Vienna dilemma

Herbert Stepic loves the Vienna Opera Ball. “I don’t do much dancing, but I do a lot of deal making,” says the garrulous 56-year-old vice chairman of Raiffeisen Zentralbank Österreich. “Business that normally takes months is concluded in five minutes.

Herbert Stepic loves the Vienna Opera Ball. Held each year on the Thursday before Ash Wednesday, it is one of the grand occasions of the Viennese winter, attracting a glittering cross section of the political, business and cultural elite of Europe and the world. But Stepic doesn,t show up at the elegant, flower-bedecked Vienna State Opera, an Italianate landmark on the city’s opulent Ringstrasse, for the waltzes, polonaises and quadrilles.

“I don’t do much dancing, but I do a lot of deal making,” says the garrulous 56-year-old vice chairman of Raiffeisen Zentralbank Österreich, the Austrian bank known as RZB. “Business that normally takes months is concluded in five minutes. Everywhere you turn, you bump into a captain of industry or a senior politician.”

Last year Stepic nailed down a $4 million financing for a Russian meat plant. This year, in a whirl to rival any waltzer,s, he agreed to extend a long-term loan to a Ukrainian coal mine, to finance three Saudi Arabian water purification plants for a total of E135 million ($119 million) and to lend up to E25 million to a Hungarian window manufacturer.

But one deal continues to elude Stepic: the sale of a 49 percent stake in RZB’s Eastern European banking network for an anticipated E1.1 billion. And the success of his multinational strategy , the boldest gambit of a distinguished banking career , is riding on the deal.

A Viennese native, Stepic began building RZB’s Eastern European business in the 1980s, before the Iron Curtain fell and before most Western bankers had set their sights on the countries of the former Soviet bloc. Today he exercises near-total management control over the most extensive retail banking network in that region and the crown jewel of its parent, Austria’s cooperatively owned, E98 billion-in-assets Raiffeisen Banking Group. Stepic’s 503-branch, 11-country Eastern European network has recorded profits for 15 years running. According to RZB’s preliminary 2001 earnings report, that business accounted for about 58 percent of the bank’s pretax profit of E218 million. Its 23 percent return on equity made it the most profitable bank in Eastern Europe.

“Both our Eastern European operations and RZB as a whole will produce record earnings again this year,” boasts Stepic.

Sponsored

But the qualities and strengths that got RZB to this point , the institution’s relatively small size, a cooperative ownership structure that doesn,t demand the shareholder returns of publicly held banks and Stepic’s ability to establish toeholds in emerging markets ahead of larger and slower-moving rivals , are no longer sufficient to sustain growth. RZB blazed a trail into countries like Hungary, Poland and Slovakia with Western-style customer service and back-office efficiencies. But as such emerging economies matured, reformed their banking systems and opened up to foreign investment, the competition has gotten much more pitched. Well-heeled commercial banking rivals like France’s Société Générale, Italy’s Unicredito Italiano and Belgium’s KBC Bank are leapfrogging ahead with expensive acquisitions, often of newly privatized, if struggling, banks throughout the region.

RZB maintains the most widespread branch network in the East. Since entering Hungary in 1997, the bank has set up shop in Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Poland, Romania, Russia, Slovakia, Ukraine and Yugoslavia, and it expects to complete an acquisition this month in Slovenia. But as competition grows, its costs are rising, its margins are narrowing, and its market share is slipping. In 1997, when only 20 percent of Eastern Europe’s banking assets were controlled by foreigners, RZB ranked fourth among Western banks in the region, with E2.9 billion in total assets, according to a study by Germany’s HVB Group, one of RZB’s toughest competitors. Today, with Western banks accounting for 53 percent of Eastern European assets, RZB’s assets have nearly quadrupled, to E11.5 billion, but the bank has dropped a few places in the ranking.

Faced with this turnabout, Stepic and his colleagues concluded that they risked marginalization if RZB didn,t accelerate its growth. To do that they needed greater financial clout. RZB,s parent agreed to add some E363 million in capital, but it lacked the deep pockets to invest more. “We face no fiscal problems, but banking is becoming more expensive, and at a certain point we will need new capital,” explains Jeffrey Millikan, the American-born CEO of Raiffeisen Bank Polska, RZB’s 45-branch Polish subsidiary.

