High non-performing loan ratios and stringent, ever-changing government policies have put foreign-owned banks in Hungary under pressure. As established players change their footing, allocating a larger proportion of their funds abroad, a number of smaller local outfits are moving in to capitalise on the potential of niche markets.

Hungary’s banks have been through a grim financial crisis of their own, culminating in the sector’s first aggregate loss for 13 years in 2012. Operating in a dismal economic environment, with growth of just 1% in 2010 and 2011 after a 6.5% recession in 2009, Hungary’s banks have also been forced to pay extraordinarily high windfall taxes to a cash-strapped government.

At the end of 2011, the forced conversion of foreign currency retail loans into local forint currency resulted in a write-down on these portfolios estimated at 25%. Meanwhile, parent banks in Austria and Italy, despairing of ever seeing a decent return on their investments in Hungary, are allocating their already limited resources to other subsidiaries in central and eastern Europe, including in Poland and Romania, where medium-term prospects look brighter.

Heavily burdened, the country’s longest-established and largest banks are retrenching, as they attempt to bring their non-performing loan (NPL) portfolios under control and establish a situation where their lending is entirely funded from domestic deposits. At the same time, and not without a political tailwind, new entrants owned by businessmen who enjoy good relationships with the government are seeing impressive growth by pursuing niche markets. These newer players also benefit from not being dragged down by a legacy loan portfolio.

Foreign currency burden

Any sympathy for the country’s loss-making banks is tempered by the scale and enthusiasm with which they embraced foreign currency lending during the boom years in the early 2000s. They seized the opportunity to lend in euros and Swiss francs at lower interest rates than were available for loans in forint, arguing that there was little risk, either to the bank or the borrower, since the forint was a currency that was only likely to converge upwards towards the euro.

Events proved otherwise in 2008, when the Lehman Brothers' bankruptcy spooked bond buyers, who left the Hungarian market en masse, prompting the Hungarian forint to fall sharply. Borrowers were left trying to repay their loans at ever less favourable exchange rates, creating an NPL headache for the banks.

But while recrimination is tempting at this point, and Hungary's government has been willing to indulge in more than a little banker-bashing, the real challenge is to restore growth to a country whose economy is set to shrink in 2012, and to make it possible for banks to start lending again.

The populist conservative government has had little success doing this, however. When it came to office in 2010, led by prime minister Viktor Orbán, the government resolved to avoid outright austerity. Mr Orbán was hoping that the country could secure an agreement with the EU and the International Monetary Fund (IMF) to run a large budget deficit to finance counter-cyclical spending. This was despite the international community imposing a deficit ceiling of 3% on the previous interim technocrat government, under the terms of the standby agreement the country had signed during the 2008 crisis.

The European Commission shot down Hungary's proposal and, shortly afterwards, the government decided to do without IMF help, as it attempted to finance a combination of tax cuts and stimulus spending by imposing crisis taxes on profitable industries, including banking, telecoms and retail. The banking tax, which is still in force and runs to €700m a year, or 4.5% of gross domestic product (GDP), is on a far grander scale than similar taxes imposed elsewhere in the EU.

But the banking tax was at least manageable, representing a clear and fixed burden. Some of the measures that came later caused a greater headache for banks, in particular a determined and highly unorthodox set of legislative measures designed to deal with banks’ portfolios of foreign exchange loans. At their peak, these amounted to two-thirds of all lending in the country, and a higher proportion in some categories such as mortgages.

Under legislation introduced in the second half of 2011, retail borrowers with foreign currency loans were able to convert their outstanding balances into local currency at an exchange rate closer to that found in the boom years. While this measure has helped out households whose budgets were crippled by debt servicing, it has hit banks hard. Preliminary estimates by the Hungarian National Bank (MNB) suggest that some €4bn in loans were converted in this fashion, or about 20% of total foreign currency loan portfolios, causing banks a loss of some Ft330bn (€1.1bn).

Credit squeeze

Unsurprisingly, lending has been hit hard, depriving an already stagnant economy of the cash it needs. According to the European Bank for Reconstruction and Development, corporate lending has contracted by about 1.1% of GDP over the past year, and banks are reluctant to extend new funds.

In this difficult environment, the country’s central bank, still undaunted after a running battle with a government which announced its intention on taking office two years ago of bringing the monetary authority to heel, is struggling to find means of getting lending going again. The latest approach, announced in February 2012, involves extending new, long-term credit lines to the country’s lenders. Márton Nagy, head of financial stability at MNB, explains the mechanism of this measure.

“We are providing a two-year credit using liquid securities the banks give us. This does not expand liquidity – we take bonds and give them cash. But the important thing is that it gives long-term liquidity. We take their short-term instruments and give them domestic currency cash,” he says.

Beyond this, the central bank has announced that it is prepared to accept a wider range of securities as collateral from mortgage lenders. It is also hoping that the government, whose relations with the central bank have improved after the failure of its economic policies to generate growth, will pass legislation to broaden the circle of banks permitted to issue real estate-secured mortgages from its present three, in the hope that this will further expand credit creation.

Policy uncertainty

But for bankers, the economic environment is not the only difficulty. Just as important is the unpredictability of a regulatory environment in which far-reaching economic policy decisions give the impression of having been conceived to deal with immediate problems, with little thought given to their longer-term consequences. “It is very hard to know which policy announcements to take seriously,” says the head of one major western European bank with a presence in Hungary. “One day we learn from the media that mortgage conversions will be allowed for properties with a value of up to Ft30m, and only afterwards does the Banking Association get a letter from the government consulting us on this idea.”

