Russian Express

Rustam Tariko’s Russky Standart sparked a consumer lending boom -- and plenty of competitors. With margins under threat, is plastic credit the answer?

Post-Soviet Russia’s financial outlook has rarely seemed bleaker than it did in the spring of 1999. A half year earlier the government had defaulted on $45 billion of domestic debt, wiping out most of the country’s fledgling commercial banks and causing the economy to shrink by more than 10 percent. Foreign investors had deserted the country, and most Russians with capital had stashed it abroad.

Yet this was the moment that liquor importer Rustam Tariko chose to found Bank Russky Standart. The upstart Tariko’s approach to banking was as revolutionary as his timing was bold. Modern Russia’s first wave of private-sector bankers had focused on collecting deposits and investing in the country’s export industries. Russky Standart (Russian Standard) did neither. Instead, it raised wholesale funds and lent to the public, figuring that the typical Russian would not only borrow at interest rates as high as 60 percent but also pay back the money.

It took a few years, but the 42-year-old entrepreneur’s bet has paid off handsomely. With Russia’s oil-driven economic boom fueling a surge in consumer spending, Russky Standart’s assets grew sevenfold in 2003 and 2004, to 41 billion rubles ($1.43 billion). Profits soared 24-fold, to 4.4 billion rubles last year. The house of Tariko is the most profitable privately owned bank in Russia, boasting three times the 2004 earnings of its largest commercial bank rival, Alfa-Bank, and lagging only state-controlled giants Sberbank, Vneshtorgbank and Gazprombank.

“This bank had a net interest margin of 34 percent last year and return on equity of 58 percent,” says Andrey Naumenko, an analyst with Moody’s Investors Service, which has assigned a Ba3 rating to Russky Standart’s $900 million of Eurobond debt. That’s one notch below the Ba2 rating Moody’s gives to Alfa and MDM Bank, the country’s two largest private banks. “None of the bigger Russian banks are anywhere near that sort of profitability in their core business,” Naumenko says.

Russky Standart has both nurtured and fed on the stirrings of Russian consumer demand. The bank pioneered point-of-sale lending at appliance and electronics outlets, promising a credit decision in 15 minutes or less. All that generally is required is an internal passport, the national identity document that serves as the nub of every Russian’s bureaucratic existence. The approval rate is about 80 percent.

Five million people have taken up the bank’s offer, borrowing, on average, the equivalent of about $400. Thirty to 40 percent of Russian electronics purchases are made with credit. “People understand that they can have the refrigerator or television they want now instead of saving their pennies for two years,” says an enthusiastic Andrei Lykov, chairman of the Russian subsidiary of Home Credit & Finance Bank, a spin-off of Czech insurer Ceská Pojis´tovna, which has emerged as the runner-up to Russky Standart in point-of-sale loans.

The borrowing boom has a long way to run, if the pattern of Russia’s former Eastern European satellites is any guide. Consumer credit amounts to less than 3.5 percent of Russia’s gross domestic product, compared with 10 percent of the Czech Republic’s and 20 percent of Poland’s, Lykov says. And the impulsive Russians may surpass the phlegmatic Europeans as debt enthusiasts, bankers hope. “Long-term in this society means the end of the year,” says James Cook, chairman of Delta Bank, a Moscow-based credit card specialist that GE Consumer Finance bought last year. “People live here for today, and that works very well for consumer finance.”

Tougher times may lie ahead for Russky Standart and other consumer lenders, however. The bank’s success has spawned imitators that are whittling its yawning interest margins. CEO Dmitri Levin, 40, who met with Institutional Investor in place of the reclusive Tariko, projects that Russky Standart’s assets will double this year but that profits will grow by a more modest 80 percent. The bank is trying to keep one step ahead of the competition by driving ever further into Russia’s provinces, nearly tripling its presence to some 12,000 stores nationwide at the end of 2004 from 4,500 a year earlier. This year the bank will make more than 80 percent of its loans outside Moscow, compared with less than 60 percent in 2003, Moody’s Naumenko says. By the end of 2005, Levin predicts, virtually all of Russia’s 143 million people will be able to encounter a snappy young Russky Standart associate at their local electronics outlet, ready to feed their data to the 24-7 credit center in Moscow.

