1

SALES AND PURCHASES,MERGERS AND ACQUISITIONS

OF RUSSIAN BANKS Tendencies. Prices and price factors. Transaction schedule times.

Presentation 12th RBC International Conference

RUSSIA AND the REPUBLIC OF SOUTH AFRICA – BUSINESS IN DEVELOPING MARKETS

Capetown, the Republic of South Africa, 4-8 November 2005

2

Whales GroupSince 1999 has specialised in sales and purchases, mergers and acquisitions, and setting up of banks,

as well as in research in this field in Russia.

Market Review Sales and purchases, mergers

and acquisitions of Russian banks Published annually in early September,

upon completion of the transactions, started in the year under review.

3

METHODOLOGY

Sale and purchase transactions are latent, the price and terms of a deal can be found out only from "inside" the transaction. For this reason the Review is based on expert opinions of the specialists, involved in the follow-through of these transactions, on interviews of bank buyers and bankers, tied up with these transactions, and their appraisal of impact on the price of a bank, on insiders' information as well as on the information made public.

4

• “A new bank” is a bank registered less than 3 years ago. Its specific feature is that its founders/shareholders s have no right to alienate their stakes/shares, therefore transactions made involve stakes/shares of the founders, and such a bank can receive a license for transactions with private individuals not earlier than 2 years after its registration..

• “An old bank” is a bank registered more than 3 years ago. As a rule, old banks are all licensed for business with private individuals.

NOTES

5

NOTES

• Here we discuss sale of the bank license, that is the right for banking transactions. The cost of assets in a transaction is evaluated separately and, by agreement of the parties, is either reimbursed by the buyer or the assets are deducted by the seller. This includes, as a rule, restructuring of a credit portfolio..

• We say that the banks are sold, meaning, of course, the sale of shares or stocks of a bank or those of its partners/shareholders s/founders/founders’ partners etc.

6

A revolution on the bank market, anticipated for so long, burst out at last in

January 2005

Early 2005 has seen an all-high demand for banks – members of the Deposit Insurance System (DIS) [1].

The revolution as always produced the results contrary to what had been expected. Bank prices instead of falling all the way down as has been predicted for about 7 years now, sky-rocketed. Banks – members of the DIS, were put up for sale at prices, up to 90% higher than a fair price, and they were gone in an instant.

• There are three main reasons for it:– An unprecedented influx of petrodollars;– December epidemic of rejections in registration of new banks;– An avalanche of denials to enter the DIS. «Those admitted» put on

airs and get expensive.

[1] A member of the DIS is eligible for a license to operate with private individuals.

7

Refused admittance to the DIS,

or “Eats Shoots & Leaves”.

• Who and why was denied admittance. • What to do? • Are there any chances to keep the license for the next few years? • Is life worth living after the 4th rejection?

8

Banks buy banks

• The market has seen a change in typical buyers of a bank – in 2002 a bank was mostly purchased with the aim to invest money of an industrial and financial group, sometimes funds of the State budget with a view, first of all, to control them, and deriving a profit came next. The second purpose by occurrence was a purchase of the license by a team of managers, who have broken away from a bank with a part of its business. In the third place were purchases by what was called in the 90s a "financial company", which in reality was an uncertain number of legal entities set up to render, as a matter of fact, banking services with the aim to evade restrictions, imposed on banking operations.

• "Buyer-2003" was a big Russian bank, a “second-class” foreign bank, and an industrial and financial group with a team of managers (or vice versa), going into this narrow niche with the aim to profit by this investment.

9

Banks buy banks

• Small-sized• Medium• Of the world’s first 10

• Abrupt changes on the market brought new buyers – now they are first of all banks and bank groups, including several financial tycoons of the world.

• Foreign investors, seeking an entry to the Russian banking market, can be conditionally subdivided into the following groups:

European

American Asian

10

For whom life is difficult in Russia

• Most difficult – for an American giant. It is likely that he would be willing to step over the constraints, but he cannot – his shareholders s are a great many ordinary Americans, and for this reason the risk level that the management can take is limited by law. This buyer should better stay away from this market, than take the risks.

• Even if the amount of the risk, meaning likely compensations to be paid in case of claims, imposed penalties and the like, is negligible compared to its capital, the giant considers the risks to its reputation as most unwanted.

• Shadow operations of a Russian bank to conform with the rates, can be considered money laundering. It is fatal to let yourself be mixed up in these operations. And with all this going on, the giant is well aware that as soon as this acquisition is made public, the bank will be “scrutinised” both by regulators and potential claimants.

11

A clean Russian bank

• Please try and formulate in definite terms what “a clear bank” is.

• Exotic are Russian banks, which have not used crediting even once for taking money out. The bigger a bank is, the greater is the number of corruption-mongers it has to upkeep for its own existence and - even more so – development. This leads to grey and black schemes of withdrawing customers’ money and “holes” under the pretext of secured credits.