RZB’s solution was to reorganize Stepic’s Eastern European operations in a newly created subsidiary called Raiffeisen International Beteiligungs and sell 49 percent of the unit. RZB,s timing was unfortunate, however. It put the stake on the block in the first quarter of 2001, hoping to make a sale , perhaps distributing shares among several parties , by year-end. But the global economic slowdown and a growing sense of caution among international banks in the wake of the September 11 terrorist attacks and Argentina’s economic crisis put those plans on hold.

“Because we don,t need money right away, we are being more particular than if we were desperately trying to meet capital requirements,” says RZB’s Millikan. “We think that if an investor comes forward and looks close to signing, a lot of the banks we,ve been talking to will also come out of the woodwork.”

How wishful such thinking may be remains to be seen. European banks that are underrepresented in the East are the most likely bidders. And several have held at least informal talks over the past year with RZB, including the Netherlands, Rabobank Group, France’s Crédit Agricole, Italy’s San Paolo IMI and Spain’s Banco Bilbao Vizcaya Argentaria. Of these Crédit Agricole , which like Rabobank shares RZB’s roots in the European cooperative banking movement started by 19th-century German social reformer Friedrich Wilhelm Raiffeisen , seems to some observers the best fit. The world’s sixth-biggest banking group, with E563.3 billion in assets, Crédit Agricole has taken minority stakes in several major European banks and has sizable holdings in Poland, a key part of RZB,s network. But only Rabobank publicly confirms its interest. “Cooperation interests us, but if that means buying a stake in their network, that is something that needs to be further negotiated,” says a Rabobank spokesman.

Banking rivals think RZB will be pressed to cut a deal , or risk watching its Eastern empire deteriorate. “Stepic has always been the first one into the countries of Eastern Europe, and he has done an amazing job building up a profitable and wide-ranging network with little money,” says one fierce competitor. “But now he has got to expand quickly while competitors like us restructure the basket cases we,ve purchased. If he doesn,t find the money soon, in three or four years he won,t be able to stay a front-line bank when it comes to gathering retail funds or making loans.”

Stepic isn,t one to panic. When losses on Russian government securities nearly wiped out his Moscow operation after the 1998 currency crisis, Stepic wasn,t tempted to leave the country, as many foreign bankers did. He calmly recapitalized the bank and plowed more money in: He wasn,t about to walk away from one of the key links in his Eastern European chain (see box below).

He approaches his current hunt for additional capital with the same patient assurance. “We have no immediate need for cash,” Stepic asserts. “However, partnering with one or several big European banks that are looking to get into Eastern Europe would allow us to increase our business servicing international clientele. We don,t just want to serve customers in the local countries. We also want to increase our regional cross-border business.”

Profits don,t have quite the same meaning to Raiffeisen Banking Group as they do to a conventional multinational bank , a cultural matter that colors the cooperative organization’s approach to market and growth opportunities.

The bank was founded 116 years ago by members of the Raiffeisen movement, which held that hard-pressed farmers, artisans and other workers who were largely ignored by the banking system should pool their savings to make loans available to one another. Today the institution is the largest domestically owned banking group in Austria, with a 24.7 percent share of deposits and 21.4 percent of the loan market. It controls the country’s largest asset manager, the E16.3 billion-in-assets Raiffeisen Kapitalanlage-Gesellschaft, and its biggest life insurer, Uniqa Versicherungen. It has 1,737 branches that are part of 637 local banks, which are owned by 1.7 million customers. The local banks in turn own nine regional banks, known as Raiffeisenlandesbanken. The managing directors of the Raiffeisenlandesbanken answer in theory to their cooperative shareholders, but in reality, as day-to-day liquidity suppliers to the local banks, they wield considerable power and are known collectively as “the kings.” It is they who sit on the board of Raiffeisen Zentralbank , RZB , which was founded in 1927 to act as the treasury, investment banking and corporate banking arm of the group.

