"analysis of sberbank's proposal to issue new shares"

HERMITAGE CAPITAL MANAGEMENT

Analysis of Sberbank’s proposal to issue new shares

by William F. BrowderManaging Director,

Hermitage Capital Management

January 2001

HERMITAGE CAPITAL MANAGEMENTBackground

� On December 28, 2000 Andrei Kazmin CEO of Sberbank sought approval of the Board of Sberbank to increase capital by 36% in order to raise $130 mln;

� The move came abruptly and unexpectedly;� The following presentation analyzes this proposal to

determine the merit of the proposal.

HERMITAGE CAPITAL MANAGEMENTWho owns Sberbank?

Central Bank58%

Investment Companies21%

Other legal entities9%

380,000 individual shareholders

12%

HERMITAGE CAPITAL MANAGEMENTProposed Capital Increase

-

5

10

15

20

Num

ber

of S

hare

s

Central Bank57.7%

18.8%

Others 9%

Investment companies 21.4%

Central Bank50%+1 share

Investment companies 15.8%

380,000individuals 11.9%

380,000individuals 8.8%

Others 6.7%

36% capital raise

14,002,000

19,000,000

4,998,000 New shares will be sold for appox.$135,000,000

[1,426,448 will be purchased by Central Bank to sustain 50%+1]

[3,571,552 will be sold elsewhere]


Why does Sberbank Management want to issue equity?

� We don’t know for sure;� But they have given two explanations:

– Because there are shares already authorized by shareholders approval in 1997;

– To improve Capital Adequacy.

HERMITAGE CAPITAL MANAGEMENTDo their arguments make sense?

NO:� The share price way too low to issue shares without

harming investors;� The proposed new issue does not substantially improve

capital adequacy;� ..as a result shareholders could face the same choice

shortly (6-8 months);� If improving Capital Adequacy is the goal, there are

more effective means of doing this.


0

50

100

150

200

250

300

350

400

Jan-

97

Mar

-97

May

-97

Jul-

97

Sep

-97

Nov

-97

Jan-

98

Mar

-98

May

-98

Jul-

98

Sep

-98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-

99

Sep

-99

Nov

-99

Jan-

00

Mar

-00

May

-00

Jul-

00

Sep

-00

Nov

-00

Shar

e pr

ice,

US

D

Shareholders authorize 5,998,000

new shares

Sberbank placed 1,000,000 new shares

to Central Bank

Sberbank decided to

sell 4,998,000

shares

Sberbank faced problems with

capital adequacy ratio

Sberbank share price

The share price is way too low to issue shares and much lower than when the discussion was made to sell shares

The first principal of Corporate Finance is to sell new shares when the price is high

HERMITAGE CAPITAL MANAGEMENTSberbank: Share Price

Sberbank shares are trading at a huge (74%) discount to the Bank’s Book Value

$110/share

$28.75/share

0

20

40

60

80

100

120

Book Value per share as of 1 Dec 2000

Market Value per share

US

D p

er s

hare

- 74% discount to Book Value

For each new dollar raised, that will anly realize $0.26 of new market value


P/B

It is rare for bank to trade at such low values relative to its capital


It is Unheard of for Banks to issue stock below book value, unless a bank is going though some sort of bankruptcy procedure

Bank Date of NewIssue

Price/Bookratio

HERMITAGE CAPITAL MANAGEMENTCapital Adequacy

Sberbank’s Capital ratios were tight early in the year, but are improving with better profitability

10.4%

10.7%

10.2%

10.0%

10%

10%

10%

10%

10%

11%

11%

Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00

Capital adequacy ratio (H1)

Central Bank requirement


Surplus is about $100 mln

$95 mln

$1.45 Bln$1.36 Bln

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

CB capital requirements Own capital as of 1 Dec 2000

Surplus

Bill

ion

US

D

Capital Adequacy


If Capital Adequacy Ratio is the key issue, there are a number of options for improving it

