Corporate banking in Serbia remains under pressure from excess leverage, legal shortcomings and the absence of a capital market.
After contracting 3.5% in 2009, Serbia’s economy staged a rather modest recovery in the next two years, growing 1% in 2010 and 1.9% in 2011 according to European Bank for Reconstruction and Development (EBRD) estimates. Too modest for the country's banking sector, it would appear, as its average non-performing loan (NPL) ratio climbed from 15.7% at the end of 2009 to 19.3% two years later.
Editor's choice
However, the headline numbers hide a sharp divergence between retail and corporate banking. NPLs in retail banking are less than 8.5%, which is reasonably healthy by the standards of the Balkan region. But the rate for corporate loans, which constitute 53% of total sector loan portfolios, is more than 23% – one of the highest in the region.
A way out
Bad loans hard to shake off
Radovan Jelasic, governor of the National Bank of Serbia (NBS) until 2010 and now the chief executive of Erste Bank in Hungary, believes new loan formation may play a rather small role in Serbian bank profitability in 2012.
“Profits this year will be determined by recoveries on non-performing loans, and by the dialogue between banks and regulators,” he says.
In addition to the sharp increase since 2009, there is even a hard core of residual problem loans dating back to the painful economic transition in the years immediately after Slobodan Milosevic’s fall from power in 2000. The tax system has discouraged banks from writing them off altogether and refreshing their portfolio, says Miroslav Stojanovic, a partner at law firm Wolf Theiss in Belgrade.
“Loan write-offs are not recognised for tax purposes, so banks still pay tax on the equivalent of the whole loan value rather than reducing their taxable income. And the write-off may also be classified as a gift for tax purposes, attracting a 2.5% ‘gift tax’. This means banks are not willing to undertake contractual write-offs as part of a loan restructuring deal – only in a bankruptcy situation,” says Mr Stojanovic.
Nor is bankruptcy such an appealing option for the banks. A new enforcement and collateral act, passed in September 2011, will come into effect in May 2012. But Minas Athanassiadis, board member for wholesale banking at Alpha Bank Serbia, says banks will need to test the implementation of the law to see if it brings about the desired improvements in bankruptcy procedures.
In particular, he highlights delays of several years for enforcement processes, and unpredictable judicial outcomes. In a number of high-profile cases, secured creditors have been included in debt-for-equity swaps, rather than being able to enforce on their collateral.
Even selling NPL portfolios is fraught with difficulties. Serbian banks are only allowed to sell loans after enforcement, which defeats the purpose of realising value immediately and transferring the legal risk to a specialist buyer. In addition, controls on capital flows create further complications.
“Local currency loans cannot be sold to investors from outside Serbia, and foreign exchange loans financed abroad cannot be assigned to a domestic investor,” says Nikola Babic, a lawyer for the local affiliate of Austrian firm Schoenherr.
Most corporate loans are in foreign currency, so they could theoretically be sold to foreign distressed debt funds. But the common technique used by these funds of incorporating a local special purpose vehicle through which to manage assets might then fall foul of the foreign exchange provisions.
Serbia's share of Greek-owned banks is also the second highest in the Balkan region after Bulgaria, at more than 27%. So far, only the Agricultural Bank of Greece (ATE Bank), has indicated that it wants to sell its position in Serbia, a 20% stake in AIK Banka, which has a 5.7% market share by assets. But several other foreign banks among the 21 present in the country are looking for the exit.
They include two banks that must divest non-core assets under EU state aid rules after receiving government assistance: Hypo-Alpe Adria, with a 5.6% market share, and KBC, with a 1.2% market share. Meanwhile, Slovenia’s loss-making Nova Ljubljanska Banka, with a 1.7% market share in Serbia, has sold out of neighbouring Bulgaria. And France’s Crédit Agricole, saddled with a sizable Greek subsidiary, may also want to divest its 2.1% market share. But Dejan Soskic, the National Bank of Serbia's (NBS's) governor since July 2010, is not alarmed.
“We are closely monitoring flows into and out of the financial sector in view of events in the eurozone, but we do not have any serious concerns at this time,” he says.
In fact, some of the 12 locally owned banks have been causing more of a headache. Agrobanka, which is 20% state-owned and was listed on the Belgrade Stock Exchange, posted the largest loss in the sector in the first half of 2011 at RSD2.3bn (€21.3m), on a 3.1% market share of assets. At the end of 2011, the NBS placed the bank under administration by the Deposit Insurance Agency.
“Although the system is stable, we need to take account of the balance sheet structure of each individual bank. If the risks faced by any one bank are not covered by its capital adequacy, we are ready to stabilise it and increase its capital. So this administration is a positive step for the bank and for the financial system, and we do not believe the situation at Agrobanka will jeopardise financial stability,” says Mr Soskic.
Retail relief
Market penetration in the retail banking sector is still comparatively low, with retail loans equivalent to less than 25% of gross domestic product (GDP). NBS regulation has also been restrictive. Only euros are allowed for foreign currency lending to retail customers (Swiss francs had previously been used), and customers taking out foreign currency (FX) loans must make a downpayment of 30% – raised from an earlier 20%. In addition, the ratio of debt servicing payments to salary is capped at 30%.
All of this has contributed to the lower NPL rate on retail loan portfolios. At Eurobank EFG, the NPL ratio for household lending is below 3%. Philippos Karamanolis, Eurobank’s chief executive in Serbia, has been one of the bank’s longest serving expatriates right across its central and eastern Europe franchise, and was originally involved in setting up the group’s consumer finance business in Bulgaria and Romania. He says the retail repayment culture and portfolio performance in Serbia are among the best in the region in his experience.
However, an unemployment rate of 24% inevitably dampens demand for new lending. Slavko Caric, chief executive of Erste Bank in Serbia, expects external factors to govern the prospects for retail lending in 2012.