At cooperative banks, loans to valued clients are of greater concern than bottom-line profits. Ludwig Scharinger, the chief executive of Raiffeisenlandesbank Oberösterreich, one of the nine regional units, was heard to brag recently that he knew he was doing a good job because he hadn,t made a profit last year.

RZB executives talk a very different game. “Our mission is and always has been different from that of our shareholders,” says chairman Walter Rothensteiner. “Even if our shareholders are not necessarily profit-oriented, we are, since our job is to fund them.” The relationship works out well for the landesbanken: They collect a 10 to 12 percent annual dividend from RZB.

Besides operating the Eastern European banking network, RZB is also one of the biggest market makers in Austrian stocks, accounting for 15 percent of turnover on the Wiener Börse, and it is the second-biggest lender to Austrian corporations. RZB’s home market, however, is tiny, with only 8 million people, and it is overbanked, with 1,300 customers per bank branch. As a result, RZB has traditionally earned a meager return on equity , estimated at less than 5 percent last year , from domestic operations. That,s why the bank was open to Stepic’s ambitious plan for Eastern Europe.

By 1987, when RZB became the first Western bank to open a branch in Hungary, Stepic had already made a name for himself by pushing the bank into emerging markets and starting a hugely profitable trade finance operation. The Vienna-born Stepic had brought into his business career a wanderlust inherited from his father, a textile merchant who encouraged his son to travel and to seek opportunities in faraway countries. After earning a Ph.D. in economics and business administration from the University of Vienna in 1972, Stepic sought to satisfy his passion for travel by joining RZB as the head of its then-small trade finance department. He helped Austrian manufacturers develop trade with China and was one of the first Western bankers to start financing countertrade with Iran following the 1979 revolution. He also did business throughout Latin America and Africa. Today his spacious office overlooking Vienna’s historic center is filled with mementos from his travels , Persian carpets and tapestries, Indian screens and pre-Columbian and African sculptures. Those interests paid off. “Because most people are afraid of emerging markets, you can capture market share there much more quickly than you can in developed markets,” says Stepic. “That means your time and your penny invested give double, triple or four times the results compared with the West.”

Regarded within RZB as a banker with a golden touch, Stepic was promoted to the board in 1987 and given free rein to go after Eastern Europe. The region had trade, cultural and political ties with Vienna that dated back to the Austro-Hungarian Empire and survived the Cold War, when Austria maintained political neutrality.

At first, the bank’s only physical presence in the region was in Hungary, where subsidiary Unicbank served corporate clients from one floor in a Budapest office building. But with the fall of the Berlin Wall, expansion accelerated. Beginning in 1991 Stepic opened a bank in a new country roughly every year and a half. RZB was invariably the first or second Western bank in each market, and until the late 1990s, when other Western banks started moving in, RZB enjoyed annual returns on equity exceeding 35 percent.

That was a worthy reward for Stepic’s multiple firsts: After his pioneering ventures in the Czech Republic, Poland and Slovakia in the early 1990s, he became the first Western banker to open in Bosnia and Herzegovina in 2000 and in post-Milosevic Yugoslavia last year. “RZB is much more adventurous than other banks in what are perceived as difficult countries, and that translated into a major advantage for the bank,” says Kurt Geiger, financial institutions group director at the London-based European Bank for Reconstruction and Development, which has cooperated extensively with RZB on loans in the region (see box, page 41).

Stepic’s preferred modus operandi was to start banking operations de novo in each target country. In the early days little was for sale, and what was was antiquated and overpriced. Once on the ground RZB pulled in retail customers, largely by automating back offices, introducing ATMs and providing higher-quality service than competitors. Even banks in more developed markets like the Czech Republic, Hungary and Poland often lacked central customer databases and communications networks linking all of their branches. But clients at Raiffeisen banks in Eastern Europe could count on quick, reliable service from young staff who have been extensively trained on RZB’s systems. Over time, as the markets matured, RZB began making consumer loans. Today the banks offer mortgages, car loans, credit cards, savings accounts and checking accounts, as well as mutual funds and insurance products from other companies owned by RZB.