Capital Adequacy

L o w e r i n gA s s e t s

S e l l r i s k yl o a n s t o o t h e r

b a n k s

S e c u r ee x i s t i n g

l o a n s

I n c r e a s i n gC a p i t a l

I s s u e n e ws h a r e s

R e v a l u eu n r e a l i z e d a s s e t s :

r e a l e s t a t e ;b o n d s ;

I m p r o v eP r o f i t

N o td i s t r i b u t ed i v i d e n d s

I m p r o v i n g C a p i t a lA d e q u a c y R a t i o

21 3 4 5 6


Capital Adequacy: 1. Share Issuance

Share Issue at a current market price does not change dramatically the capital adequacy ratio (H1)

0

5

10

15

20

1-Dec-00 After new issue

Bil

lion

US

D

Total Assets = $19.6 bln

Capital $1.45 bln Capital $1.59 bln

10.7% -> 11.7%Issuance Shares dilutes equity with only marginal effect on Capital Adequacy


Capital Adequacy: 2. Revalue unrealized assets

Realizing Market Value of fixed assets can add $494 to the capital

1,386

892

494

0

200

400

600

800

1,000

1,200

1,400

1,600

RAS book value IAS book value Rebalance

Mil

lion

US

D


Capital Adequacy: 2. Revalue unrealized assets

$1.74 Bln

$1.45 Bln

1.30

1.35

1.40

1.45

1.50

1.55

1.60

1.65

1.70

1.75

1.80

Old Capital New Capital

Bill

ion

US

D

10.7% -> 12.5%

Revalue unrealized assets can result in much stronger impact on Capital Adequacy


Capital Adequacy: 3. Improving Profitability

0

200

400

600

800

1,000

1,200

1,400

1,600

Non-interest cost structure (2000E)

Mill

ion

US

D

Wages34%

$1,890

Overheadcosts55%

Others 10%

Possible Actions� Reduce headquarter by 10% => $66 m;


Capital Adequacy: 3. Improving Profitability

� 2000 Net Profit _____________� Cost Savings Low estim� Cost

� Change in Capital at year 2001

Improving Capital Adequacy from 10.7%

X%

Y%


Capital Adequacy: 4. Not distributing dividends

Dividend Policy

Million Rubles Million USD1997 132.0 21.0 1998 315.0 12.5 1999 462.1 16.6

2000E 798.1 27.5

If Sberbank does not pay dividends in 2001, the capitalization will increase by approx. $30 mln


Capital Adequacy: 5. Sell Risky Loans

mln USDTotal Assets 19.54 Loans 8.43 Gov't Bonds 6.08 Cash 3.64 Real Estate 0.76 Others 0.63

Central Bank provisions Loans 100% Gov't Bonds 20% Cash 0% Real Estate 100% Others 100%


Capital Adequacy: 5. Sell Risky Loans

Sberbank could increase Capital Adequacy by:� Realizing 15% of Risky Loans can result in 11%

increase of Capital Adequacy

HERMITAGE CAPITAL MANAGEMENTCapital Adequacy - Summary

L o w e r i n gA s s e t s

S e l l r i s k yl o a n s t o o t h e r

b a n k s

S e c u r ee x i s t i n g

l o a n s

I n c r e a s i n gC a p i t a l

I s s u e n e ws h a r e s

R e v a l u eu n r e a l i z e d a s s e t s :

r e a l e s t a t e ;b o n d s ;

I m p r o v eP r o f i t

N o td i s t r i b u t ed i v i d e n d s

I m p r o v i n g C a p i t a lA d e q u a c y R a t i o

u p f r o m1 0 . 7 % t o

1 1 . 7 %

u p f r o m1 0 . 7 % t o

1 3 . 9 %

u p f r o m1 0 . 7 % t o

1 1 . 3

u p f r o m1 0 . 7 % t o

1 0 . 9

u p f r o m1 0 . 7 % t o

? ? ?

u p f r o m1 0 . 7 % t o

1 1 . 8

21 3 4 5 6

HERMITAGE CAPITAL MANAGEMENTCapital Adequacy - Summary

� Issuing New Shares is a very expensive way to provide only a small increase in Capital;

� Revaluing Assets and cutting Costs are much better ways to improve capital adequacy without diluting shareholders.

