For bankers in the Balkans, there was an unwelcome sense of déjà vu at the start of 2010. A year earlier, some economists had warned that the economic downturn stemming from events in the US would lead to a tidal wave of non-performing loans (NPLs) sweeping the immature banking markets of central and eastern Europe (CEE).
NPLs certainly rose in 2009, but they remained within manageable levels in almost all CEE countries. Then Greece unveiled a budget deficit that was double previous estimates, its sovereign bond spreads began to widen, and economists once again started speaking of collateral damage on the hinterland of the eurozone.
Top of the at-risk list were Romania and Bulgaria, two markets where credit had expanded sharply in the boom years, and where Greek banks had significant market shares of about 20%. There were predictions that Greek parent banks squeezed out of the wholesale funding markets would not be able to support overstretched subsidiaries in those countries.
In the short term, at least, the supply of credit is not the issue in Bulgaria and Romania, because slow economic growth has weakened demand for lending from both companies and households. Gross domestic product (GDP) contracted by an estimated 5% in Bulgaria and 7.1% in Romania in 2009, according to the European Bank for Reconstruction and Development (EBRD), and improvement in 2010 has been hesitant.
"Everybody is extremely cautious; financial management, especially for corporates but also at a personal level, is much more careful. Even if companies have not had a significant drop in production volumes and orders, they are trying to run their businesses with less borrowed money," says Levon Hampartzoumian, the CEO of Bulgaria's largest bank, UniCredit Bulbank, and a former deputy economy minister in the country.
Cold shower
Momchil Andreev, the CEO of Raiffeisen Bank in Bulgaria, was on the board of the country's Postbank during the economic crisis of 1996-97, and he says the current situation is far milder. In 1996, hyperinflation bankrupted one-third of the Bulgarian banking sector. In 2009, inflation was less than 3%, and is projected to fall further in 2010.
No Bulgarian bank required special public support during the 2008-09 crisis, and the country had run fiscal surpluses every year from 2004 to 2008 inclusive. This makes the 3.9% budget deficit of 2009, as automatic stabilisers kicked in, eminently affordable and most likely temporary. Dimitar Kostov, the deputy governor of the Bulgarian National Bank responsible for bank supervision, says the fiscal situation has helped keep sovereign credit default swap spreads tighter than those of other Balkan states, which gives private borrowers in the country a competitive advantage as well.
Even so, after very high growth in Bulgaria's GDP and credit in the years leading up to 2008, Mr Andreev characterises the downturn as a "cold shower". The analogy is apt, because there were widespread fears that Bulgaria was overheating during the boom years, and the slowdown provides an opportunity for banks to adopt a more considered business model.
"We were opening 20 to 30 branches and hiring 500 staff per year, every year for five years," says Mr Andreev of Raiffeisen Bank. "Of course, with such strong growth, it is a challenge to continue providing a top-quality service to customers. When the crisis started, we thought it a good time to focus even more on delivering added value to the customers, so we invested in a branch service excellence project, which means we have reviewed and simplified all documentation, streamlined offices, provided extra training to employees, changed incentives towards quality of service and centralised our complaint management."
Mr Hampartzoumian says UniCredit Bulbank has also intensified its attention on optimising its branch network, alongside its efforts to enhance electronic distribution channels for its services. He adds that the bank has taken what he calls a "belt and suspenders" approach to liquidity and funding needs.
"We are not paying ridiculous prices for deposits, but we are trying to keep our loan-to-deposit ratio slightly above 100%, down from a peak of about 130% in late 2008. But we also use support from our mother company. We want to have a conservative balance between the two," says Mr Hampartzoumian.
Overall, the Bulgarian banking sector's liquidity ratio is relatively low by EU standards at 22%, according to Mr Kostov. Greek-owned banks often had loan-to-deposit ratios above 200% - and more than 500% in isolated cases - relying heavily on parent-group funding.
