Mikhail Fridman was late into the oligarch game in the 1990s. One of the original seven “boyars” that flourished under president Boris Yeltsin, Fridman and his Alfa Group empire always amounted to the junior player forced to do more real business than peers, who were all making money out of their state connections.

Alfa Bank was the jewel in his financial-industrial group (FIG), as the business model was then. And it was an iconic bank as unlike the others that largely speculated against hyperinflation, Alfa could say it did real business. The game was easy in those days. Alfa borrowed long and cheap on the international markets with a stream of bonds and lent short and expensive on the home market. Suffice to say that when the 1998 finance crisis hit in Russia, Alfa Bank was the only oligarch-controlled bank to survive in its original form.

Given all of this, it is no wonder that bne IntelliNews' report this week, “Kremlin to buy Alfa Bank from oligarch Fridman”—written by Jason Corcoran reporting on Fridman’s rumoured plans to sell his baby, and probably to either state-owned VTB Bank or Gazprombank—caused a mild storm.

Why would Fridman sell?
The first reaction was that the state and “Putin’s friends” were simply taking over another profitable business.

“Alfa Bank is the biggest & best private bank in Russia. If it is being taken over by a state bank, private banking is over in Russia. Back to the USSR in the form of authoritarian kleptocracy. Very sad. This has been rumoured for some time. Alfa Bank was the family silver,” tweeted Anders Aslund, a fellow at the Atlantic Council and well known Russia commentator.

The state share in the banking sector has increased to some 70% of the assets since the mini-banking crisis last autumn that saw several leading commercial banks collapse.

Promsvyazbank (PSB), Financial Corporation Otkritie and Binbank (aka B&N Bank) were all top commercial banks. And they have all been taken over by state-owned banks or are directly controlled by the Central Bank of Russia (CBR).

But the story is more complicated than some sort of smash and grab by the Kremlin. bne IntelliNews has reported extensively on the saga: the bottom line is that these banks were pumping up their balance sheets, using pension funds under their control. They were a disaster waiting to happen.

The CBR is in the midst of a banking sector clean-up that is coming to its end game as the number of banks in Russia fell below 500 in November. The CBR wants to have fewer banks to supervise (and informally is aiming for a total of 300) whereas the Kremlin has a clear preference to have state-controlled entities leading important sectors, while ensuring in each field that there are at least two companies in direct competition to ensure efficiency. It's a hybrid state/private market model.

Has Alfa Bank been caught up in this bank sector reform? It's hard to say as talks and motives at the Kremlin are so opaque.

Profits for the banking sector as a whole fell to nothing during the “silent crisis” that started at the end of 2014. Net profits for the sector in the fourth quarter of 2014 crashed to a loss of RUB99bn from a very healthy RUB238bn in the third quarter. The return on assets and equity (ROAE) likewise fell from 13.9% to -5.6% in the same two quarters.

For the full year in 2015 the entire banking sector earned a total profit of RUB107bn ($1.65bn). But Sberbank earned nearly all of that by itself. In other words the only profitable bank in Russia was Sberbank. It was earning the entire sector's profits with the rest of the sector effectively treading water to survive.

In the last three years the sector has finally returned to growth and other banks are making money again. In September this year, the aggregate banking sector profit was RUB167bn—in other words the whole sector made as much profit in one month this September as the sector made in all of 2015.

However, despite the recovery, the only really profitable banks in the sector are Sberbank and Russia’s only pure online banking upstart, Tinkoff bank. Both these banks have ROEs in the 20s where as in August (the last data available) the ROE for the sector was 12.4%.

One of Alfa’s problems is that it can no longer fund its lending business with wholesale borrowing from the international capital market because of the 2008 crisis and the imposition of sanctions in 2014. International borrowing has become more expensive and more difficult to do.

On the other side of the equation following almost three years of uninterrupted rate cuts by the CBR, the interest rates on loans have fallen. The current overnight rate is 7.5% whereas the commercial loan rate has fallen to under 10%.

That’s where banks make their money—on the net interest margins (NIMs)—the difference between the cost of borrowing and the income from lending. But factor in the rising competition from aggressive low-cost banks like Tinkoff, and the margins on the banking business are no longer fat.

“We used to earn percentage points on profits in deals. Now we only earn basis points,” Alex Knaster, the former Alfa Bank CEO told me as far back as at the end of the noughties.