HERMITAGE CAPITAL MANAGEMENTSummary - Wider Implications

1) There is an oligarch “waiting in the wings” to buy the major part of new issue and control a crucial and undervalued economic asset;

2) The Management is too “soviet” and does not understand the most basic principals of Corporate finance.

HERMITAGE CAPITAL MANAGEMENTWho made this decision?

Unanimous decision

V i c t o r G e r a s h e n k oC h a i r m a n , C h a i r m a n o f C e n t r a l

B a n k o f R u s s i a

V l a d i m i rG o r y u n o v

D e p u t y C h a i r m a n o fC e n t r a l B a n k o f R u s s i a

A l e x e iK u d r i n

M i n i s t e r o f F i n a n c e

A l l aA l e s h k i n a

D e p u t y C E O o fS b e r b a n k

A n d r e iK a z m i n

C E O o f S b e r b a n k

B e l l aZ l a t k i s

D e p u t y M i n i s t e r o fF i n a n c e

B o r i sF e d o r o v

M i n o r i t yS h a r e h o l d e r s

R e p r e s e n t a t i v e

I l y aS h e r b o v i c h

M i n o r i t yS h a r e h o l d e r s

R e p r e s e n t a t i v e

. . .

HERMITAGE CAPITAL MANAGEMENTSberbank: Share Issuance

How long does it take to breach capital adequacy ratio again?

Will shareholders face the same problem in 6-8 month?

HERMITAGE CAPITAL MANAGEMENTSberbank: Loans Portfolio

Analysis of Loan Book

NN Amount Customer Provision12345678910

HERMITAGE CAPITAL MANAGEMENTSberbank: Retaining Profit

The situation can be resolved by retaining future $280 mln in profit (7.9 bln Rbl)

Current Future

Capital 40.5 retaining 7.9 Bln 48.4

H1 = -------------------- = ------------ = 10.7 ============> ------- = 12.8

Risk Adjusted Assets 378 378


Sberbank: Central Bank regulations

� Central bank increased the low limit for capital adequacy ratio from 8% to 10%;� Algorithm of calculations of Risk Adjusted Assets (RAA) was significantly

changed which resulted in 71% growth of Sberbank RAA.

Sberbank faced problems with capital adequacy ratio (H1) as a result of:

During the same year 2000 Sberbank breached the required limit of Maximum exposure ratio (25%) by three times and received special permission from Central Bank.

Whether it will be cheaper way for Central Bank to issue the same type permission for capital adequacy ratio rather than put additional financing to sustain its position in Sberbank?


Disclaimer

This material is for information purposes only and is not an invitation to subscribe for units or shares in the Hermitage Fund. Subscriptions will only be received and units or shares issued on the basis of the current prospectus for the Fund, and prospective investors should carefully consider the risk warnings and disclosures for the Fund set out therein. Investors should also consider any other factors that may be relevant to their circumstances, including tax considerations, before making an investment.

The information is based on data obtained from publicly available sources, which have not been verified by Hermitage Capital Management Limited, or any of its respective associates or affiliates. As a result of the difficulty in obtaining reliable data in Russia, we do not represent this information to be accurate and complete and we do not accept any responsibility for the reasonableness of any conclusions based upon such information.

Past performance is not necessarily indicative of the likely future performance of an investment. The price of units or shares can go down as well as up and may be affected by changes in rates of exchange.

The Hermitage Fund has been authorised by the Guernsey Financial Services Commission as a Class B Collective Investment Scheme under the Protection of Investors (Bailiwick of Guernsey) Law 1987 and the Collective Investment Schemes (Class B) Rules 1990. It must be understood that in giving this authorisation the Commission does not vouch for the financial soundness or correctness of any of the statements made or opinions expressed with regard to The Hermitage Fund. Investors in The Hermitage Fund are not eligible for the payment of any compensation under the Collective Investment Schemes (Compensation of Investors) Rules 1998 made under the Law.

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