Russky Standart and other consumer lenders were investigated last year by Russia’s Federal Antimonopoly Service, which responded to borrowers’ complaints that the actual interest rates on point-of-sale loans ran as high as twice the advertised figures. Although it issued no fines and named no banks, the FAS noted the prevalence of “hidden payments and commissions” in a report on the industry last December. The agency’s action moved the Central Bank of the Russian Federation to issue voluntary guidelines on loan disclosures that officials may seek to codify into law.

“We publicize absolutely all our commissions and fees,” Levin says. The information available on Russky Standart’s Web site, however, emphasizes the relatively low nominal rates on loans rather than the effective cost, including fees.

In this stiffening competitive and regulatory environment, Tariko and Levin are looking for growth in the nascent market for credit cards. They began issuing MasterCards in January and, with typical aggressiveness, announced in July that the bank had already put its millionth card into circulation. Although many cards gather dust in the drawers of a population unaccustomed to revolving credit, Levin hopes to have 1 million active plastic users by the end of the year, propelling Russky Standart to the top of this market. This initiative pits the bank against its toughest rivals yet, including GE’s Delta Bank and Sberbank. The state-owned savings bank holds 60 percent of Russians’ deposits and is seeking to convert some of its millions of debit cardholders into credit card users.

The biggest question mark over Russky Standart’s future, however, is what happens when Russia’s oil-driven expansion slows or reverses. Tariko and Levin have managed to grow the bank rapidly in large part because Russia’s economy has expanded at an average pace of 6.5 percent a year since 2000. Disposable income has soared more than 80 percent during this period, according to World Bank estimates. If the economy falters, however, the bank’s profits could stumble too.

Levin says that fewer than 5 percent of Russky Standart’s loans are nonperforming. Analysts believe the bank could handle a doubling of that NPL ratio as long as loan growth and interest margins remain strong. If they weaken, though, the bank could quickly find itself squeezed. Russky Standart has just 7.6 billion rubles in share capital and reserves, a thin cushion if defaults begin to rise.

“What we can’t predict is how our clients will behave in a general recession,” Levin says. “We can study the experience of Brazil or Argentina, but that is not necessarily applicable to our public.”

Tariko last year announced plans to strengthen Russky Standart by selling a 50 percent stake to BNP Paribas, but that deal fell apart acrimoniously in January. In a statement, the French bank said the collapse was “due to Mr. Tariko and his group failing to comply with their commitments.” BNP subsequently filed for undisclosed damages in a London arbitration court. “At this stage the divorce is not finished,” a spokesperson for the bank tells Institutional Investor. Analysts suspect that Tariko turned down BNP’s reported $300 million offer because of his bank’s breakneck growth last year. Levin cites cultural differences, saying, “a big, bureaucratic corporate culture could reduce our flexibility in the market and slow our growth.” He contends that Russky Standart is no longer for sale, favoring fleetness over financial security, but many analysts believe Tariko would consider a richer offer.

RUSTAM TARIKO BUILT HIS FORTUNE, ESTIMATED at more than $800 million, by placing big bets on the growing appetites of Russian consumers and then exploiting those gambles with help from top multinational firms.

Born in a village in Tatarstan, a province that sprawls between the Volga River and the Ural Mountains, Tariko studied economics in the early 1980s at the Moscow Institute of Transport, then plunged into private business when Mikhail Gorbachev made that possible later in the decade. Tariko’s first great insight was that many Russians, despite being impoverished, could find the cash for some imported luxury. At a 1990 trade fair, he persuaded Italy’s Gruppo Ferrero to front him a shipment of its Kinder Surprise, a chocolate egg with a small toy inside, which Moscow and St. Petersburg consumers snapped up from street-corner kiosks. Through Ferrero he came into contact with spirits maker Martini & Rossi, now part of Bacardi-Martini, and built Russia’s top premium drinks distributorship. Eventually, he landed exclusive import rights from Diageo that included brands like Baileys Irish Cream, Johnny Walker and Smirnoff.