Without cheap bonds for funding, banks are forced to tap their deposits to finance their lending. This is a plus as this is much safer than borrowing in foreign currency, but here too the competition means the rates banks have to offer depositors have been driven up, something which also depresses the NIMs.

Finally the rise of the big state-owned banks has been a particular problem as in addition to scooping up millions of Russian depositors, thanks to such banks enjoying the implicit backing of the government, these banks have also scooped up the lion’s share of the big state-owned corporate deposits, which gives them even more money to fund lending. Increasingly the commercial banks are picking up the crumbs left on the table.

Alfa Bank also has Alfa Capital, its investment bank arm. But even this business has been almost driven to oblivion. In the 90s the trading of Russian stocks and bonds was an extremely profitable business. In the noughties the stock market was gaining some 50% in value every year. But following the revolution in financial market reform in 2012, when Russia’s capital market was hooked up to the international clearance and settlement systems of Clearstream and Euroclear, foreign investors no long needed to open up accounts with local investment banks where they were gouged for fees. They could trade Russian assets directly from their desks in London or New York. All the 90s era iconic investment houses—Renaissance Capital, Troika Dialog, Aton—have either been sold or are a shadow of their former selves, Alfa Capital included.

But Fridman is also a ruthless businessman, a fact that his dumpy exterior and jolly manner conceals. And on one of these jazz evenings he made two comments that sum up his attitude to business.

At the time Alfa Bank was riding high. Following the 1998 crisis, Alfa stepped neatly into the top slot as the number one retail bank and was busy rolling out modern retail banking services to cater to the growing middle class.

The bank had always been the most professional of all the lenders and every bank in Moscow was constantly poaching its staff to run their new “real banking business departments” post the 1998 meltdown. The bank was something like the Moscow Times at the time: a training ground for bright but green young people, who went on to become the best in the profession and took up leading roles all over the industry.

During the course of dinner, I idly asked Fridman if he would ever sell Alfa. “Of course!” he immediately replied. “If the price was right. And it would have to be a very good price.”

Fridman is laser-focused on making profits. He famously got his start in business scalping theatre tickets and washing windows. But his first real businesses were involved in trading things like loose tea and art. His Alfa Eko is still around today, but it has become a corporate raider that targets weak companies with debt problems. It takes them over, restructures and sells them on.

Even in the case of the TNK-BP deal which Fridman famously sold to Rosneft for a personal gain of $14bn, the part of that story which is forgotten is that Fridman paid $1bn for his stake in TNK in the 90s. The move was hailed at the time as the first “real” privatisation in Russia where a “real” price was paid for an oil asset. All the other oligarchs got their oil and metals companies for pennies on the dollar during the infamous loans-for-shares deal in 1995-6.

The second comment Fridman made that evening concerned a minor scandal that followed Alfa Bank’s decision to renege on a Canadian export credit deal. I asked Fridman why he had not honoured the debt when the bank had clearly borrowed the money from the Canadians.

“My lawyers said we didn't have to pay so we didn't,” was Fridman’s deadpan reply.

Fridman’s cold and frankly cynical attitude to deals was later displayed in his battle for control of a stake in Megafon with its Scandinavian investors. Alfa simply ran its opponents around the regional courts in Russia until they gave up. It played the same game in a dispute over Kyivstar in Ukraine where the investors also eventually surrendered to their fate.

As Corcoran related in his report, Pytor Aven, Fridman’s number two, takes care of most of the government relations and has been extraordinarily successful at keeping Alfa out of trouble. (The BBQs were often held at Aven’s dacha where he has a terrific collection of Russian expressionist art.) But it is Fridman that is the motor of the organisation.

The final point to note is that Fridman is clearly pulling out of Russia. After he received his $14bn from the TNK-BP deal, president Vladimir Putin pointedly said during a press conference shortly afterwards that “Of course they can spend their money as they like, but I would encourage them to invest it in Russia.”

Fridman ignored this advice point blank. Shortly afterwards he invested $1bn into New York real estate and set up LetterOne (aka L1—a play on the whole “alpha” theme) based in London where he has been looking for new investments in the energy space.

Fridman doesn't do little deals. He doesn't do low margin, long-term in sectors that are in retreat. He is bold and aggressive. From this whole story the most worrying aspect should be that someone of Fridman’s calibre, with such ample capital, would not want to invest into Russia when it has provided him with so much success in the past.