Fearing Contagion, Russia Bails Out Bondholders in its Biggest Bank Collapse Yet

by Wolf Richter, Wolf Street:

“The panicky mood has been dampened down,” as other banks are rumored to be teetering.

True to the playbook of bank bailouts, the Central Bank of Russia (CBR) decided to bail out Bank Otkritie Financial Corporation, the largest privately owned bank in the country, and the seventh largest bank behind six state-owned banks.

The Central Bank put in an undisclosed amount of money in return for at least a 75% stake. This is likely to be Russia’s biggest bank bailout ever, well ahead of the current record holder, the $6.7 billion bailout of the Bank of Moscow in 2011.

Otkritie and its businesses would operate as usual, the Central Bank said. The banks obligations to creditors and bondholders, which include other Russian banks, would be honored to avoid contagion.

The controlling shareholder of Otkritie bank is Otkritie Holding, with a 65% stake. The bank had grown by wild acquisitions, grabbing other banks, insurers, non-pension funds, and the diamond business of Russia’s second largest oil producer Lukoil. Otkritie Holding is owned by executives of Lukoil, state-owned VTB bank, Otkritie, and other companies. So clearly, this bank is too big to fail.

Lukoil is also one of Otkritie’s largest clients. So Lukoil CEO Vagit Alekperov said in a statement that he saw no risks for Lukoil associated with the bail out, and that Lukoil supported the Central Bank’s decision.

In July, according to Reuters, Kremlin-backed rating agency ACRA downgraded Otkritie to a BBB- rating, citing the “low quality of its loan portfolio.”

On August 17, Moody’s placed Otkritie on review for possible downgrade, citing two big issues:

  1. “The recent elevated volatility of the bank’s customer deposits, which puts pressure on its liquidity position and negatively affects its funding costs”
  2. The bank’s “increased involvement in financing the large financial and industrial assets of its controlling shareholder Otkritie Holding.”

Since 2013, the Central Bank, which is also the banking regulator, has shut down over 300 Russian banks, trying to clean up the banking sector. In July, it revoked the banking licence of Yugra (or Jugra) Bank, stating that it had falsified its accounts.

On August 18, Fitch Ratings warned about Russian banks in general and about Otkritie in particular:

A flight to quality triggered by depositors’ concerns following the withdrawal of Jugra Bank’s licence could intensify as the clean-up of Russia’s banking sector continues, Fitch Ratings says. This would put some weaker privately owned banks’ liquidity at risk.

The clean-up is likely to highlight further problem banks, adding to concerns about weak solvency positions at certain private lenders and uncertainty about how the Central Bank of Russia (CBR) may address these issues.

Otkritie, B&N Bank, Promsvyazbank and Credit Bank of Moscow (CBOM, BB-/Stable) are among the banks that have been subject to Russian media speculation in recent weeks, regarding the liquidity position of some and the potential knock-on effect on others.

The run on deposits was in full swing, and the bank was in collapse mode. In June and July, according to Moody’s, Otkritie’s depositors yanked out 435 billion rubles ($7.4 billion), or 18% of the bank’s total liabilities. According to the Central Bank, between July 3 and August 24, corporate clients yanked out 389 billion rubles, and retail clients yanked out 139 billion. Where were they putting their rubles? State-owned banks and precious metals? In early July, the gold price started taking off.

Reuters notes that ruble liquidity “in the Russian interbank market rose unexpectedly this month as the banking sector started borrowing more from the central bank, seen as a symptom of deteriorating trust in the interbank lending market.”

The Central Bank’s first deputy chairman, Dmitry Tulin, told reporters that Otkritie’s expansion “was financed via borrowing and key risks were taken. The bank’s operations are connected to high risks and need to be seriously changed.”

The CBR will now assess Otkritie’s loan loss provisions and capital, which could take three months. If the capital is “deemed to be in the red,” as Reuters put it, Otkritie shareholders would lose all their ownership rights.

On paper the bank didn’t looked too bad. For 2016, it had a non-performing loan ratio of 7.5% and Tier 1 capital of 12.3% under Russian accounting standards. This is above the CBR’s requirements. But that’s on paper. And in reality?

“The capital disclosed in (the previous) reports seems to have been significantly higher than in reality,” Tulin said. “At a certain point, the bank owners realized they couldn’t solve the issue with capital on their own and turned to the central bank with a proposal to start discussing financial rehabilitation measures.”

“Everyone is breathing a sigh of relief,” Maxim Ryabov, a trader with Russian brokerage BCS, told the Irish Times. “The panicky mood has been dampened down.”

But “the overall situation and the central bank’s action raises questions about the quality of the central bank’s supervision of one of Russia’s largest systemically important lenders,” lamented Dmitry Polevoy, chief economist at ING Bank in Moscow.

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