With central Europe already wrapped up, Erste Bank is having to look for ways to make its mature Czech and Polish markets more productive – and for new clientele, writes Robert Anderson in Prague.

Erste Bank’s dramatic expansion drive from Austria into the rest of the old Hapsburg Empire has now reached maturity. Last year it became the largest financial provider in central Europe in terms of assets, after already leading in terms of customers.

It now has 12 million customers in six countries and €148bn in assets.

Central Europe’s share of group net profits has steadily grown to 68%, with Ceska Sporitelna in the Czech Republic alone representing 41%. But, as acquisition opportunities in the region dry up and competition from rival bidders increases, Erste is having to look into the Balkans, to bid for smaller banks and to pay higher multiples.

Moreover, easy profits in Erste’s more mature markets such as the Czech Republic are now harder to come by, raising questions about where the bank will find future profit growth.

Profits from central Europe – helped by currency appreciation – have easily outpaced those achieved in the mature and highly competitive Austrian market. In the first quarter, the return on equity in Austria was 13% compared with almost 23% in the Czech Republic, leading to a group average of 18%.

Growth potential

There is still a lot of ground to make up, given that GDP per capita in central Europe is barely half of that in the rest of the EU.

Erste’s chief executive, Andreas Treichl, who has led the bank’s expansion from the beginning, believes that the full extent of this potential has not been reached yet.

“In reality, the growth here has not even started yet,” says Mr Treichl. “Central Europe will not stop at 70% of the EU average GDP per capita. It will go right to the top. It will happen faster and broader than in Portugal and Spain.”

Yet the environment now is much tougher, as shown by the experience of Ceska Sporitelna, which operates in the most mature market in the region and, as one of Erste’s first acquisitions, has had the longest experience of restructuring.

Unlike in Poland, where many people still do not have bank accounts, in the Czech Republic there is little growth potential in the number of retail clients or their deposits. At a time when consumers are spending rather than saving, Ceska Sporitelna was content to increase deposits in the first quarter by 5% year on year.

Margins of terror

Banks have also had to accept lower net interest margins as rates converge towards the eurozone level. Until now, banks have been able to cut deposit rates but there is not much room to go further down, with rates under 50 basis points, below inflation. Czech margins have therefore decreased to 3.5%, although they are still well above Erste’s margin in Austria of 1.6%.

The squeezing of net interest margins threatens Ceska Sporitelna more than other banks because it is the main deposit bank and has traditionally invested in government paper, which is now much less lucrative. The bank’s net interest income rose 4.9% year on year in the first quarter.

Ceska Sporitelna’s profits are also no longer flattered by writing back loan provisions that were built up when Erste took control. Jack Stack, the bank’s chief executive, says that a final Kcs1bn (€330m) will be written back in 2005, making a total of Kcs4.2bn over four years.

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Jack Stack, chief executive of Ceska Sporitelna

The easy efficiency savings have been achieved. Ceska Sporitelna’s workforce has been brought down by almost a third from 15,500 in 1999 to 10,800 today. The bank’s cost-income ratio was 58% last year, better than the 65% achieved at Erste’s Austrian operations. Mr Stack still hopes to cut costs further but at a much slower rate: the target for the ratio this year is 55%-56%.

Quest for growth

If little can be done to increase client numbers or cut costs, the priority for banks in mature markets such as the Czech Republic is to make their money work harder.

“There’s always room for improvement but now we’re working on a growth story,” says Mr Treichl. “You can’t restructure the whole time. At some point you have to grow. The motivating thing is to create top-line revenues.”

One key area for growth is lending to small and medium-sized enterprises, which offers higher margins than lending to big corporates, for whose business there is tough competition.

The main focus for achieving growth at the moment, however, is in building market share in retail lending, particularly mortgages. Central Europeans want to catch up with the rest of the EU in acquiring property and consumer items. They are increasingly able to do so because of rising real incomes and easier and cheaper loans from banks and non-bank institutions.

Behaviour is changing

Central Europeans used to be very conservative about taking on debt and are still loath to take out heavy mortgages or to use their credit cards frequently. Behaviour is beginning to change and Czech household credit has risen to about a quarter of the EU level of 50% of GDP.

Banks, helped by improved legislation, have increased mortgage lending at a staggering rate. Ceska Sporitelna, the market leader, lent 59% more in the first quarter than a year earlier.

Consumer loans – which have higher margins than in western Europe – have also grown strongly, though Mr Stack predicts that this will soon begin to slow down. Ceska Sporitelna increased individual consumer loans by 36% year on year in the first quarter.

Credit card use has also increased explosively in the past year. Ceska Sporitelna, the market leader, doubled the number of its card customers to 231,000 in the first quarter. Until recently, credit cards were only for top customers but they are now targeted at ordinary retail clients. Ceska Sporitelna plans to have one million card holders within two years.

Wealth management

The consumer boom is already probably past its peak and in the longer term Erste sees more potential in what it calls wealth management – such as pensions, life insurance and mutual funds. There is a huge gap between the use of these products in central Europe and the rest of the EU.

Erste believes it is best placed to benefit from this coming convergence because its banks in the Czech Republic and Slovakia have access to a huge client base to which they can cross-sell products from the rest of the Erste group. Ceska Sporitelna, for example, has the third largest pension fund with 434,165 clients, and in asset management it has a market share of 55%.

Ceska Sporitelna is making a big push in this area, spending Kcs30m this year on advertising investment products, and backing this up with interviews with personal client managers. But Mr Stack admits that his bank is still too bureaucratic in its procedures and is not making good enough use of its client information.

Take-up of pensions and mutual funds is increasing – particularly as bank deposit rates have turned negative in real terms – but Erste admits progress is slow.

The main obstacles to growth remain the tiny number of wealthy people with cash to invest (particularly among Ceska Sporitelna’s clients), ignorance about products and memories of the mid-1990s when many fund managers embezzled their clients’ money.

Czechs are spending not saving at the moment, delaying the take-off of wealth management. Fees and commissions at Ceska Sporitelna grew 9.4% year on year in the first quarter, barely above Erste Bank Austria’s 8.8%.

“It takes quite a while before people get into the income bracket for wealth management,” says Mr Treichl. “That’s the time when we will start to make money, when people slow down on the borrowing side and start to save. At some time it will boom. No-one has seen the magnitude of this change yet.”

The profitability problem

Erste’s problem is that the slowdown in profit growth, because of lower net interest margins and falling gains from restructuring, is happening now. By contrast, Mr Treichl says, loan growth will be pretty subdued and the profit growth from wealth management is not quite there yet. “There could be a drop in profitability in 2006-7,” he warns.

He says that convergence is bringing interest rates down rapidly, not just among the new EU member states but also in the poorer future EU members in the Balkans. As Erste expands there, it could consequently find profitability much more difficult to achieve than in its glory days in central Europe.

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