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WorldOctober 1 2014

Chinks of light for Romania's financial landscape

The previously bleak economic picture in Romania is improving, and with it the performance of the country's banks. But high non-performing loan ratios, underdeveloped financial markets and a slump in the credit market are making it difficult for the country's lenders to pick up much momentum.
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Chinks of light for Romania's financial landscape

Romania is on the up. The global financial crisis hit the country hard, its economy faltered and, in 2009, it became the third EU country to be bailed out. But since then work has been done to put Romania back on track and in reach of eurozone membership. After a 6.6% plunge in real gross domestic product (GDP) in 2009, and 1.1% contraction in 2010, the Romanian economy beat expectations with 3.5% growth in 2013.

In the second quarter of 2014, however, the country's economy slowed, recording a 1% contraction in GDP. “The main reason for this contraction was a year-on-year drop in government public investment,” says Radu Craciun, chief economist at Banca Commercială Română (BCR). “Despite the fact that exports are doing well and we have been seeing a slight increase in consumption, this is not enough to provide sustainable growth as long as the government is not using budget expenses to boost economic activity. All analysts have now revised their full-year GDP growth figures from more than 3% to close to 2%.”

Previously, the European Commission forecast GDP rises of about 2.5% in 2014 and 2.6% in 2015.

Mr Craciun lists the issues that still need to be tackled by the government, including unemployment – only 4.5 million of the 20 million-strong population are officially listed as employed – tax evasion and privatisation. Also, he says, reform in the education system is long overdue.

Still, the economic sentiment indicator compiled by the EU's official statistics office, Eurostat, which tracks sentiment across industry services, consumers, construction and retail trade, shows that in 2014 Romania's score edged above the mean figure of 100 for the first time since October 2011.

Banking recovery

Romania's banking sector is starting to recover from the losses it suffered between 2010 and 2012, when its return on equity (ROE) went into the red. In 2013, the sector's average ROE had rebounded to 4.05%, with this figure increasing to 6.3% in the first quarter of 2014. But, heavy provisions at the country’s largest bank by assets, BCR, have since dented this recovery.

BCR, a subsidiary of Austria’s Erste Bank, reported a loss of 276.6m lei (€61.9m) for the first half of 2014, as the bank accelerated plans to cut its non-performing loans (NPL) ratio, which stood at 30%.

“During the first half of 2014, we have been subjected to three regulatory reviews,” says Tomas Spurny, CEO at BCR. “[First was] a review of the restructured exposures of the bank, which was done by the local regulator. Second was the ECB’s asset quality review, [which was] a pretext to the stress test. And third, the regulator publicly announced intentions to stimulate the banking sector to reduce the level of NPLs, to accelerate write-offs and to take other measures.”

These regulatory reviews caused BCR to reassess its strategy for tackling its NPL portfolio, with the result that the bank shortened the timeframe of it strategy, which originally stood at five years.

“Our results for 2014 will [consequently] be driven by condensing the recovery strategy into a significantly shorter period of time than originally anticipated,” says Mr Spurny. “We will have to adjust the books of the bank in the second half of 2014, and we will generate a loss, but we are not in need of additional liquidity; we are focused on inefficiencies.”

BCR had already decreased its NPL level from 13.6bn lei at the beginning of 2013 to 12.9bn lei as of July 2014 and 11bn lei as of the end of August 2014. The bank is planning to finish the year with less than 10bn lei of NPLs.

High level of NPLs

NPLs are not just a problem for BCR. The NPL ratio for the whole Romanian banking sector is high, at more than 20%. However, what often gets overlooked with this figure is that the definition of NPLs in Romania is not easily comparable to the definition in most other European economies.

In Romania, the calculation compares non-performing credits to the volume of outstanding non-government credits, while the European Banking Authority (EBA) definition includes both government and non-government exposures, generally resulting in a lower ratio than under the Romanian rules. When measuring the ratio by the EBA's method, the NPL ratio for the Romanian banking sector was estimated at 17.9% as of the end of March, compared to the 20.4% reported by the NBR.

Romanian NPLs also include prudential filters, which further raise the figure.

“[Romania's] NPL ratio was 22% at the peak, but almost 90% of that is provisions,” says Mugur Isărescu, governor of the National Bank of Romania (NBR). “Our supervision department decided on a tougher and more cautious approach in response to the banking crisis in the 1990s. The figure itself is alarming but when you look behind it, it is not quite as bad. And I believe it is highly improbable that we will see NPLs increase after the asset quality review in Romania, because we were already very tough before.”

