Iowa native Justin Bruch marveled at the opportunity when Morgan Stanley called in late 2007 to recruit him for an unusual assignment.
The New York bank — flush with $7.5 billion in fiscal 2006 profit, the biggest in its history — was going to be farming 11 parcels on the steppes of Ukraine. The commodities team wanted Bruch, who had been farming all his life, to manage one of them.
Bruch saw a chance to dig into some famous dirt. The former Soviet republic has 30 percent of the world’s black soil, earth so fertile that Adolf Hitler had Nazi troops cart some back to Germany during World War II. Wheat, corn, rapeseed and sunflowers thrive there.
“It’s like the prairie land that was broken in the Midwest 100 years ago,” says Bruch, 34, who grew up on his family’s 2,500-acre corn and soybean farm. “The soil and potential for crops that Ukraine has is the best in the world.”
Morgan Stanley was primed for the investment. It was then the second-largest U.S. securities firm by market value, after Goldman Sachs, and chief executive John Mack was pushing managers to take more risks.
The year Morgan Stanley called Bruch about running a farm in the Mykolayiv region, near Odessa on the Black Sea, the bank spent $6.5 billion for Crescent Real Estate Equities, which had 54 office buildings, in Dallas, Las Vegas, Miami and elsewhere.
The bank also financed an Atlantic City casino resort after buying the land for it in 2006. The commodities division, which had acquired operators of fuel terminals and oil tankers, recruited for its European agriculture desk, anticipating rising food prices. The increases would spark riots in several countries in 2008.
Enselco, the Morgan Stanley-funded company that owned the Ukrainian farms, bought satellite-guided John Deere tractors to plow the weed-strewn Ukrainian acres and imported mold- preventing grain bags as long as football fields. Bruch picked up enough Russian to joke with his tractor drivers and order a meal.
Things began to fall apart within months. The locals stole fertilizer and insecticide, Bruch says, and he suspected that harvested wheat was disappearing, too. He wound up fighting with tax, immigration, fire and police inspectors and trying to satisfy officials who wanted him to build roads, not just till fields. He left the farm, called Golden Fields, in June 2009 to manage a Ukrainian farm owned by another foreign investor.
“I worked my tail off for a year on that, trying to do a good job, produce a good crop,” Bruch says in a beer garden in Lviv, in western Ukraine, over a meal of spit-roasted pig. “It was pretty stressful and pretty much a headache, so I’m really happy not ever to deal with any of it again.”
Morgan Stanley gave up on farming in Ukraine in July 2009, abandoning the initiative in the middle of a harvest. It bought out its local partner, Aleksandr Mamontenko, and then sold Enselco to an investment firm based in Jersey, in the Channel Islands, at what people familiar with the situation say was a loss. All told, Morgan Stanley put about $30 million into Enselco, in the form of loans, according to Igor Bobrov, who was hired in 2008 to be Enselco’s chief financial officer and later became chief executive. Hugh Fraser, a London-based Morgan Stanley spokesman, says bank officials declined to comment for this story.
Morgan Stanley’s failed gamble in Ukraine is an example of how Wall Street firms, in the last gasp of a debt-fueled bull market, strayed further from their traditional business of advising companies and underwriting stock sales to embrace diverse projects with unfamiliar risks.
By 2007, banks’ investments ranged from casino development to mortgage lending in Russia. That year, the five major U.S. investment banks had only $1 in capital for every $40 of assets, meaning a 3 percent drop in asset value could wipe out a firm, according to a January report by a congressionally appointed panel probing the 2008 credit crisis.
“You don’t buy farms if you’re a brokerage,” says Richard Bove, an analyst who follows Morgan Stanley for Stamford, Conn.-based Rochdale Securities and has covered Wall Street for 30 years. “It’s an example of stretching too hard to make a killing without thinking about the core responsibility.”
After credit and equity markets collapsed in the wake of Lehman Brothers’s failure in September 2008, Morgan Stanley borrowed $107.3 billion from the Federal Reserve, according to data compiled by Bloomberg News and obtained through Freedom of Information Act requests, litigation and an act of Congress. Morgan Stanley also got a $10 billion capital infusion in October as part of a $700 billion government bailout of the industry.
Morgan Stanley’s misadventure in Ukraine points up risks for current-day investors lured by statistics that may seem to paint agriculture as a no-brainer.