Then came the 1998 crash, in which the ruble lost 75 percent of its value in a few days and Russian imports nosedived. Searching for a new strategy, Tariko hired U.S. consulting firm McKinsey & Co. One of its conclusions was fairly obvious: Russians’ consumption would shift to domestic goods. Tariko promptly responded by founding a brand of Russian-distilled vodka, Russky Standart, which is now the country’s leading premium brand. McKinsey’s second prediction verged on the visionary, given the general devastation: Financial markets would recover because the government was no longer issuing its GKO bonds, which had crowded out other borrowers by paying interest at rates of up to 70 percent. Thus funds would be available to lend to a wide range of borrowers.

On this premise, Tariko launched Bank Russky Standart with $30 million in capital in May 1999. Within a year it was revolutionizing Russian finance as consumers, frustrated by the snail’s-pace lines and truculent bureaucracy at Sberbank, flocked to the bank’s in-store kiosks to finance their cherished items in a matter of minutes.

Tariko got a boost in 2001 from the International Finance Corp., the World Bank’s private sector affiliate, which agreed to guarantee 60 percent of its first domestic bond issue, a 500 million-ruble offering. In February 2003 the IFC bought 6.4 percent of Russky Standart for $10 million -- its first investment in a Russian bank since the 1998 crisis. “Russky Standart is one of the few banks that actually work the way we would like to see a bank work,” says Tomasz Telma, chief investment officer in the IFC’s Moscow office. “Their finance company model of not seeking deposits but financing themselves from capital markets has been quite successful.”

American Express Co. gave Tariko a vote of confidence in April of this year by granting Russky Standart an exclusive license to issue its cards in Russia. “Tariko is a great advertisement for the new class of Russian entrepreneur,” says Peter Wright, who manages AmEx’s credit card business in Europe. “We are very impressed with his gift for marketing, and the end-to-end management of his team has been world-class.’'

Tariko and Levin have played a deft hand in the credit markets to fuel the bank’s growth. The pair capitalized on international enthusiasm for Russian credit to issue three $300 million, three-year Eurobonds at rates as low as 7.8 percent between April 2004 and April 2005. They also have taken advantage of high liquidity in the domestic market to raise 3 billion rubles in March at 8.99 percent, and have announced plans to float a 5 billion-ruble bond by year-end.

“The market sees Russky Standart’s focus on a single sector, consumer credit, as a benefit,” says Boris Ginzburg, ruble bond analyst at UralSib Financial Corp. in Moscow.

Such canny moves have made Tariko a wealthy man. His fortune, including his 91 percent stake in the bank, is worth $870 million, according to Moscow-based Finans magazine, which ranks him as the 41st-richest Russian. Tariko is loath to discuss strategy publicly, and he avoids the business press, though he granted an interview three years ago to upscale lifestyle magazine Domovoi, in which he showed off his mansion outside Moscow, his villa in Sardinia and his yacht, the -- what else? -- Russky Standart.

THE TARIKO REVOLUTION IN RUSSIAN BANKING IS on display one Saturday morning at a sprawling outlet of electronics chain M.Video on Moscow’s Garden Ring, the spectacularly misnamed, smog-filled, six-lane road that encircles the city center. At one end of the store, ten wide-screen TVs flash the mantra of the oil-boom times: “Credit! Super Credit! Up to Two Years!” At the other a fresh-faced Russky Standart employee who gives her name as Svetlana is settling in for a 13-hour shift, armed with nothing more than a keyboard, a flat-screen monitor and a smile. She is flanked by four blue-blazered competitors, from Ceská Pojis´tovna’s Home Credit; Rosbank, Russia’s eighth-largest bank, backed by Norilsk Nickel oligarch Vladimir Potanin; Finansbank, a Moscow-based retail specialist; and Renaissance Capital, a lender owned by shareholders of the Moscow investment bank. Home Credit, which opened its Russian business in 2002, claims to have made 3 million point-of-sale loans to date. The others are playing catch-up.