• In a big bank it is complicated to discover a hole during a check-up.

• Transactions are made, in which the buyer understands that a hole in the bank to be purchased is small compared to its assets, and thinks of the long-term business with assets, sufficient to “service” it, as bankers say.

12

A clean Russian bank

• It is also worthy of note that sellers are not keen as well to be audited Western-style and face a very likely termination of the deal because they do not meet the requirements of a foreign investor. They understand that a Russian buyer will have a different view of the operations, the deal has more chances to be concluded and that will happen many times quicker.

• On top of that, a big Western buyer is unable to pay a deposit, which is a must in most transactions if a would-be buyer is to participate in a check-up of the bank. Although, he could suggest to sign a contract with an obligation to pay damages for recession from the contract, but, first of all, this is not quite the same thing, and, secondly, this will take from two weeks to two months.

13

A clean Russian bank

• It is of interest that without exception all buyers – foreign banks state their requirements to a target bank as follows:

• «the bank and its sellers must not be involved in trading weapons, drugs of abuse and other black-market deals, or have anything to do with the criminal cases »

• which is a usual requirement from a Russian buyer. A bank with demerits like these can hardly be sold.

14

A clean Russian bank

• Asian buyers carry on this business in a most enigmatic way- after several years of communication with some of them you may find yourself in the same position without a clear idea about what they want: face to face with one more Russian target bank, they crawl back frightened and in a few months emerge again, with no signs at all that their requirements to the merger target have changed in any way. And because to insist, as you would do with Americans and Europeans, is absolutely out of the question when you deal with such a delicate as Asia, you remain somewhat in the dark about what in particular frightens off Asian banks.

15

What are the chances that the bank will be purchased for short-term use?

Can you safeguard yourself against such a sale?

• The only safeguard is to overstep the limits of the lowest price category. Although, deals of this kind are concluded mostly with “refusniks”, preferably those based in Moscow.

• We know deals, which were not even put on paper: verbal understanding with the management in view of pending license withdrawal made it possible to complete transactions required by the buyer.

• If actively involved in laundering, a bank could be afloat for about two months. An incredible amount of petrodollars in the treasury cries for laundering schemes and the demand is so high that black-market players are ready to pay USD 1 million for a Moscow-based “refusnik” to be used for only two months.

16

What are the chances that the bank will be purchased for short-term use?

Who and what for will be called to account?

• Formally, responsibility lies with immediate directors, but remembering Yukos case, nobody will have the audacity to proclaim this. Khodorkovsky was made responsible as an informal organiser for the business of organisations, of which existence he was almost unaware. That is why it is impossible to maintain that those figuring in a case will not be branded in a statement of charge as “an organised-crime gang in a conspiracy…”.

17

Pyramid of Deals

• The base of the pyramid shows deals in bare licenses, they make up the majority. The demand for the lower price category licenses of the banks – members of the DIS is the highest.

18

Pyramid of Deals

• A loan portfolio, other assets, as well as authorised capital actually available, are viewed for the purposes of these transactions as weak points, as these take more time and resources for their assessment, lead to a higher risk of cancellation of the deal in case of a difference in assessment, increases the buyer’s costs.

• As banks with a small number of clients – below ten thousand – cannot be viewed as a business worth buying, for those banks, which are in the gap between a bare license and the banking business, there is almost no demand. They only have to wait until there are no more offers on the market from the lowest price category, and only then will they able to fit into this niche.

19

How to sell a banking business?

• Demand for banking businesses comes mostly from medium-sized and big Russian banks, as well as from foreign banks.

• How is the structure of assets and liabilities evaluated in a deal?

20

Difference in evaluation of assets by the Central Bank and investors.

• Although the Central Bank declares that in a check-up of a bank the economic substance of a transaction has a priority over its form, a buyer’s approach to the bank evaluation and check-up remains different. The Central Back has no recourse to management accounts and openness of the staff.

• Basic methods to evaluate the bank’s financial situation are those of comparative analysis of the bank’s financial performance and expert assessments against the background of additional information from the bank management.

• For analysis purposes we do not adhere to the Central Bank rules of drawing up bank reports. Based on the same principle, as well as the principle of materiality, we do not seek absolute accuracy of figures and intentionally use approximate values, which do not result in any misrepresentations in the balance sheet and the statement of income and losses in the period under review and which do not have any material effect on assessment of the bank’s financial situation.

•

21

Intellectual capital of a bank

In what way do you assess the quality of management, the level of corporate management, the price of the intellectual capital as the aggregate of the knowledge of the whole staff of an organisation, making it competitive?