Rising wealth is changing the diets of 2.5 billion people in China and India, requiring more grain to feed cattle and pigs just as soil erosion and urbanization are limiting available farmland.
To keep food inflation under control, at least 185 million new acres — twice the area of Germany — will have to be cultivated by 2015, says Philippe de Laperouse of HighQuest Partners, a consulting firm.
Less than 60 million acres was added during the 10 years through 2005, he says. Global food prices surged to record highs in 2008 and again this year, according to a United Nations food index. Prices peaked in February but were still 26 percent higher in August than a year earlier.
Hedge funds, mutual funds, university endowments and other investors with little experience in agriculture are buying farms at an unprecedented pace, pouring at least $13 billion since the end of 2007 into land or funds that involve agriculture, according to London-based research firm Hardman & Co.
“These investments are driven by people who put investments together; they aren’t farmers,” says Howard Buffett, the son of Berkshire Hathaway Chairman Warren Buffett.
Howard Buffett runs a farm in Illinois and is a former director of agricultural behemoths ConAgra Foods and Archer Daniels Midland in addition to sitting on Berkshire’s board. (Warren Buffett is a former member of The Washington Post Co. board of directors, and through Berkshire Hathaway has a substantial minority stake in The Post Co.)
“It’s a very difficult business, and people really underestimate that,” Howard Buffett says.
Some foreign investors have had a tough time in Ukraine, even with the humus-laced black earth — called chernozem in Russian — that once made the region Europe’s breadbasket.
In Ukraine, Morgan Stanley saw a first step into a potential multibillion-dollar agricultural business, according to people with knowledge of the discussions.
Record profits from advising on mergers, underwriting stock offers and selling mortgage-backed securities tied to U.S. housing prices had transformed Wall Street. Banks were opening the throttle on risk-taking.
Mack was hired in 2005 after executive defections and lagging profits weakened his predecessor, Philip Purcell. He wanted managers to emulate New York rival Goldman Sachs and wager more of the firm’s own capital, says Brad Hintz, a former Morgan Stanley treasurer who left the company in 1996 and is now an analyst at Sanford C. Bernstein in New York. Mack set aside $2.5 billion for principal investments and encouraged employees to come to him with ideas.
Mikhail Chernyy, who worked in the bank’s Moscow office, helped propose the investment in Ukraine, according to two people familiar with the creation of Enselco.
Mamontenko, a member of the supervisory board of AKB Finbank in Odessa, says Chernyy called him to suggest a partnership. The company was registered in Kiev, the capital of Ukraine, on Jan. 11, 2007, amid a two-year surge in food prices that peaked in mid-2008. Chernyy, now deputy director of strategy and energy markets at OAO Bashkirenergo, a utility in Russia’s Bashkortostan region, declined to comment.
Mamontenko led a search for suitable property for Enselco, of which he was chief executive. After the Soviet Union was dismantled in 1991, most of Ukraine’s land was given to its people in plots that average three hectares (7.4 acres) and that cannot be sold or used as collateral. Enselco acquired 11 operating farms that leased land from thousands of peasants in the Mykolayiv region, where Bruch was a manager, and in the Khmelnytsky region of western Ukraine. The farms produced wheat, rapeseed and other grains and oilseed.
“I can imagine the visions of sugarplums,” says Bove, the Rochdale analyst. He says the bank may have wanted to grow grain to give its traders in futures markets an edge, as it has in crude oil by chartering tankers.
Bruch, the farmer from Iowa, was finishing an MBA at California State University at Fresno in 2007 when Morgan Stanley called. He had acquired a taste for international farming in Brazil, where he worked with his brother running a 1,250-acre farm in the state of Bahia.
In Ukraine, Bruch says, he was struck by the timelessness of a place where on some plots women still drop seeds by hand behind horse-drawn plows.
“When you come from Iowa, you’re naive,” Bruch says on a rainy afternoon, by a wheat field owned by his current employer, Alpcot Agro, a Stockholm-based farm investment company. He soon learned that the ancient landscape hid a bureaucracy little changed from Soviet days.
The red tape begins with the process of bringing equipment into Ukraine. Most countries require one piece of paper for imports, says Joseph Gooch, an Indiana farm equipment broker. That’s not how it went for Morgan Stanley’s Ukraine operations in 2008.
The equipment included a 500-horsepower John Deere 9620 tractor, a 300-horsepower John Deere 8430 tractor, a self-propelled sprayer and two grain-bagging systems. He says that in Ukraine, importers need a “certificate of quality,” a “certificate of origin,” a packing list and a “pro forma” invoice.