But Mr Kostov says the Bulgarian system is strengthened by a large excess of capital, with a Basel capital adequacy ratio of 18.2%, compared with the national regulatory minimum of 12%. This means that banks are holding excess capital equivalent to 4.6% of GDP, with Greek-owned banks holding capital ratios above average for the sector. Mr Kostov adds that Bulgarian banks began to provision early in the cycle, and provisions across the sector amount to about 80% of NPLs, meaning that coverage is sound once collateral is factored in. "The earlier write-downs are now bearing fruit with earlier write-backs, although the number of loans in the watch [at risk] category is accelerating," says Mr Kostov.
Levon Hampartzoumian, the CEO of Bulgaria's largest bank, UniCredit Bulbank
Grounds for confidence
Perhaps equally important, return on equity among Balkan banks looks set to be stronger than in Greece, given the depth of public sector cuts proposed to correct the Greek budget deficit. The head of CEE markets at one of the top three Greek banks says the region's strong relative and absolute prospects are driving his bank's continued commitment there.
"Our business strategy for the region has not changed. Of course, what is affected is the profit and loss account, but our approach to the market has changed only in the sense of technical adjustments, looking at the banking needs and the financial conditions of our clients in more detail," he says.
He adds that the difficult conditions in Greece have encouraged the bank to develop new products to assist customers, which could be usefully exported to the Balkan subsidiaries. As an example, his bank has offered better repayment terms and lower interest rates to good clients affected by the public sector cuts in Greece, to offset potential repayment difficulties.
"We adapt our business model to market conditions to gain client loyalty and market share, although obviously we would only switch clients over to our bank after careful credit analysis," he says.
That product model may be more relevant for Romania, where the fiscal position was less healthy than in Bulgaria going into the financial crisis and is now critical. Romania's budget deficit, already at 5.4% of GDP in 2008 when the economy was growing by 7.3%, spiralled to 8.3% of GDP in 2009 and was forecast to exceed 9% in 2010 without corrective action.
To avoid that scenario, the country has entered an International Monetary Fund programme and embarked on a dramatic austerity package, announced in May 2010, which included a 25% cut in public sector wages, broadening the tax base and reducing benefits spending by 15%. In June 2010, the constitutional court ruled that a planned 15% cut in pension payments would be unconstitutional, leading the government to consider a 5% hike in value-added tax that would further suppress domestic demand.
Bulgaria's top five banks ($m)
Romania's top five banks ($m)
Added risks
The impact of the downturn on Romanian banks has been aggravated by higher personal indebtedness in some retail segments, according to Mihai Bogza, the CEO of Bancpost, which is owned by Greece's EFG Eurobank. Until 2004, Mr Bogza was a deputy governor of the National Bank of Romania, where he was in charge of bank supervision. NPL ratios in Romania are running at more than 15% and, although this is only about a percentage point higher than in Bulgaria, Romanian capital adequacy ratios were lower on average going into the crisis, at about 14%.
As a former regulator, Mr Bogza had intentionally kept Bancpost's capital adequacy significantly higher, at 19%. Even so, he says the severity of the downturn and the extent of payment difficulties among individuals and companies were hard to anticipate, and expectations of a recovery from 2010 onward now look premature, which means that repayment problems are likely to persist.
"While spreads are pretty generous in Romania, it is difficult for the banking system to cope with the rise in NPLs," says Mr Bogza. "In addition, following many years of boom, banks were little prepared to deal with a high number of insolvencies and clients unable to repay. There were few restructuring products available, so banks had to struggle to put everything in place to enable still-viable borrowers to delay payments until they found a way to put their financial house in order."
By the time the crisis struck, Banca Comerciala Romana (BCR), the country's largest bank, had completed the process of bringing underwriting standards into line with those of its owner, Austria's Erste Bank, following its acquisition in 2005. Dominic Bruynseels, BCR's CEO, says the bank had taken a conservative line on real estate exposure in particular. This has helped maintain the quality of the loan portfolio, and the bank has been able to pick up some large corporate customers from less healthy banks that are in retreat. But, overall, prospects are uncertain in the short term.