On the commercial side RZB initially financed trade deals, then stepped up to larger corporate loans for international and local companies. Margins were handsome because the countries tended to be underbanked and competition was limited , at least until recently. “In Eastern Europe people generally are happy just to have a well-run bank and don,t discuss margins. You can make a lot of money there,” notes RZB chairman Rothensteiner.

RZB stressed , and customers noticed , its ability to quickly approve loans, largely because it pushed decision making down to the local level. Other foreign banks moving into Eastern Europe tended to impose complicated reporting structures, with decision making heavily controlled by their home offices. RZB sets risk policies centrally and keeps track of performance through technology, but it leaves most credit decisions to local bankers. The Austrian bank also pursues low-risk, fee-generating transactional businesses, such as payroll and international payment services.

Never satisfied to be a mere niche player, Stepic has successfully established RZB as one of the top five foreign banks in Croatia, Romania, Russia, Slovakia, Ukraine and Yugoslavia. But there have been signs of slippage elsewhere: Since the mid-1990s RZB has fallen out of the top five in the Czech Republic, Hungary and Poland.

In Poland, the most competitive Eastern European banking market, RZB has had to rein in its ambitions to be a universal bank that offers a full range of corporate loans and retail financial services. Having rejected a number of merger opportunities as too expensive, RZB is concentrating instead on loans for small and midsize corporations and retail banking for high-net-worth individuals , still highly profitable in Poland. Even though the country is likely to see GDP growth of only 1 percent this year, RZB is forecasting that loans for small and midsize companies will grow 20 percent. But with intensified competition, margins have already shrunk to Western European standards.

“I,m sure Stepic wishes we were further along in our development than we are, but the priority for us at the end of the day is profit, not market share,” says Millikan.

With competition heating up, Stepic no longer has the luxury to dictate the pace and price of expansion. Other banks are moving into his territory through acquisitions, and RZB, which long preferred the “green-field” method of starting in new markets from scratch, has had to respond in kind.

But Stepic considers himself far choosier than newer entrants like Citigroup, HVB, KBC, Société Générale and Unicredito. Stepic has acquired selectively, spending less than two times book value for banks with clean balance sheets; his rivals have spent between 2.5 and six times book value for big banks that were often poorly run and losing money. “Western banks are now throwing money at these countries at rates which do not reflect the right premium, and they are completely disturbing those markets and their development,” complains Stepic.

In July 2000 RZB paid about E14.5 million, or 1.9 times book value, for Sarajevo-based Market Banka, Bosnia and Herzegovina,s most profitable bank, with a return on equity of 18.5 percent. With only 3.9 million people and a United Nations peacekeeping force on the ground, Bosnia and Herzegovina is clearly a fringe market, and Market Banka was tiny by regional standards, with only about E72 million in assets and six branches. Yet in a measure of how competitive the region has become, Stepic explains, “we decided acquiring was the only way to build a presence in Bosnia and Herzegovina, because it would have taken too much time to build it up from scratch.”

In July 2001 RZB added a smaller but also profitable bank in Bosnia and Herzegovina, Hrvatska Postanska Banka, for less that 2 times book value, or E6.6 million. With roughly 20 branches in the Serbian, Croatian and Bosnian Muslim sections of the country, RZB is now the largest bank in Bosnia and Herzegovina and the only one in all three ethnic enclaves.

Stepic has another relatively small deal pending at 1.8 times book: the E36 million purchase of Krekova Banka, Slovenia,s ninth-largest bank, with 14 branches and E350 million in assets.

One previous acquisition , RZB’s biggest , underscores how different the challenges Stepic faces today are from those of the green-field era. Last July RZB bought Banca Agricola, Romania,s third-largest bank, with 225 branches. The price was $15 million, plus $37 million in new capital. The bank, which had gone into receivership in 1999, had its bad debts wiped clean as part of the deal with RZB, leaving E387 million in assets currently on its books.

Agricola came cheap and has a relatively clean slate, but RZB has a “massive effort in front of it,” acknowledges Heinz Wiedner, the RZB executive in charge of the restructuring. “We will spend two to three years and two to three times the purchase price refurbishing and rebranding, and retraining Agricola’s 3,600 employees branch by branch, product by product and person by person in credit and risk evaluation, as well as in what it means to be customer-oriented.”