More than 90% of retail deposits are kept in foreign currencies, although we did see 50% dinar deposit growth in 2011
“We have seen a lot of success with mortgages, but they do tend to rely on government subsidies for certain population tranches, or low-cost credit lines from development banks such as the EBRD or [Germany’s] KfW. Cash and consumer loans offer slow but steady growth, and we think there would be good demand for refinancing these loans with longer maturities if the NBS will authorise this product,” he says.
Draginja Djuric, chief executive of the country’s largest bank, Intesa, says there are reasons for optimism beyond the headline macroeconomic numbers. Official figures on salaries and unemployment tend to leave out a portion of earnings, and above all from expatriate remittances to Serbia that bring household inflows of at least €3bn a year. Even so, she says Intesa must be creative, given the difficulties of expanding its already large market share in a slow growth environment.
“We are very active in mortgages, and have a significant lead in the card business with 1 million customers already. So we look to innovate beyond cards, to link them to product bundles to generate more non-interest income from our good-quality client base. We do not want to increase loans if it means increasing NPLs,” she says.
Funding challenge
The NBS regulations on foreign exchange are part of its strategy of encouraging the use of dinars in the financial system, to reduce exchange rate risk for unhedged customers in particular. Klaus Priverschek, chief executive of UniCredit Bank Serbia, says his bank instructed staff two years ago to advise retail customers on the effects of various exchange rate scenarios on their loan repayments before approving any FX loan.
Mr Soskic would still like to see the proportion of FX loans fall from current levels of about 70%. To achieve that, however, banks will need to find more sources of funding in dinars. Overall, the funding position in Serbia is healthy. Deposit outflows of €1bn in the aftermath of the Lehman Brothers crisis in 2008 have been followed by inflows of almost €3bn, with most of the top 10 banks, including the Greek-owned players, no longer reliant on their parent companies for funding.
But the dependence on multilateral financial institutions for long-term financing is likely to continue for some time, according to Mr Priverschek. And dinar deposits are very limited, while the dinar bond market for private issuers is virtually non-existent. This all makes dinar mortgages impractical from a funding perspective, but it is possible for banks to finance short-term consumer loans locally.
Mr Karamanolis at Eurobank says: “We were one of the first banks to offer fixed-rate lending in dinars, which was not available two or three years ago. We encouraged it, and now the demand is mainly in dinars, with more than 95% of our new consumer loan production in local currency. But on the liability side, it is an uphill struggle that will take some time, it is a matter of people regaining confidence in the national currency. More than 90% of retail deposits are kept in foreign currencies, although we did see 50% dinar deposit growth in 2011.”
The infrastructure to build a corporate bond market already exists on the Belgrade Stock Exchange (Belex). With technical support from the Luxembourg Stock Exchange, the Belex complies with European standards according to its managing director, Gordana Dostanic. But the investor base is lacking, with local pension funds small compared to the volume of bank credit, and almost 90% invested in government bonds.
“The legal framework for a corporate and municipal bond market exists, but it depends on the NBS, which regulates the percentage that pension funds could allocate to corporate bonds. There are no local rating agencies, so it is hard to estimate how much investment could go into unguaranteed corporate bond, while purchasing guarantees raises the cost of issuance above the cost of bank credit,” says Ms Dostanic.
Corporate pain
Even if funding improves, banks and investors will still find it difficult to identify good quality corporate clients. Darko Popovic, head of wholesale banking for Intesa, estimates that only 30% of Serbian companies are viable borrowers, owing to overleverage, poor earnings and weak corporate governance among the rest of the Serbian corporate universe.
Interestingly, most of the banks interviewed said their corporate NPL rates were about half the market average. In any case, the NBS lists Agrobanka, Alpha Bank and National Bank of Greece’s (NBG) Vojvodjanska Banka as the three largest loss-makers in the first half of 2011.
“We have a number of legacy challenges from our acquisition, including non-income generating assets that have left us with a balance sheet that is too large for our P&L [profit and loss], for example, real estate holdings in secondary locations that we cannot sell or rent,” says Vojvodjanska Banka’s chief executive Marinos Vathis.
A collection of several banks that were then merged with NBG’s greenfield operation in Serbia from 2006, Vojvodjanska had 40 different IT systems, with most branches functioning as mini-subsidiaries with their own back-office functions. Mr Vathis had to wait until 2010 when a headcount agreement expired to begin major restructuring, cutting 980 staff and 48 branches to leave a network of 120 branches with 1780 staff. In the meantime, the economy slowed and opportunities slipped away.
“We avoided some of the large corporate accidents where hits were concentrated, but we also lost some of our corporate relationships as the network became quite retail-focused. For us, 2012 must be the year of quality as we look to regain good corporate clients,” says Mr Vathis.
Thinking big
Unsurprisingly, larger corporates and non-interest income tend to be the focus for many banks’ business strategies in 2012. But even large Serbian companies are not immune from governance crises. Construction and road maintenance group Nibens was forced into bankruptcy in 2011, owing about €300m to creditors, after its owner was arrested and lucrative government contracts cancelled.
“We see opportunities to bank multinationals in Serbia, to be their first point of contact for them, as we have zero NPLs in this segment. And for all corporate business, our standard approach is not to lend without a fair share of the client’s wallet, usually at least pro-rata – if we provide 50% of their funding, we want to have 50% of their deposit business,” says Oliver Roegl, chief executive of Raiffeisen Bank Serbia.
Ms Djuric says that agriculture, export-oriented sectors and infrastructure are all areas where Banca Intesa will look for growth opportunities in 2012. But she emphasises that “clients cannot necessarily keep borrowing more; we need to act as an advisor as well as a lender, offering a tailor-made approach to help them manage their balance sheets”.