"The retail side regularised toward the end of 2009, but we have started to see a little fresh deterioration in the wake of the latest government economic measures. Our large corporate exposures are very good, but the issues have really started to emerge much more in the SME [small and medium-sized enterprise] base. It looks as though this provisioning cycle might have a couple of wheels, and we are moving onto the second element, but we are well prepared for that," says Mr Bruynseels.
Foreign currency dilemma
In addition to the fiscal problems, the other factor that differentiates Romania from Bulgaria is the exchange rate. Bulgaria's fixed exchange rate currency board system has served it well in terms of financial stability, whereas the Romanian leu deteriorated by more than 15% against the euro in the four months to February 2009.
This devaluation had an especially strong effect on retail customers who had borrowed in foreign currencies, including euros, yen and Swiss francs, to enjoy the lower interest rates on offer. While the immediate impact of the devaluation had largely flowed through the portfolios of Romanian banks by September 2009, they face a dilemma about how widely to offer foreign-currency consumer lending products in the future.
"Traditionally, we have been very careful with loans in foreign currency, and we offered this product only to affluent customers. In addition, we have avoided offering retail loans in foreign currencies other than euros," says Guy Poupet, the CEO of BRD-Société Générale.
Mr Bogza says banks still face a difficult choice on long-term loans such as mortgages: to leave customers with exchange-rate exposure or to run maturity mismatches on the bank's own books. "We were aware there was a danger, but we compared this with the danger of lending long-term in leu at a time when there was no wholesale market in leu," he says. "Almost all the deposits in Romania are very short-term, no more than three months. So it appeared riskier to us to try to fund 30-year mortgages with short-term deposits, rather than using credit lines in foreign exchange."
The EBRD's May 2010 initiative to encourage local currency capital markets in the Balkan region could help, but it will rely on support from national governments, and will take time. In any case, one Greek banker active in the region says it is possible to offer euro loans to retail customers with an in-built exchange-rate hedging facility, at an all-in cost to the customer that is still cheaper than extending the loan in most CEE local currencies.
Dominic Bruynseels, BCR's CEO
Finding the niche
For now, as in Bulgaria, the Romanian banks are focusing on improving their quality of service and keeping a close eye on customer solvency. Mr Poupet says BRD-Société Générale is hoping that a broader product range will offset weaker loan demand.
"As far as competition is concerned, we can see on the market a switch from a quantitative approach, based on hard selling and marketing techniques, to a qualitative approach, based on a careful watch on the customer's needs," he says.
There is general consensus that loan penetration, especially in the retail segment, is still low in Romania - while some households are overleveraged, other groups remain underbanked. The key will be finding the right niches. Banca Transilvania, the only locally owned bank among the Romanian top five, has come up with an innovative response to government healthcare reforms enacted from 2007 that made much of the country's medical profession self-employed rather than state employees.
"We saw many people in the medical sector who wanted to be more entrepreneurial, and we saw certain parallels with the products we already had for the SME sector. So we decided to hire 80 doctors to become bankers, as interlocutors with the medical sector, we opened specialist branches on the sites of the main medical universities, and we developed a separate credit-scoring system for the sector, which we called DNA," says Robert Rekkers, Banca Transilvania's CEO.
The bank provides doctors with tailored products ranging from credit cards to professional insurance. In the process, it has picked up 18,000 high-value new customers who are midway between retail and SME clients, with a portfolio of 450m lei ($140m) and reliably low NPL rates.
On the corporate side, Mr Bogza says it is difficult to know for sure which of the country's major export-oriented sectors will recover most strongly once growth returns to the eurozone. As a result, Bancpost seeks to select larger lending exposures on the basis of finding individual companies within each sector that appear better positioned than their peers.