To keep up with the competition, RZB will have to make more such investments throughout Eastern Europe. And the cost of doing so is mounting. RZB’s assets in the region rose 46 percent last year, to E11.5 billion, but its staff more than doubled to 11,271. Stepic expects to spend E200 million to E300 million this year on employee training, information systems and the largest retail and corporate marketing campaign in RZB’s Eastern European history.

His big hope is that similar economic realities will hit home with competitors and return some sanity to the acquisition market. That, he thinks, might even open up some new doors for RZB.

“It’s going to be very hard to make money in Eastern Europe if you are paying more than two times book value,” says Stepic. “As banks come to realize this, it could be that one or another will fade out, making their Eastern European operations an attractive acquisition target.”

Unfortunately, Stepic can,t control those market forces, just as he can,t wave a magic wand to raise the capital he so desperately desires to stay competitive. Nor will he be able to fall back on the Raiffeisen Banking Group, which, after adding E218 million in capital in November 2000 and committing to hand over a further E145 million this year, has made clear that there will be no further contributions.

That leaves the 49 percent sell-off as his only real option, and he is unabashedly flogging it. “Our network is ideal if you want to offer your clients regional banking services but don,t want the headache or expense of trying to build something yourself through costly acquisitions of questionable banks,” says Stepic.

It may not be just the economy that is standing in the way of a deal. Investors are put off by the lack of control afforded by the proposed minority stake and by the unusual cooperative structure of RZB’s parent. “Even if RZB operates according to a profit principle, who wants to invest in a venture controlled by a group whose priority is something else entirely?” one banker asks.

Stepic won,t comment on any potential buyers, though he says he has been talking to at least five. None of the candidates attended this year’s Opera Ball in Vienna, he says, but he doubts that would have made a difference. “This is a complicated and important deal,” allows Stepic, who hopes to have a deal inked by the first quarter of next year. “It’s really not the kind of thing that normally gets settled at a ball.”

The EBRD-RZB waltz

Back in 1991, when the European Bank for Reconstruction and Development was drafting its policies and procedures for loans in Eastern Europe, it turned to Viennese native Herbert Stepic for help. EBRD officials knew Stepic, vice chairman of Austrian cooperative bank Raiffeisen Zentralbank Österreich, to be one of the few Western bankers with detailed knowledge of the region, and they welcomed his counsel in identifying opportunities and setting priorities.

“His bank was one of the few that were very active in the region,” says Kurt Geiger, financial institutions group director at the London-based development bank. “Over the years Stepic has helped us pioneer new markets.”

The relationship has been mutually beneficial, leading to new business for RZB and helping to spread its influence well beyond what might be expected of a bank with E11.5 billion ($10.1 billion) in assets. Indeed, except for HVB Group, which includes the recently merged Bank Austria and Germany’s Bayerische Hypo- und Vereinsbank, RZB has been the biggest participant in the EBRD co-financing program. More than 130 banks take part in that program, jointly funding loans in virtually every business sector , telecommunications and agribusiness are the biggest EBRD beneficiaries , to stimulate free-market development in Eastern Europe.

The banks in EBRD co-financings get preferred-creditor status, meaning they get paid ahead of other lenders in cases of default. But the banks also bring along sophisticated risk management systems that tend to minimize losses. RZB says that its corporate loan default rates in Eastern Europe are between 0.5 and 1 percent , about the same as in Western Europe, but with profit margins as much as three to four times better.

“The great thing about RZB is that they,ve positioned themselves as a local bank using Western banking techniques and technology,” says Ilaria Benucci, a senior banker in the EBRD’s financial institutions group.

The EBRD first worked with RZB in 1993, when it helped convince the Austrian bank’s state-controlled partners in Slovakia’s Tatra Banka to sell out to RZB. Two years later Tatra Banka won EBRD,s first subordinated credit for Eastern Europe, Dm25 million ($11.2 million) earmarked for corporate loans.