• The quality of management and the personnel are assessed by the buyer in the course of the bank audit. In most cases the sale itself means that control goes over to a more dynamic and potentially more successful team of managers, which implies a mismatch in personnel, working styles of the seller and the buyer personnel. As a rule, no more than 20% of the previous managerial staff stay after one year after sale. This percentage is confirmed both by Russian and foreign buyers.

• Part of the intellectual capital is also an organisational structure, i.e. an artificially created form to control the use of knowledge. The complexity of such assessment is evident – the intellectual capital is a form of "the knowledge of the past", which cannot be evaluated in quantity and which transfer to the buyer can be guaranteed. .

22

Investment and market price of a banking business.

Methods of bank pricing.

• It is known that the market price is determined by the motivation of a typical seller and buyer. The investment price depends on the individual requirements of the investor to the object of investment.

• In this market it is practically impossible to determine the price by calculating the costs. Two methods prevail here: comparative (market) method and revenue method – an estimate of the future profit-making potential (loss of profits during down-time of the buyer’s project also comes here).

23

General tendencies, influencing the transaction climate and the height of the barrier on the way

to the market of banking services in Russia

• The downtrend in a number of active banks, market expansion and stronger competition only became pronounced in 2005. Consolidation made competition fiercer, but it is still smoothed out by the growing money supply. The capacity of the market for sales and purchases, mergers and acquisitions is ever growing. The total market value of transactions in increasing.

24

General tendencies, influencing the transaction climate and the height of the barrier on the way

to the market of banking services in Russia• We can affirm that in principle all banks not owned by the State can

be bought – some of them just consider the sale as a long-term outlook to which they work - build up assets, increase the volumes of their business and effectiveness of technological processes, improve personnel and management standards, change over to Western accounting standards, go to the country’s regions, and get involved in mergers and acquisitions of Moscow and regional businesses.

• But even they are prepared to consider a sale at any stage of their development, as they understand that by increasing the value they limit the circle of would-be buyers.

• For a big foreign bank this bank target will be tiny anyway, and will not let it accomplish its true objectives. This buyer is prepared to pay only for the entity set up and for the time saved on entering the new market. At the same time it is not ready to take reputation risks, and no Russian seller can guarantee this. Therefore, almost no transactions are concluded with foreign buyers, in spite of both parties being eager to do this.

25

• World tycoons (those of the first ten) have been considering an entry to the Russian market for about a year and a half. To all appearance, they will be there within half a year. No more than one year will pass before they start an active stage of their activity.

• One can suppose that this will bring a fundamental change to the Russian market. The giants' resources are so vast and cheap that they could be dumping on the market for years until they squeeze out their main competitors. This is for about five more years after which Moscow banking market will remind the banking market of Eastern Europe.

• Primarily this will affect consumer credits and big borrowers. Russian banks will have their niches in regions, mostly in those which are not large and rich, as well as offer corporate services to meet specific needs of Russian legal entities.

• An influx of petrodollars will still keep pocket banks afloat for some time.

General tendencies, influencing the transaction climate and the height of the barrier on the way

to the market of banking services in Russia

26

General tendencies, influencing the transaction climate and the height of the barrier on the way

to the market of banking services in Russia

• Stronger competition will probably promote consolidation and this will lead to growing number of transactions on the banking market.

27

Location Type of license

Age of a bank

Price inmln USD

2001

Price inmln USD

2002

Price imln USD

2003

Price inmln USD

2004

Price inmln USDJan 05

Price inmln USDNov 05

Moscow Foreigncurrency

old 0.58 0.65 1 mln 1.2 1.6 2.6

Moscow Foreigncurrency

new, AC € 1 mln

0.5 0.68 0.85 - - -

Moscow Foreigncurrency

new, AC € 5 mln

- 0.78 0.95 1.5 2 2

Moscow General license

old 1 1.3 1.8 2.6 - 3.4

Moscow Ruble license

old 0.32 0.4 - 0.55 0.65 1.6

Regions 2-4

Foreigncurrency

old 0.3 o.42 0.45 0.55 0.6 1.5

Regions 2-4

Ruble license

old 0.15 0.25 0.25 0.45 0.45 0.85

LICENSE PRICE MOVEMENT 2001-2005

28

TIME AND MONEY

Ways to enter the sector Time limits Cost, USD

1 Purchase of an old bank license 6 months to 1.5 years

2,700

2 Purchase of the license and business of an old bank

1 to 2.5 years (?)

4 Registration of a new bank 13 months (?)

29

SPRINT- 2005

• The shortest time in which a bank was bought in 2005 was:

(this time is the period between the day of the first negotiations between the buyer and the seller and the day when the signing rights of the new CEO are confirmed by the Accounts Centre of the Russian Central Bank and includes completion of all procedures, registration, and approvals of purchase and sale transactions)

• An old bank in Moscow – 6 months

• A regional bank – 8 months