Furthermore, Romania was later than other countries in enforcing International Financial Reporting Standards (IFRS), which can also be said to have had an impact on the current high NPL figure. Domestic legislation prior to the introduction of IFRS in 2012 made it difficult for banks to write off loans, which is why exposures were sold off to recover some value.

“In most countries you can take any asset and come to the conclusion that the value of it is lower, let’s say zero, and then write it off,” says Steven van Groningen, CEO at Raiffeisen Bank Romania. “[Before the introduction of IFRS] in Romania, this could only be done through legal derecognition, which meant I would have had to agree with the client that they didn’t owe me the money any longer – and, of course, I didn’t want to do that.”

Raiffeisen, the sixth largest Romanian bank by assets, made the conscious choice to seek quality and efficiency over pushing to accumulate more market share early. “Banks were accepting more risk and lower interest rates before the crisis,” says Mr van Groningen. “We had already increased our market share from about 3% and we were uncomfortable with what was happening in the market in 2007.”

At the time, Raiffeisen Bank Romania was put under scrutiny for its more cautious approach, but now it seems that the strategy has played out well – the bank has one of the lowest NPL ratios in Romania – at about 10% – and reports strong returns on equity of 18% in 2013.

Consolidation options

Romania’s banking sector, comprising 40 banks in total, is dominated by foreign-owned lenders, which hold about 80% of its 352.42bn lei of total assets. Some institutions have a relatively small presence in the banking sector, a fact that is leaving many market watchers expecting a wave of further consolidation. According to Raiffeisen research, six Romanian banks are potential targets for merger and acquisition activity.

Millennium Bank’s Poland-based parent has reached an agreement with the European Commission (EC) to divest its Romanian subsidiary with about €600m of assets by June 2015, while Austrian Volksbank Romania’s operation, which has €3.1bn of assets, is meant to be sold by the end of 2015, according to another agreement with the EC.

Bancpost, which has €2.5bn of assets, is, according to Raiffeisen research, a likely candidate to be sold because its parent Eurobank has been nationalised by the Greek state, while Marfin Bank, with its €600m of assets, is expected to be divested by owner Cyprus Popular Bank following an agreement with the EC.

Meanwhile, Romania’s third largest bank, the Cluj-Napoca-headquartered Banca Transilvania, could see its 10% and 15% stakes held by Bank of Cyprus and the European Bank of Reconstruction and Development (EBRD) sold, Raiffeisen says, while Romanian private property fund SIF Oltenia is expected at some point to sell or reduce its 6% stake in BCR.

Sluggish credit market

Overall, the NBR is content with the Romanian banking sector’s health, regarding both its asset quality and capitalisation. However, Mr Isărescu criticises the weak appetite for lending among banks. “We have gone from credit growth of 40%, 60% and 90% annually until 2008, to negative growth levels now,” he says.

The total amount of loans contracted by 4.8% to €49.077bn in 2013, according to Raiffeisen Bank research. The contraction is largely due to the sharp drop in foreign currency lending – though this may pose problems for the country, given its history of foreign exchange loan problems.

During the boom years leading up to the financial crash in 2007 and 2008, subsidiaries of foreign banks received cheap money from their parents and lent these funds on to the Romanian population, in euros or other foreign currencies, and at lower interest rates than domestic loans. In a banking sector with more than 80% foreign ownership, the foreign exchange loan market boomed. Then came the global financial crisis, when it crashed. This put significant stress on the banking sector and local debtors, most of which had little defence because their liabilities were in foreign currencies, while revenues were in local currency.

But, despite these dangers, Romania needs more foreign exchange lending than it currently has, according to Mr Isărescu. “The commercial banks have turned from being overly optimistic to being overly pessimistic,” he says.

Loans to households in Romania fell 2.5% year on year in July 2014, driven by a 7.5% slump in euro-denominated loans and an even more staggering 15.4% plunge in loans in other foreign currencies. The 10.5% rise in local lending still means the aggregate figure remains in negative territory.

Low on loans

The picture is even bleaker for lending to non-financial corporations, which dropped by an aggregate 4.9% in July 2014. A 7.3% increase in domestic lending was outpaced by a 12.6% drop in euro-denominated loans and a 32.6% slump in credits extended in other foreign currencies.