Five lenders offering basically the same product is bound to drive down the price, although it is hard to tell by how much. Levin does not disclose Russky Standart’s average loan rate, saying costs vary by customer, but he acknowledges that rates are dropping fast. The bank’s net interest margin fell by almost 6 percentage points during 2004, to 32.6 percent, Moody’s Naumenko says. Given the bank’s funding costs of 8 to 9 percent, that implies an average interest rate on loans of more than 40 percent, compared with an inflation rate of about 12 percent. The loan calculator on Russky Standart’s Web site (www.bank.rs.ru) last month gave an indicative loan rate of about 33 percent a year -- advertised as 19 percent interest plus 1.9 percent monthly “cashier’s fees.” Sergei Rutkovsky, chief of research at Moscow banking data provider Rating, reckons that Russky Standart’s average lending rate, including a growing volume of lower-rate credit card balances, has fallen to about 25 percent from 60 percent two years ago.

A net interest margin of 16 to 17 percent (assuming an average lending rate of 25 percent and borrowing costs of 8 to 9 percent) would be the envy of most banks around the world. Then again, most banks have better means of assessing credit risk. At Russky Standart loan applicants must supply their income and employment history, but the only facts the bank can verify in 15 minutes are those linked to the passport: date of birth, official residence and criminal history. The scoring model, such as it is, depends on bad loan averages for the borrower’s age group and hometown.

“What has surprised me about our business is how much credit risk can differ in different regions, even those that are geographically close and have similar income levels,” Levin muses. The most treacherous areas, he has found, are Soviet-built factory towns, where trouble for the dominant employer can depress the whole local economy.

“There is a potential danger that the banks do not yet have enough experience evaluating the risks from credit to individuals,” says Vladimir Safronov, a deputy director at the central bank. “But in a stable macroeconomic situation, we evaluate this market as having great potential.”

Russky Standart reported 3.7 percent of its loans as nonperforming at the end of 2004, says Moody’s Naumenko, but that is based on a narrow definition of loans issued within the past four months that are at least 90 days overdue. The real level is much higher, contends Richard Hainsworth, chief executive of Moscow-based bank rating agency RusRating. “But even if the number is 10 percent, the bank is very profitable,” he says. “At 20 percent the whole thing is a pyramid that will collapse when there is a downturn in the economy.” The agency rates the bank as a double-B-minus credit: “stable in the short term.” That’s three notches below MDM Bank’s triple-B-minus.

In a bid to maintain growth, Tariko and Levin have launched a typically aggressive campaign aimed at dominating Russia’s budding credit card market. The two men will use their agreement with American Express to target affluent customers while attacking the mass market by offering MasterCards with credit limits of 50,000 rubles. Levin expects to have 1 million active card users by the end of this year, roughly equal to the number of genuine credit cards extant in Russia.

“Many of our classic credit products are already declining to a minimal margin,” Levin acknowledges, “so we are looking to credit cards to maintain profitability.”

Success is far from guaranteed, though. Russians may not take to revolving credit as readily as they have to point-of-sale loans, which are closer to their traditional experience of borrowing a bit from friends or relations until payday. There are more than 30 million cards outstanding in Russia, but the vast majority are debit cards or employer-issued cards that enable workers to draw their salaries in cash.

“The credit card business will be a big breadwinner, but it will take two to three years to mature,” says Michael Madden, a former AmEx executive who moved to Moscow last year to run Renaissance Capital’s consumer credit effort.

Russky Standart can’t count on competitors’ napping through the takeoff phase in credit cards as they did when Tariko was pioneering point-of-sale credit. GE, which bought Delta Bank in July 2004 for $100 million, is offering a Visa Instant credit card in stores to compete with point-of-sale loans. The card offers a higher credit limit than Russky Standart’s average $400 loan -- generally $500 to $1,000. Chairman Cook says Delta has 300,000 cards of various types in circulation and warns that the bank and its deep-pocketed parent will “accept lower profit than some of the local competition as a way of acquiring customers.”

Sberbank, which maintains a big overall lead in Russian retail banking, is ramping up its own credit card program. The bank asserts that it issued its 10 millionth card this summer, and it is targeting new products at premium market segments: 60,000 cards issued jointly with Aeroflot Russian Airlines, for example, give bonus points for international travelers.

Tariko didn’t get to where he is today by shying away from competition, though. With Russia’s consumers increasingly driving the economy, there may be more than enough business to go around.

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