase its share in Troika’s capital?

We’ll see, we have two more years, but I don’t think this will happen. By stipulating the option of increasing Standard Bank’s share by 4%, we simply removed the question about the value of the AvtoVAZ and KAMAZ stakes. I don’t see any problems, even if the share increases to 37%, but this is unlikely to happen.


How will AvtoVAZ overcome the situation with its debts? What is its future?

The future exists even in the grimmest situations. We entered AvtoVAZ during a crisis and did three things: started cleaning out the accumulated problems, participated in developing a new modular row and found a technological partner. But management permitted several mistakes: overestimating the impact devaluation would have on the market and erroneously estimating market capacity. But it also wasn’t possible to predict such a drop in demand for cheap automobiles. There is a difficult, but feasible task – lowering expenses, reducing personnel and the management structure, a precise definition of what AvtoVAZ is about. Right now it is a conglomerate of everything: it has auto components, a dealer network, a scientific-technical center, and a social sector. It is necessary to determine which functions should remain, which should be transferred to others, to the region, or to private companies. The difficulty with AvtoVAZ is not only that it has an inefficient system, but most of the auto parts are less than superior in quality. A car is no better than the parts it is made from. That’s the first issue. The second issue is the cost and markups due to all the links that were artificially created by managers inside the factory and the people surrounding it. It is necessary to lay bare the situation with all these “subsidiaries.” The social burden should be lowered and staff numbers at the factory should be reduced.

Do the officials think differently?

Officials in all countries, for example, the U.K. and Spain, demand that no workers be laid off.

Do you still think it’s possible to reduce staff?

I’m convinced the opportunity exists to do this sensibly and judiciously, for example, by sequestering the non-core business lines into separate businesses together with employees. But that’s a question for management to address.

When Renault purchased AvtoVAZ, did it foresee these problems? Did they simply underestimate the risks?

Everyone appreciated the risks, but the estimation of the market was a different matter. Experts evaluated the market at 2.3–2.4 mln cars per year, making Russia one of Europe’s largest markets. The drop to 1.2 mln automobiles per year was outside everyone’s forecast.

How does Troika Dialog, the owner of a blocking stake, suggest handling the factory’s debts and the additional share issue? What particular reductions are necessary?

I don’t oversee management at the factory; I’m a member of the Board of Directors. And I’m not a specialist in auto manufacturing – I don’t know how many people should work at the factory. We do’'t provide commentary on our valuation of the fair cost of the AvtoVAZ stake. We don’t have any specialists in the automobile business. We are financial investors who did several important things: we completed disentanglement, returned a blocking stake to the government while accommodating the interests of minority shareholders, attracted a foreign strategic partner. We always said we would help in attracting financing, but we didn’t say we would manage the factory. We will participate in discussions about appropriate valuations of the company and converting debts into shares. However, we will not determine which cars to manufacture.


What lessons can be learned from the crisis?

The crisis showed a lot – the imperfection of legislation, standards and ideas about what’s possible and what isn’t. Many people continue calmly shaking your hand without delivering on the promises they made to you. Because of the crisis, obligations before minority shareholders, banks, western automobile suppliers and others went unfulfilled. The crisis was a litmus test that showed not only how effectively you managed your business, but other true values as well. Happily, other positive things can be said. A number of mid-sized Russian banks deserve a tip of the cap: they fulfilled their obligations during the crisis without saying a word. Not all company-debtors acted this way. The crisis was incredibly hard in terms of its effect and severity. But today, one year later, we can already say that nothing has changed at the systemic level. No conclusions were made at the legislative level – you go to court, but the arbitration managers fail to show up for the hearing for the umpteenth time. And suddenly you’re in a strange situation: it seems to be a public debt, but there’s no mechanism to require that the debt be returned. This is a question to the system in general – how people and the system react to this.

And how do they react?

They don’t react at all. Everything is possible. And it’s too bad, because this is dangerous: we took quite a strong hit, but, even after everything that happened in the economy and the country, no reinterpretation has occurred.

Is the crisis over? Superficially, it seems that all is suddenly much better. There’s money again, no inflation, and the market drop has slowed down. Is the situation in fact stabilizing?

