Even at the height of the Covid-19 pandemic there was some good news for Bulgaria, as it continued on its path towards joining the eurozone, with its inclusion in the Exchange Rate Mechanism (ERM II) — a major step in the process of adopting the euro currency.
At the same time, measures taken by the authorities and the banks themselves have helped to limit the economic impact of the coronavirus, even as healthcare issues continue to weigh heavily. In the face of the global pandemic, the Bulgarian National Bank rolled out a package of measures worth more than 8% of the country’s gross domestic product (GDP). A moratorium on loan repayments was also put in place.
“It goes without saying that 2020 was a very different and challenging year in all aspects. And of course, the cost of risk and the quality of loans are points of attention,” says Teodora Petkova, chief executive and chairman of the board at UniCredit Bulbank, Bulgaria’s largest bank in terms of assets.
Economy in retreat
Bulgaria’s economy contracted by 4.2% in 2020, according to preliminary data from the National Statistical Institute, after growing by 3.7% in 2019. This compared favourably to the EU as a whole, which shrank by around 6%. At the same time, the Bulgarian banking sector had a solid year.
The local sector performed relatively well during the pandemic. Only profitability has declined
“The local sector performed relatively well during the pandemic,” says Oliver Rögl, chief executive of Raiffeisenbank Bulgaria, who points to the growth in total loans, deposits and assets. “Only profitability has declined, with profit after tax down by around 50%.”
As of the end of 2020, total assets in the banking system grew to Lv124bn ($75.95bn), roughly 104% of GDP and up 8.6% on an annualised basis, according to the Association of Banks in Bulgaria (ABB). The five largest banks represent two-thirds of all assets, an amount that has been steadily growing. Those five banks accounted for 88% of all net profits in 2020, according to ABB.
Teodora Petkova, UniCredit Bulbank
Net profits for Bulgarian banks, meanwhile, dropped 51.4%, to Lv814.7m in 2020, with income down across the board and credit provisions doubling to Lv876.1m over the year. Return on equity and return on assets also more than halved compared to the year before, dropping from 11.8% and 1.5% in 2019 to 5.5% and 0.7% in 2020, respectively, according to Sofia-based First Financial Brokerage House (FFBH).
“The biggest factor for the drop in net profits was definitely the provision charges. Banks are expecting this year that non-performing loans are going to increase, so they’re preparing for this,” says Veselin Radoychev, director of capital markets at FFBH.
Loan growth
In 2020, the Bulgarian banking sector saw overall loans grow by 4.8% year-on-year, with corporate loans up 4% and consumer loans rising by 3.7%. Mortgages surged by 10.1%, aided by strong demand in the residential real estate market. However, interest rates on corporate and mortgage loans have continued to decline, affecting banks’ bottom lines.
“The demand for loans dropped in the first months of the pandemic in Bulgaria, but recovered in the second half of the year to almost pre-crisis levels,” says Petia Dimitrova, chief executive of Postbank, the local subsidiary of Eurobank Group.
At the same time, non-performing loans fell from 6.8% at the end of 2019 to 5.29% one year later, aided by a moratorium on repaying loans brought in during the pandemic.
According to Jakub Kopiec, a director in the financial institutions department at Fitch Ratings, asset quality in Bulgarian banks has been a problem for some time, but the loan moratorium has obscured this issue for the moment. “Before the pandemic, banks were on track to resolve those legacy problems, however asset quality remains among the weakest across banking sectors in central and eastern Europe,” he says.
“On the positive side, most Bulgarian banks were quite quick in front-loading impairments, building up provisions for expected credit losses,” he adds. “We think risk charges will remain elevated in 2021, but materialisation of asset quality risks should not drive risk charges to be significantly higher than those recorded in 2020. Once the economy more solidly picks up in 2022, risk cost should start to come down to more normalised levels.”
Impairments for the banking sector almost doubled in 2020, as part of efforts to control risk. Meanwhile, the capital adequacy ratio of the banking sector rose slightly from 20.2% in 2019 to 22.7% in 2020, even while cost of risk almost doubled from 0.7% to 1.3%.
Liquidity overload
At the end of 2020, the liquidity coverage ratio (LCR) in the Bulgarian banking sector was 279%, up from 269.9% at the end of 2019.
“There is a huge liquidity in the system. Many companies didn’t plan any capex last year because it was a turmoil year,” says Anca Ioana Ionescu, head of Bulgaria at the European Bank for Reconstruction and Development.
Despite this “there are a lot of companies that took working capital or small investments’ loans at a level that is not healthy,” she says. “If you look to the small and medium-sized enterprise sector in general, the level is in the range of five- to six-times operating profit; [in the future] — when the commercial banks will not receive the guarantees from the state or the EU to cover the risk of providing this funding — these companies will face a problem to renew these facilities. This will require a lot of equity to be injected into the real economy. This is an issue to monitor.”
Ms Ionescu adds that in 2020 there was fierce competition between banks, since there were not so many investments taking place. “If you look at the interest margin, the cost of funding decreased fantastically; the risk increased, but the interest decreased in the market,” she says.
Fibank troubles
So far, banks in Bulgaria have largely managed to weather the challenges brought about by the pandemic. One slight exception is First Investment Bank (Fibank), the fifth-largest lender in terms of assists, which required a cash infusion from state-owned Bulgarian Development Bank in June 2020, in exchange for an estimated 19% stake in Fibank. This came about after the European Central Bank uncovered a capital shortfall of €262.9m back in July 2019.
However, there are still concerns over the bank’s ability to turn things around, with the capital increase merely deferring a reckoning over longer-standing asset quality issues.