“Everybody is back in the mode to write loans,” says Mr van Groningen – though these loans are made, obviously, only to clients with the right risk rating. Raiffeisen Bank Romania takes all credit decisions centrally, he says, and all retail loan applications are put through a scoring system, while applications for corporate loans are scrutinised by a central credit committee.

And there is reason to expect that some corporates will not receive a loan.

While capitalisation among Romanian banks is high, companies often are not well capitalised, according to Mr Craciun. “Banks are selective in giving loans but loan supply still cannot pick up if demand is not picking up,” he says. “Currently, corporates use their reserves first, before applying for new credit lines.”

Furthermore, while the Romanian economy as a whole has picked up, all-important consumer confidence is still low at negative 27.5, according to an EC survey, in which a score of zero represents equal numbers of positive and negative responses. This has markedly improved from the -63.3 low it hit in June 2010. An increase in consumer confidence is needed if demand for lending is to increase.

In the current environment, deposits are increasing, and the most sought after loan products are mortgages – the only type of loan that has consistently increased in volume in Romania across the past few years. In July, overall mortgage loans increased by 8.3% year on year, driven by a 199.2% hike in local mortgage lending.

BCR is a strong player in the mortgage market and has, over the past 18 months, grown its underwriting capacity from close to zero to 30% of the market, according to Mr Spurny. “The Romanian mortgage market is one of the key sources of growth in our retail franchise going forward,” he says.

Financial markets initiative

A new trend that is emerging in Romania is that banks are boosting their local funds by selling bonds in the domestic market, allowing them to increase their domestic funding bases. UniCredit Tiriac, the country’s fourth largest bank by assets, and Raiffeisen Bank Romania were the first two banks to issue, with a 550m lei deal in July and a 225m lei deal in August 2013, respectively. Further bonds followed in 2014, with a second 500m lei transaction for Raiffeisen and a 300m lei bond for Garanti Bank Romania.

“When you think about access to finance, you also have to think about diversifying sources of finance,” says James Hyslop, country director for Romania at the EBRD. “Romania used to heavily rely on the banks for finance with a strong use of foreign exchange borrowing. With our local currency and capital markets initiative, we have recognised that and are really keen to help develop the equity and debt capital markets in Romania. It is good for pension funds, good for corporates and good for the banks in diversifying their funding base.”

The EBRD launched a Romanian financial institutions bond market framework in June 2013, which enables it to invest in medium to long-term debt securities issued by local financial institutions. The total amount of the framework is €150m and, so far, the bank has utilised almost half of this by supporting all four bank bond issues since 2013.

Outside of the financial sector, the EBRD has participated in the corporate bond for electricity company Transelectrica. It is also active in the Romanian equity markets, where it worked with the ministry of energy on the 15% initial public offering (IPO) of the previously 85% state-owned natural gas producer Romgaz and on the public offering of the now less than 50% state-owned electricity company Electrica.

“We have been very keen to promote private ownership in the predominantly state-owned energy sector, but you can’t just go to the equity capital markets,” says Mr Hyslop. “We worked with Romgaz and Electrica for a number of months on corporate governance action plans to make sure that institutional investors and retail investors would have confidence that they are investing in a company that is well-run for all shareholders.”

Development phase

Local financial markets transactions have also attracted other investors from western, central and eastern Europe, the Nordic countries and the US, according to Ludwik Sobolewski, the CEO of the Bucharest Stock Exchange. He says that the stock exchange also aims to get the attention of Asian investors.

“In the coming months, we expect to see IPOs of some state-owned enterprises as part of the country’s privatisation process,” says Mr Sobolewski. “Private companies have shown an interest in corporate bond issues – a segment that has gained traction in the past year.

"The Bucharest Stock Exchange is also close to launching a series of measures aimed at stimulating listings of private companies... by facilitating the listing process, increasing liquidity and providing a modern alternative trading system for small and medium-sized enterprises [SMEs]. Through this, I hope, Romania will be known for having a regionally important platform for SME financing and it will make the central and eastern European region more colourful.”

There is a real need for foreign capital in the country, according to Mr Craciun. He says that Romania does not have enough domestic capital to support the development of the country itself.

“One way or another, you need foreign capital in Romania. This can come through foreign direct investment, which is badly needed; through funding lines provided to foreign banks locally, which then lend it on to local corporates; or through financial investments in the stock markets,” he says. “It doesn’t matter in which shape it comes; foreign capital is needed for Romania’s development.”

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