You’ve got to be happy. At the St. Petersburg Economic Forum, 42% of people said there would be a w-shape recession. There’s a bit of folk wisdom in this. There’s a high amount of liquidity pressing down on the market and the dollar, and, as a result, prices on oil and other goods and commodities are rising. It’s a good situation for Russia when the world experiences inflation and there’s an abundance of cheap money. It’s clear that Russia fell further than others, so the rebound was stronger as well. It’s clear that the adversity wasn’t that severe and certain problems that seemed insurmountable were overcome; this has also created a positive mood. The negative side – the legal system didn’t work before, and it still doesn’t now, deferred loans remain deferred, and people who deceived others were never punished. Our dependence upon oil prices is clearer than ever, and modernizing and diversifying the economy is now the main task. We lack the $30-40 billion needed to recapitalize the banking system. And it will require at least another $300-400 billion over the next several years for infrastructure changes. There’s a dearth of long money in Russia, and it isn’t clear where this might come from. Given the weak banking system and lack of an equity funding market, capital distribution mechanisms don’t work. Manufacturing becomes difficult when infrastructure is lacking and businesses can’t pursue capital expenditures – everything has stopped. There’s no bankruptcy mechanism or effective means of liquidation, which creates problems for both the borrower and the lender, because the systemic lack of trust still hasn’t disappeared. Certain companies in need of money are still unable to borrow. The problems weren’t resolved. Sure, they poured out the fire. But my feeling is, for now at least, this is just a shot of anesthesia, the kind an injured footballer gets so he can finish the match.


What kind of explanations do SKOLKOVO students receive for Russian realities like, for instance, the presiding arbitrator failing time and again to attend a court hearing?

We teach that different paths exist and that you make the decision yourself. There are two options: pursuing non-market courses of action, or continuing litigation. You have to understand that these are the risks in this country, and, earning a large margin, you can end up losing even more. You aren’t protected – that’s the reality in Russia, either you accept it or you don’t.

We were discussing the SKOLKOVO business plan, which some consultants wrote and others perfected. The first facts about the project are coming to light. How do they match up with the business plan? By the key parameters: profits, expenses, endowment, venture fund, pace, timeframes.

You’re interested in the profits and expenditures parts. This is very important, of course, especially for the non-commercial partnership. But, in my opinion, what’s more important is the fact that $120 mln was raised in a country lacking any kind of tax breaks, that 18 companies and private individuals believed in this idea, and respected people like Mikhail Kusnirovich, Leonid Mikhelson, and Alexander Abramov spent their own time and efforts and take pleasure in this project. Lee Kuan Yew, the Minister Advisor of Singapore, a man who has achieved everything in life, spends his time with a Russian business school, traveling to Russia every year. We are working on a totally new project with a new management system, implementing a new educational model. Have we diverged from the plan? If you look at the details, then yes. But essentially – no. The model is right – it works. And some good students have enrolled. Now for profits and expenses. We spent several tens of millions more than planned. We underestimated expenses on executive education by 200% because of the crisis. When you try to value the SKOLKOVO project in monetary terms – which is right, of course – but, when you get down to it, the money isn’t the point!

SKOLKOVO isn’t a philanthropic project?

It is a philanthropic project. Nobody among the founders will receive their money back. But, for the first time in history, Russian and western businessmen did something together, creating a real, functioning private-state partnership in which the “government and private business” link actually went to work. And by no means out of a desire to pocket the government’s money.

Do you have many Russian cases?

Our training model isn’t based on cases, but projects. The Russian cases are gradually being written. As it turns out, this is somewhat of a problem. A case is an illustrative example of a certain situation. However, if you lack complete information, how will you write about this? The conditions in Russia are such that complete information is rarely available.

How much is already written?

Two dozen or thereabouts. But the cases are not the ultimate goal. Our task is to teach students through actual projects and real affairs. For example, our people are working on social projects. What should be done with a mono-factory town when the main factory is shutting down? What a situation! In my opinion, this is more interesting than any case could be.

Ruben Vardanyan on the second wave of the crisis

“You can’t live as if you’re building an atomic bomb shelter all the time and all around you is springtime and flowering gardens. Meanwhile, you tell everyone: “No, sorry guys, I’m going to live in this bomb shelter and wait out the second wave of the crisis.” That won’t work. You’re living and working in a dynamically changing environment, in a tremendously unpredictable situation, and given all this you need to make decisions. Many companies turned out to be unprepared for this. The crisis revealed a number of charlatans – people who can’t make appropriate decisions and don’t know how business works. The rules of the game have to change; responsibility must be improved. Do you know why Brazil managed to avoid a banking crisis? The laws in that country stipulate that the lead shareholder answer for the bank with all his or her property. If the bank goes bankrupt, the shareholder bears legal responsibility. Who would have thought that Russia would get swept up by the U.S. subprime mortgage crisis? Nobody can predict when the second wave will occur. It’s a well-known curse to live through an era of changes. We’ve been living in an era of changes for the past 20 years. So you can’t just sit and guess what’s going to happen – you have to live and work in the new reality.”

What Vardanyan likes

“My home is in the writers’ village in Vatutinki. It’s a 450 sqm house. We live next to the Dragunsky and Matusovsky families. We moved in 15 years ago. The house was built from scratch according to our own project, a good wooden home. We like living there.”