“Their asset quality remains a problem,” says Mr Kopiec. “Fibank’s impaired loans stood at about 22% of their loan portfolio and they have a sizeable portfolio of repossessed assets, which is an additional burden. The successful capital increase last year has improved their capacity to cushion potential losses, but the resolution of legacy problems will continue to be their main challenge as they are lagging Bulgarian peers in this respect.”
Low interest landscape
Banks around the world have been dealing with low interest rates, shrinking margins and competition from fintech companies for several years.
“According to the latest data, more than two-thirds of [European] banks currently have a profit which is lower than their capital costs,” says UniCredit’s Ms Petkova. “In Bulgaria, the banking sector has not reached that point yet. We still have a return that justifies the cost of capital. At the same time, each bank is adjusting its business model, mainly providing additional value [for] the customers through consulting services.”
Net interest income accounted for 63.6% of operating income for the Bulgarian banking system, as of end 2020. Overall, the sector’s cost-to-income ratio ticked up slightly to 47.1% at the end of 2020, from 45.7% a year earlier.
Postbank’s Ms Dimitrova points out that despite interest rates being close to zero, the banking sector experienced a record growth in deposits, which amounted to 78.4% of GDP at the end of December 2020.
“This is an indirect effect of the pandemic and the limitations created by it,” she adds, while pointing out that this accumulation of funds can be seen as a potential future stimulus for the recovery of the economy, which should happen when the pandemic is under control and people return to their normal lives.
Towards the euro
Bulgaria has targeted joining the euro in January 2024, now that it is included in the ERM II. In October, the country also joined the Single Supervisory Mechanism and the Single Resolution Mechanism, which brought five of the largest banks under the direct supervision of the European Central Bank.
“Membership in the banking union proves that the Bulgarian banking sector is sound and stable, and in a very good condition,” says Raiffeisenbank’s Mr Rögl.
Digital and all distance processes, particularly in the banking sector, will continue to evolve and be the preferred way of everyday banking
The new supervision is also seen as a positive for the sector as a whole, even if the five specific banks were already being supervised indirectly through their parent banks.
“These banks were already indirectly supervised through their parent banks, so we wouldn’t expect anything significant,” adds Mr Kopiec. “We think, overall, from a sector perspective, joining the banking union will be positive in the long term, because it addresses one of the main problems that we’ve seen for the sector as a whole in the past, which was the weaker, albeit improving, supervision.”
Banking run
In 2014, Corporate Commercial Bank (KTB), the then fourth-largest banking in the country, went bankrupt after a run on deposits, prompted by news of questionable deals by the bank’s main shareholder, Tsvetan Vassilev. It was the country’s biggest banking scandal in almost a quarter of a century, and exposed major failings in the banking sector.
An audit showed that two-thirds of KTB’s assets had to be written off because of bad business practises, with only 13% of loans having valid collateral. Mr Vassilev was charged with embezzling about $140m from the bank.
Even at the time, however, the insolvency of KTB was considered to be a political scandal, rather than pure banking one, stemming from a conflict between two oligarchs close to the ruling parties. “The system managed to absorb this crisis, including the trust in it, and the banking sector kept the confidence of the customers,” says Mr Rögl.
Others agree. “The government stepped in, guaranteed all the deposits and everyone received their money, so confidence was restored,” says FFBH’s Mr Radoychev.
M&A potential
Bulgaria’s banking sector could be gearing up for more consolidation deals in the near future.
In late 2019, Postbank completed its merger with Piraeus Bank Bulgaria, creating a bank with a market share of around 10%, the fourth-largest in the country. The deal was the second one for Postbank in just three years, after the integration of Alpha Bank in 2016.
Oliver Rögl, Raiffeisenbank Bulgaria
“This deal strengthened the leading position of Postbank as a systemic bank in the Bulgarian market. It turned us into a bigger and stronger financial institution, while giving us an opportunity to develop an even more ambitious growth strategy,” says Ms Dimitrova.
Others see a need for more mergers in the banking system.
“It’s a €62bn economy with 7 million people, and you have 18 banks. At the end of the day that’s too many banks in a low interest-rate environment, so consolidation should be expected,” says Mr Kopiec, who points to recent deals that included OTP Bank subsidiary DSK Bank buying Expressbank from Société Générale Group, which was also concluded in 2019; the merger of Postbank and Piraeus Bank Bulgaria; and before that the 2017 acquisition of United Bulgarian Bank by the local subsidiary of KBC.
“We think once the uncertainty of this year subsides, we should expect further consolidation of the banking sector,” he adds.
Of the banks operating in Bulgaria, just eight now have domestic owners, accounting for less than a quarter of assets, a trend that is only likely to increase.
Digital uptick
Those in the sector believe that the pandemic could ultimately help Bulgaria, specifically when it comes to catching up with some of its peers in the adoption of digital banking and fintech solutions.
“Before 2020, the pace of digitalisation of the banking services was not the same as in other countries,” says UniCredit’s Ms Petkova, before adding that the pandemic has greatly accelerated the digitalisation of banking products and services in the country.
“In 2020, utility payments through the online banking channel increased by 50%. Since the beginning of 2019, our mobile banking customers have grown by more than 65% and are now half a million,” she says. “Digital and all distance processes, particularly in the banking sector, will continue to evolve and be the preferred way of everyday banking, even after we forget about Covid-19.”
Ms Dimitrova suggests that the pandemic has proven to be a catalyst “not only for the digitalisation of the banks, but an incentive for financial literacy of the customers. It successfully shifted attitudes, a change which we would have waited years for in normal circumstances.”
