Dmitry Patrushev, Chairman of the Board and CEO of Russian Agricultural Bank, spoke to Vedomosti newspaper

15 September 2014

Dmitry Patrushev, Chairman of the Board and CEO of Russian Agricultural Bank, spoke to Vedomosti newspaper about his work in the sphere of agribusiness, where the Bank will attract funding with markets being closed and why the shareholder does not require high returns from the Bank.

— Among the banks that came under sanctions RusAg is most dependent on debt markets, almost 20% of its funding is attracted in capital markets. How do you plan to substitute this source of funding, taking into account that Asian markets may not live up to our expectations?

— RusAg has a comfortable international debt repayment schedule - most foreign currency debt does not mature until 2017. But you are right in saying that a lot of bond issues are placed in international markets, and the fact that we do not have the opportunity to refinance these issues in the same markets – is not quite comfortable. But there is a way to solve this problem. Prime issuers like RusAg have access to local debt market, where we are present. Partners from China show interest in RusAg as a potential investment target. Another important source of funding is customer deposits. Also we will continue to attract funds from the CBR. According to rough estimates, we can attract up to RUB 200 billion against collateral of our loan book alone. But we will draw down the limit when it is needed. As a last resort, if negative circumstances arise, that could interfere with the accomplishment of our targets set by the shareholder, we do not rule out the possibility of turning to the shareholder for support.

— What amounts did you plan to place in external markets in the coming years under the 2020 Strategy?

— This is not set forth by the plan. We have always been guided by the shareholder targets and market environment. But in view of the general task on import substitution we can confirm that a lot of funds will be needed. About RUB 100 billion, I guess.

— How much will the Bank need as capital contribution?

— Currently the State Program on Agribusiness Development undergoes changes that stipulate an increase in the industry financing. Under the Program we will need about RUB 90 billion of capital contributions till 2020.

— If you were appointed RusAg’s CEO before the start of the State Agribusiness Development Program implementation, would you implement it in the existing form? Would you change the underwriting criteria for companies eligible for subsidies?

— I am not a state official and do not manage the agribusiness sector. The Bank implements a certain strategy that is set forth by the shareholder – the state. At the same time, I absolutely agree that we need certain program and targets to manage this industry. Regarding subsidies, the existing allocation mechanism, in my view, needs correction. The subsidies are allocated by regional authorities, also there is a Commission at the Ministry of Agriculture that authorizes subsidies for investment projects earlier chosen by the banks. This scheme was set up after the 2008 crisis and was justified at that time but today it should be revised. The banks have best knowledge of their borrowers and they understand whether this or that project is viable and when it will pay back. And if the banks that lend to agribusiness were closer involved in subsidies allocation it would ensure comfortable work for the borrowers, the banks, and the industry regulator. We also proposed to allocate subsidies through banks but the final recipients should be agricultural producers. The borrowers have to work on land and not waste their time on bureaucratic procedures.

— Do you think that fast import substitution is feasible, taking into account that agribusiness is the sector with one of the highest level of debt?

— It is not obvious that agribusiness has high debt leverage. In the first place, agribusiness itself is a capital intensive industry. In the second place, in a lot of segments we see a significant need for loans and the respective demand. Third, agribusiness goes through an investment stage. Estimated investment potential of agribusiness till 2020 is above RUB 4 trillion. Larger part of these investments will come in the form of loans. In Russia agribusiness has high import substitution potential, especially in meat, milk, vegetables and fruit. Today, we have a real chance of increasing business, in the first place, by using the existing facilities that have to work at 100% capacity. The key task is to harvest crops, preserve them and be able to deliver foodstuffs to the final consumer. Correspondingly, the most needed projects are that in warehousing and logistics.

— It means that we still do not produce enough, and we cannot preserve what we produce. Is that correct?

— Absolutely. We cannot preserve our production in full, but outputs are high. We cannot deliver it in good quality to the consumer. We do not have enough warehousing facilities. The Bank actively expands its participation in such projects.

What impact has the WTO accession had on creditability of your borrowers and your loan book quality?

— I personally was skeptical about the WTO accession but the most pessimistic forecasts have not come true. Regarding agribusiness, the serious impact was felt by pork, milk and agriculture machinery producers. But timely state support that is allowed by the WTO standards has offset the impact. We have the appropriate tools that have been tested by a lot of countries. More often than not we deal with exaggerated negative sentiments that do not persist for a long time.