The EBRD and RZB have since made eight joint corporate or project finance loans totaling E160 million in five countries. Now the EBRD is in the process of providing Stepic’s operation more than E250 million in medium- and long-term financing, which RZB in turn will on-lend to small and midsize corporations throughout Eastern Europe.

RZB’s development lending program is a significant breakthrough for markets like Bosnia and Herzegovina, Romania, Russia, Ukraine and Yugoslavia, says Herbert Maier, the executive responsible for the bank’s relationships with supranational institutions like the EBRD. “This allows us to be among the first local lenders to smaller companies in these countries,” explains Maier. “In addition to establishing beachheads, the EBRD connection is also a marketing advantage both for ourselves and our clients.”

Embracing the Russian bear

For foreign banks operating in Russia, the currency crisis of 1998 was a moment of truth. Devastated by the government’s defaults on short-term securities known as GKOs, the banks had to quickly replenish their capital accounts , or lose their licenses.

A few banks, among them Bank of America Corp., pulled out. Most of those that chose to remain put in only the minimum capital required , but not Austrian-owned Raiffeisen Zentralbank Österreich.

Underscoring Russia’s importance in its Eastern European banking strategy, Vienna-based RZB was the first of the foreign banks to deposit new funds with the Russian central bank. The sum , E150 million ($132 million) , was E20 million more than RZB had lost in GKOs.

“That showed our commitment to the market and gave us huge prestige,” recalls Jeffrey Millikan, then an RZB executive in Moscow and now CEO of its Polish subsidiary.

The payoff? RZB’s ZAO Raiffeisenbank Austria, with $811 million in assets and six branches, today ranks as the third-largest foreign bank in Russia, trailing affiliates of Germany’s HVB Group ($2.4 billion) and New York,based Citigroup ($1.3 billion). And given Russia’s economic progress , it is running a trade surplus and balancing its budget, GDP is expected to grow 4 percent this year, and corporate earnings should rise 10 percent to 13 percent , the country has become fertile banking territory. The RZB unit says that it increased operating profit last year at least 45 percent, to E48 million, while assets grew 78 percent and corporate loan volume 100 percent.

“RZB made a commitment to be a major bank in Eastern Europe: It didn,t walk away when it got hit by losses, and that left it in a stronger position to take advantage of opportunities missed by other banks,” says Richard Spikerman, a director of Moscow-based MDM Bank, a $1.5 billion-in-assets Russian institution that has received financing from RZB. (In November RZB led a $13 million syndicated loan to MDM, the first uncollateralized loan to a Russian bank since the ruble crisis.)

Back in 1998 RZB’s Russian recapitalization was a leap of faith. Although the Austrian cooperative bank had established a presence in Russia in 1996, it did not yet have a full banking license. But vice chairman Herbert Stepic’s plan all along was to build from scratch what he calls a green-field operation, rather than acquiring existing banks. Buying, he says, means having to “spend ages training employees to be more client-oriented. You can be profitable much more quickly if you select the people yourself and get fresh blood from the universities.”

Stepic shrugs off the GKO losses as nothing more than “bad timing.” Says he: “We were in the midst of founding our bank. The license was not in place, and we had to employ our funds somewhere.”

He adds that the Russian loss marked the sole instance when virtually all of the cash of an RZB Eastern European affiliate was exposed in a proprietary trade. “The general rule is that 90 percent of our business is customer-driven,” he explains.

Despite the setback, Stepic saw a market with even more opportunity than before , and not necessarily with more risk, so long as he could pick and choose his businesses, which are largely trade and transaction related. Today RZB is the primary foreign lender to seven of the country’s biggest oil companies. The bank also has gained a significant share of low-risk transactional services, accounting for 10 percent of foreign exchange and 15 percent of money market transactions in the country.

The RZB unit is also the largest foreign bank in consumer deposits, with $153 million. Its other retail services include mortgage lending, consumer lending, car leasing and credit cards.

“Stepic is a steely-eyed arbitrageur who seizes opportunity,” says a rival Austrian banker. “While other banks licked their wounds and retreated after Russia’s meltdown, Stepic moved in aggressively because Russia was even more underbanked than before.”

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