“The communist mentality just hasn’t died,” Gooch says.
On the farm, Bruch faced a rash of thefts.
“It’s mind-boggling what people will steal from you,” he says. “The chemicals don’t go in the sprayer. They go in the back of someone’s Lada and are sold to a neighbor down the road.”
Bruch says he didn’t mind losing a few gallons of insecticide. What concerned him was the wheat that might not grow because he didn’t have enough to cover the last few acres. After the 2008 harvest, his doubts increased. Bruch wondered whether whole truckloads of wheat had been pilfered.
“I would look at a wheat field and know that it was about a 41 / 2-ton field, that I had a good crop,” he says. “Then it comes across the scale at 31 / 4 tons, and I would lie awake at night and wonder was I way off or did that wheat get stolen? I’ll never know.”
Still, yields weren’t bad; some wheat fields came in at 5.2 tons a hectare and some rapeseed fields at three tons a hectare, above the average in Ukraine, Bruch says. The larger concern was the bank’s dispute with its partner, he says.
“I didn’t have the brains to see what a problem that would be,” says Bruch, declining to be more specific.
By 2008, Morgan Stanley was sparring with Mamontenko, according to two people familiar with the situation. Enselco was owned by Venusaur Holdings Ltd., a Cyprus-based firm whose sole shareholder was Mamontenko, according to documents in the Department of the Registrar of Companies in Nicosia. Venusaur pledged 100 percent of the equity in Enselco as collateral to Morgan Stanley, the documents show.
The bank questioned Mamontenko’s decisions, people familiar with the matter say. Enselco bought chemicals from intermediary companies that charged markups and sold crops to middlemen at prices below market levels, according to three of these people, who declined to be quoted by name because they don’t have documents to prove the markups.
Mamontenko says that he wasn’t affiliated with intermediaries and that he coordinated prices with Morgan Stanley officials. He says he had a good relationship with the bank.
During an interview in his Finbank office in Odessa, he says the market panic after Lehman’s September 2008 collapse caused the bank to bow out.
“The biggest problem was the financial crisis,” Mamontenko says. “That spoiled everything. Without that, we’d be farming 200,000 hectares now.”
By the end of the 2008 harvest, Morgan Stanley was cutting its far-flung investments as fast as it had made them. By the end of March 2009, Mack reduced leverage — a measure of how extensively a firm is using borrowed money — to 11 times capital from almost 28 times a year earlier, according to bank figures.
The Ukrainian farms went out the door in July 2009 when Enselco was sold to JadenFinch, a firm that invests on behalf of oil trader Robert Finch and his family. Kernel Holding SA, Ukraine’s largest sunflower oil producer, agreed Sept. 9 to an option to buy Enselco for $52.3 million.
The bank’s shares haven’t recovered. So far this year, the stock has dropped 49 percent through Oct. 4, closing at $14.01 — or less than one-fifth of its $74.13 peak in June 2007.
James Gorman took over as Morgan Stanley’s chief executive in January 2010. Mack, who stayed on as chairman, will end that role Jan. 1, giving Gorman both titles. The bank wrote down all but $40 million of its $1.2 billion investment in a half-built Atlantic City casino last year, another sign it’s getting back to the business of banking.
Bruch is in his element, too. Fishtailing up a muddy track in a red Lada, he points to the wheat and rapeseed fields he is cultivating for Alpcot.
After losing money for three years, the company, which specializes in the black-earth belt of Russia and Ukraine, said Aug. 31 that it had turned its first operating profit in Ukraine.
“I just want to raise the best crops I can for the best value,” Bruch says. “Now I just focus on raising crops.”
The full version of this Bloomberg Markets magazine article appears in the November issue.
Amount of money former Morgan Stanley Chairman John Mack
set aside for principal investments after he started in 2005. Mack wanted managers to emulate New York rival Goldman Sachs and wager more of the firm’s own capital.
How much Morgan Stanley put into Enselco, a company it funded and is said to have sold for a loss in 2009. The company owned Ukranian farms, including one run by Iowa native Justin Bruch.
Bruch ran the farm until June 2009, when things began to fall apart. “I worked my tail off for a year on that, trying to do a good job, produce a good crop,” Bruch says. “It was pretty stressful and pretty much a headache, so I’m really happy not ever to deal with any of it again.”