— What is the average margin earned on your loan book?

— This is not an objective indicator. It will not give you the right picture.

— This is a rough indication, but still …

— The rate depends on a lot of factors: funding cost, administrative expenses, a borrower’s risk profile, etc. For seasonal field works we extend loans at 11.25% for prime borrowers, further it could be revised depending on the borrower’s risk profile and quality. For investment projects the interest rate starts at 13.5-14% p.a. For milk livestock breeding the Government took a decision to extend subsidized loans for 15 years because the payback period is very long in this segment. And the banks were given a task to think how it could be done. Today, we are ready to finance such projects for a 15 year term. In the near term, we will start financing a number of such projects.

— How have your interest rates changed since the year start?

— The average interest rate on issued corporate loans since the year start grew about 1.5-2% p.a., which is in line with the market.

— What problems did you face when you assumed the CEO’s office? In 2010-2012 there was a lot of news about criminal proceedings against RusAg’s branch heads. How many branch heads did you have to replace because of fraud?

— Since mid-2010 we have significantly tightened control of branch operations. We have drawn up a vertically integrated risk management system which is now centralized in the Head Office. We have changed the underwriting limits for branches and they are closely monitored by the Bank’s Management Board. 85% of regional directors have been replaced since the end of 2010. Criminal cases were opened against 11 of them. Total damage is assessed at RUB 23.5 billion.

— Do all these criminal charges relate to branch operations?

— They are all related to our clients’ operations and only partly – to our employees’ actions at branch level. Out of 1,500 proceedings only 68 were instituted against employees.

— Sberbank was in a similar situation upon which it decided to lower the branch limits many times. By how much did you lower the limits?

— Today, the highest underwriting limit of RUB 300 million is set for the Moscow branch.

— This is a small amount.

— Yes, it is. On average this limit is set at RUB 50 – 100 million across the branch network. The rest is approved through the Head Office. Our measures on risk, internal controls centralization, allowed us to prevent possible damage of about RUB 100 billion, meaning we haven’t issued this amount to potentially problem borrowers.

— Do these borrowers have bad financial profiles or are they fraudulent?

— Both.

— Was this damage caused by the employees’ actions?

— By both - clients’ and employees’ actions at branch level. I’d like to mention that we have set up a working group in cooperation with the General Prosecutor’s Office. We actively use these tools when we have to recover debts from fraudulent borrowers.

— This is harsh.

— All measures we take are legal and we have to recover debts by all means possible. The Bank is not a charity.

— RusAg has about RUB 150 billion of watch list loans on its balance sheet. How did it happen?

— These amounts have been accumulated for years. Problem loans arise due to a number of factors. Borrowers face bad weather, droughts – 3 years running, floods. The policy previously carried out by the Bank that allowed branches to make independent decision on loan approval resulted in a lot of unrecoverable loans in a number of regions. There are large borrowers whose problems are widely known – OGO, SAKhO, Optifood agricultural holdings.

— How many companies does the Bank control as a result of recovery procedures?

— RusAg controls about 36 companies. The key task is to preserve their business. But at the same time we prepare these companies for potential sale to a new investor at any moment. Our aim is to sell non-core assets.

— Have you sold any of these companies?

— In 2013-2014 the Bank closed 71 deals on non-core assets sale.

— What is the amount of debt of these 36 companies?

— More than a half of them do not attract financing for current operations. The rest are financed through working capital replenishment and a small part – for the purpose of production assets upgrade to maintain the investment attractiveness.

— Have you managed to recover anything?

— Starting from 2013 we have recovered RUB 14 billion in cash.

— At the end of 2013 on the Bank’s initiative the issue of the obligatory insurance of crops and livestock with partial state support was discussed.

— I wouldn’t call it our initiative. In Russia, like in the rest of the world, the state seriously supports agrarians. In 2013 alone the financing under the state program amounted to RUB 198 billion. The aim of the support is to increase agricultural production and profitability of businesses. It is highly important that the state investments pay back at a maximum rate. Anywhere in the world agriculture is exposed to climatic and epizootic risks. Crops and livestock insurance is one of the most efficient tools to manage these risks that allows producers to avoid negative impact after occurrence of these events and not to suffer losses from the money invested by the state and agrarians.

— Do you think insurance companies in view of all these risks are ready to cooperate with agribusinesses or it is the exclusive market for RSHB Insurance?

