The rehabilitation of Austria’s Volksbanken

Just over a year ago, Austria’s Volksbanken stood at the edge of the abyss. The consortium of co-operative banks had failed the European Central Bank’s (ECB's) asset quality review in 2014, a flashback to the group’s bailout during the global financial crisis, which had brought the realisation that radical change was necessary.

The Volksbanken sector, which consists of 50 banks from across Austria, agreed to a voluntary restructuring under the supervision of the ECB and European Commission, first suggested before the results of the stress test in early October. The restructuring, which began in July 2015, includes plans to significantly reduce the group’s number of banks, branches and product offerings. In doing so, the banks hope to cut costs, return to profitability and repay state aid.

The restructuring means the transfer of non-core assets into Immigon Portfolioabbau, a wind-down institution for the banks’ real estate assets as well as its central and eastern European leasing business.

The second step is the merger of the 50 individual banks into 10 – one for each of Austria’s eight regions, the so-called ‘Bundesländer’, plus specialist banks for doctors and pharmacists, and the Sparda-Bank brand, which has a historical link to the unions and thus continues to offer some specialist products. Volksbanken are on track with both.

A stronger leader

While the banks, once merged into their new form and number, remain separate institutions, they will be guided by a new centralised institution, Volksbanken Verbund. The body is based on a contract between all Volksbanken, improving the consortium’s governance and handing Volksbank Vienna some additional functions such as the authority to give the separate banks directions. Volksbanken Verbund chief executive Gerald Fleischmann is already overseeing the merger processes.

“The new centralised institution has the authority to give directives in all matters related to risk, capital, liquidity and regulation,” says Mr Fleischmann, who is also chief executive of Volksbank Wien, the Vienna-based regional bank. As such it can make use of general or individual directives according to the contract between all banks. In addition, the banks will co-operate on the product offering and will decide the banks’ direction together – a process that will be significantly simpler now only 10 individual institutions will have their say.

The more powerful central institution was a precondition for the authorities’ green light for the Volksbanken restructuring, as was an increase in the consortium’s capital levels. Despite the involvement of the supervisors, the restructuring remains voluntary, according to Mr Fleischmann, who adds that it was not the supervisors who told the banks they had to merge.

“It is important for us to work according to plan because this will create trust and show that we have understood that through the restructuring we can get back to being a good, strong Austrian banking group,” he says.

As of the end of 2015, the Volksbanken Verbund will have posted more than 12% of core capital on consolidated Verbund levels, according to Mr Fleischmann. Core capital should be further boosted to above 12.5% after a sale of the group’s so-called ‘start’ group, which includes its building society, as well as Immo-Bank and estate agency Immo-Contract.

Perfect timing

The timetable for Volksbanken’s mergers is strict. Two banks are merged into one nearly every second weekend of the year, as agreed with the supervisors in Frankfurt and Brussels, according to Mr Fleischmann. This allocates one weekend to merge the banks’ technologies, while allowing a second weekend for troubleshooting, should this be necessary.

By mid-April, the number of Volksbanken had already fallen from 50 to 31 banks, with another 16 mergers scheduled for the year.

“The mergers are voluntary, which means that the board at every single Volksbank decides that it will be merged separately,” says Mr Fleischmann. This is also why the mergers are not being conducted in any specific geographic order.

“It is a coincidence that the Volksbank Carinthia merger was the first one that was finished,” says Mr Fleischmann, adding that the completion of the mergers in the regions of Lower Austria and Upper Austria will likely take the longest time, as those Bundesländer previously had the largest number of Volksbanken.

Slimming down

The new, slimmer consortium looks set to be more efficient and less risky, because after the transfer of non-core assets very little foreign exposure remains, most of which is in Germany.

The next step is cost reduction. The transfer of some responsibilities allows for synergies within the consortium of banks, as will the mergers.

“At the moment we have a cost-to-income ratio of more than 80%, and we have to get down below 60% in the coming years,” says Mr Fleischmann. He admits that this will have to be achieved through the closure of about 20% of the consortium’s branches and reduction in staff numbers of a similar percentage.

The strategy is to create a network of larger but fewer branches across Austria and to shed employees through fluctuation rather than enforced redundancies. Mr Fleischmann stresses that the wheels are already in motion. “We don’t have the time to wait until we are eight plus two banks,” he says.

Another important step for the bank is the reduction of its product portfolio, from more than 700 to 50. Every bank used to be proud to be independent and created its own products, says Mr Fleischmann. “Now we have to tackle the task of migrating our customers from 700 products to 50. All of that still lies ahead of us, but it is our target to reduce complexity where possible.”

This strategy also means doing “the simple things – loans, deposits and transaction banking – and buying in the rest, which allows us to bring down costs”, says Mr Fleischmann. To that end, for example, Volksbanken have teamed up with Union Investment, after selling its own investment fund provider to the company, and with consumer credit bank TeamBank, both of Germany’s DZ Bank group.

Targeting profitability

Through cost reduction, the Volksbanken consortium wants to return to profitability sooner rather than later, especially as Mr Fleischmann is targeting an upgrade of the banks’ Fitch rating from BB+ to investment grade by early 2017.

There are good reasons for this target: while Volksbanken is a classical retail banking group and has a loan-to-deposit ratio that stands at less than 100%, the consortium will still need access to the capital markets.

“We need the possibility of raising funds through the capital market to make us safer as a banking group,” says Mr Fleishmann, adding that retail banks are at a structural disadvantage with regards to upcoming EU regulation demanding a minimum requirement for own funds and eligible liabilities (MREL), which is part of the Bank Recovery and Resolution Directive. “We have very few bond issues on the passive side because we have a lot of deposits – but under MREL those don’t count, which is why we will have to issue in future.”

With MREL rates expected to be prescribed from the end of 2016, Volksbanken needs to be able to steer its MREL rate by having the option to access capital markets at a reasonable rate, says Mr Fleischmann.

At the time of writing, Fitch was optimistic regarding its BB+ rating on Volksbanken, mentioning a “high likelihood” that the consortium will be upgraded, possibly by “up to two notches, once the execution risk of the consolidation plan has sufficiently receded”.

Profitability will also be central in the process of repaying €300m in government subsidies. Under the agreement with the European Commission and the Austrian state, Volksbanken has until 2023 to settle the debt, but the consortium aims to do so three years early.

“Our plans suggest 2020 is realistic – we should have a capital base of about €2.2bn by then,” says Mr Fleischmann. “We are at €1.9bn at the moment and if we target 10% return on equity then that should be doable.”