[In January] the forint was nudging 287 to the euro compared to 310 in December, and already I was starting to get interested phone calls from investors

Radovan Jelasity

The same goes for another idea that has been periodically floated by government officials and members of parliament for more than a year now – that of converting the €5bn in foreign currency municipal debt on a similar basis to consumer loans. That, bankers agree, would be a near-intolerable blow, and few expect the IMF and the EU, with whom Hungary is currently negotiating for a renewed standby loan, to allow it to happen. Although it has not been implemented, the proposal has still not been taken off the table, making it an unavoidable obstacle for business planners. But bankers insist that it would take very little to put an end to the uncertainty and improve the sentiment in the financial sector.

“There were relatively few spectacular policy initiatives over January and February, and market perceptions of Hungary were already starting to improve,” says Radovan Jelasity, head of the Hungarian subsidiary of Erste Group. “The forint was nudging 287 to the euro compared to 310 in December, and already I was starting to get interested phone calls from investors.”

December 2011 saw international criticism of Hungary reach its height, when the country, having been forced by the devaluing forint and bond-buyers’ reluctance to buy Hungarian debt, was forced to return to the IMF and the EU for a standby loan to replace the loan it terminated in 2010.

The IMF has committed itself to acting in concert with the European Commission, which has expressed concerns about a number of legislative measures in Hungary that it says contravene European law, including a law that it says could compromise the independence of the central bank. The EU’s executive body is also demanding changes to laws that it says raises civil liberties concerns, harming media freedom and circumscribing the independence of the judiciary.

Looking elsewhere

In the face of such headwinds, it is no surprise that parent banks in western Europe appear to be allocating their funding to other countries in the region, where the political environment appears more stable, and where economies are expected to grow in 2012. Banks committed themselves to maintaining their funding towards troubled economies such as Hungary as part of the 2008 Vienna Initiative – but that commitment came to an end with the termination of Hungary’s IMF standby agreement. Since then, funding levels to Hungarian subsidiaries have been falling.

“Forint funding started to decrease in mid-2010, but this was a natural process as credit was also down. However, the risk increased in 2011 because forint funding outflows accelerated,” says Mr Nagy.

Even OTP Bank, the locally listed and independent bank which, by some measures, makes up a full third of the domestic banking market, has been following its western European rivals in allocating funds away from Hungary. Some 30% to 40% of its profits now derive from subsidiaries in Bulgaria, Russia and Ukraine.

The slowing in foreign funding is having a very immediate impact on banking in Hungary. CIB, a subsidiary of Italy’s Intesa Sanpaolo, has closed about 25 branches out of a total of 150 in the country and cut staffing by 20%. Several other foreign-owned banks have pursued similar contractions. With funding from parent banks largely a thing of the past, domestic players are attempting to manage a long-term shift towards financing their lending from deposits. Loan-to-deposit ratios now average about 140% (still high), and most anticipate lowering the ratio to about 110% – the eurozone average – over the next three years.

But in this, too, the loan conversion has caused problems. Mr Jelasity points out that the conversion, which was only available to those who could raise sufficient cash in domestic currency to pay back their existing foreign currency loans, was used mainly by borrowers who were in any case better credits. The conversion has left banks with smaller loan portfolios of which non-performing loans constitute a greater proportion.

But senior figures in the government often appear perplexed by the banks’ difficulties. One banker relates a conversation with a senior official involved in setting economic policy: “'Why do we need foreign-owned banks if you’re going to finance your lending from savings, anyway?’ the official asked me.”

New entrants

Mr Orbán has in the past expressed the view that more banks should be “Hungarian”, without specifying whether this should refer to their headquarters or their capital base. There are signs of policies pointing in that direction. Several new, minor players have started recently, targeting niches such as online banking and small and medium-sized enterprise lending.

One of these, Gránit Bank, is primarily owned by Sándor Demján, a billionaire property developer who has in the past acted as a close economic advisor to Mr Orbán. Éva Hegedűs, its chief executive, says its growth – its balance sheet has grown fivefold in less than two years – is largely due to its lack of a traditional branch infrastructure and its loan portfolio’s freedom from the encumbrance of bad debts. The bank also appears to have benefited from counting state-owned companies and municipalities among its clients. More recently, there have been media reports suggesting the government is contemplating buying Gránit Bank.

Another recent start-up, Széchenyi Bank, also seems to have found a supportive official sector client base. And in 2011, its former owner István Töröcskei sold his interest in the bank in order to take a government-appointed post as head of the state debt management agency AKK.

Despite the government’s approach of pursuing policies that favour locally owned banks over their foreign-owned competitors, bankers acknowledge that the country is exposed to forces that are well beyond its control. The funding squeeze faced by eurozone banks undoubtedly fed through into Hungary in 2011. This in turn implies that the country might ultimately benefit from a more local flavour to the banking sector.

“In a country where 70% of total assets are controlled by foreign strategic investors, you cannot separate broader European developments from domestic developments,” says György Surányi, head of the Italian bank Intesa Sanpaolo’s eastern European operations and a respected former MNB governor.


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