— Some time ago the market lost confidence in agro insurance because of many low-quality players who did not compensate losses. RSHB Insurance is quite efficient, we reach the initially set targets.

— Who are their clients?

— They are our corporate clients, first of all, from agribusiness. Also clients comprise population of small and mid-sized tows, rural areas. Mostly, the same segments as the Bank’s client base.

— When will the company start to increase agro insurance with state support? What market share does it plan to occupy under the 2020 Strategy?

— Today, RSHB Insurance is one of the leaders in the market. As of 1H 2014 we were second with the share of 7.6%. In agro insurance segment with state support we show positive dynamics as well. In 1H 2014, we became sixth with a share of about 5.4%. By 2020 the company plans to reach a 14 - 15% market share overall and 13 - 14% in the segment with state support, taking the leadership in both cases.

— RusAg has a significant exposure in its loan book not related to agriculture. Tell me about it.

— Under the adopted strategy the share of loans extended to agribusiness should be 70%. Excessively high concentration on a single industry poses high risks. To mitigate these risks and increase efficiency, we diversify our loan book. Currently the break down is about 80% to 20%.

— And if we split the loan book – what is the margin earned by the main part and the remaining part?

— We make minimum profit from the key segment. The profit comes from the small part of loans not related to agribusiness. Risks are lower there.

— And what industries comprise this part of the loan book? What exposure do you have to real estate, construction, trade, what is the breakdown?

— We have exposure to real estate, construction, trade, metals, energy companies. Almost all industries of the Russian economy. But we do not have a lot of such clients given that our key business segment is agribusiness.

— How much have these non-key business segments grown over recent years?

— Initially, the share of agribusiness exceeded 90%, and we gradually reduced it. However, it is not much welcome on part of the industry regulator.

— But they are not bankers.

— Yes, we have a difficult task – we have to both lend to agribusiness and ensure that the Bank’s operations satisfy the CBR, shareholder and the auditors.

— In this case you have a very interesting task. On the one hand, you have to maintain the Bank and comply with the ratios, and on the other hand, there is a political interest that RusAg services. And it does not matter at all for political interest how much the Bank earns. And you are the person responsible for this. How do you live as a manager in such environment?

— I would like to stress that we do not service anyone’s political interests. We work and accomplish the state task for which the Bank was established. The mission is to finance agribusiness and provide banking products to rural population.

— Have you analyzed other countries’ experience? How do agribusiness banks work there? There are a lot of such banks in Germany.

— Yes, we have. They occupy a large share of lending to agribusiness but have no benchmarks as to what share of loan book should be devoted to agribusiness. They lend to all industries while maintaining a large share of agribusiness exposure.

— How large is it?

— It depends on the bank but not more than 50%. Almost no bank has such a large share of exposure to a single industry.

— Did you try to come to an agreement with the Ministry of Agriculture on reducing the share?

— As I have mentioned, we currently reduce the share of agribusiness but still haven’t reached the threshold specified in the Strategy. Today, our market share in agribusiness lending is 45 - 50%. In seasonal field works financing our share is 70%.

— Are there any differences between loan repayment by agribusiness companies and other industries? Sometimes you have a sharp growth of overdue loans, since your borrowers make a bullet interest repayment upon loan maturity.

— Yes, there is such specifics. Another difference is seasonal factor since the clients have different interest repayment schedules which depend on subsidies allocation. As I’ve mentioned there are fraudulent borrowers and we have special measures for such cases.

— Large companies say that your loans are expensive. Sberbank, Alfa-bank offer more attractive rates. It means that quality borrowers do not need your bank. Do you refuse to work with quality borrowers on purpose?

— I do not have details on borrowers serviced by other banks and will refrain from comparisons. We have well-known companies from various industries among our clients. More often than not we do not compete with smaller banks in agribusiness. We extend investment loans, while they extend working capital financing. So, we work as partners. In current situation, we come across absolutely different opinions. Some say we lend to anyone, some say we have very strict underwriting criteria. But our client base is growing and the clients opt for our bank. Recently against the backdrop of markets closure we saw a significant growth of applications from large companies who are mostly guided by the interest rate level when choosing a bank.

— Moody’s report said that loans more than 90 days overdue and restructured loans comprise 23% of your loan book. The coverage ratio is only 36% and it has declined since 2008. If you create loan provisions at the level Moody’s sees as appropriate your Tier I capital ratio will decrease twice. Proceeding from your reporting the Bank’s profits are directed to provisions in full, with a fraction left to be in the black at least on paper. Your returns on equity and profits are zero.

— The shareholder does not require that we maximize profits. Our key task is to finance agribusiness and population of rural areas, where, I’ll remind you, live about 30% of the Russian people. Speaking about loan provisions, there are no questions on part of the CBR in this respect.

— How much profit do you have to make not to take contributions from the shareholder and the budget?

—In 2012-2013 we received about RUB 30-40 billion annually as capital contributions from the shareholder. This is the level of profit we have to generate to cover our clients’ loan demand at the acceptable interest rate and to comply with the state program targets.

— And why doesn’t the shareholder want you to make profit? Certain allowances are possible to preserve budgetary funds?

— In any country agribusiness needs state support. The shareholder supports the industry rather than the Bank. There are certain tasks set by the National Food Security Doctrine. To satisfy all the criteria set forth in this doctrine we have to increase internal production. Today, each rouble contributed to RusAg’s capital by the state is multiplied by around 9 roubles attracted from investors and allocated for agribusiness development. And this is a serious indicator confirming the efficiency of the Bank itself and state investments.

— And where do 9 roubles come from?

— We take them from the market, investors.

— Will this correlation change given the markets are closed?

— It may change, we earlier spoke on how to substitute the part of liabilities that are not available now, from international investors.

— Do you consider asking for support from the National Welfare Fund?

— If such need arises, we will turn to our shareholder for support.

— Do you believe that we will see progress with import substitution? Currently, neither you nor I as a consumer notice that we have more local products. The Bank has worked for more than 10 years now. What kind of impact has its work had on the situation? Does this effect translate to figures?

— The Bank has turned 14 years in June. I am sure the import substitution is underway. But in Moscow I agree there is a feeling that most foodstuffs come from abroad. In food stores outside Moscow we can find a lot of local foodstuffs. Local products are better than a lot of international substitutes.

— But currently we have certain products imported from such places where meat is most probably better quality than local products.

— In certain cases we have to use imported foodstuffs. Yes, we do not have enough locally produced beef. But there are investment projects in this segment and we have such projects on the balance sheet. I visited the Lipetsk Region recently and also a premium beef production facility. So I believe that in the near future we will reach the required outputs in this sub-segment as well.

— How much in contributions on part of the shareholder will you need for loan loss provisions to cover the non-performing loans?

— The RUB 90 billion that are proposed under the State Program for our recapitalization till 2020 should be enough to solve the tasks of agribusiness financing and partly solve the problems on our balance sheet.

— Judging by the Bank’s IFRS reporting it’s not enough to cover problem loans of RUB 150 billion.

— We asked for RUB 110 billion, the Ministry of Agriculture considered providing RUB 77 billion. The government currently discusses RUB 90 billion. I’d like to reiterate that if the decision is taken we will be able to settle our problems partially.

— Judging by the capital replenishment in recent years, these amounts will not suffice until 2020.

— RUB 90 billion is the amount proposed to be allocated under the State Program on Agribusiness Development. To support faster import substitution we will need funding of RUB 100 billion.

— RUB 100 billion in funding… Where do you plan to attract this amount and at what price?

— RusAg will grow its customer accounts, focusing on their diversification. Also we plan to tap Asian markets, since there we can attract the funding for maturities needed for us.

— Why is the decision on the Bank’s transformation to a development institution postponed?

— Our shareholder acknowledged it is not worthwhile, first of all, in view of the budget expenditures. Besides, in current geopolitical and macroeconomic tensions the reorganization of a systemic bank poses high risks for the industry further development.

— You were appointed RusAg’s CEO in May 2010, over 4 year ago. In what areas has the progress been achieved?

— It is not for me to say what has been successful and what not. We take decisions on investments in specific projects. Often, when we take decisions to invest in green field projects, time passes and they turn into European level production facilities. We have taken decisions on a lot of projects during 4 years. They allow to create jobs, infrastructure, increase living standards. These are right measures of success. A banker’s achievements are the success of his clients.

The full version of the interview is available in Russian at http://www.vedomosti.ru/library/news/33390351/vzaimodejstvie-s-pravoohranitelyami-ochen-poleznaya-vesch