The year 2015 is set to be a year of change for the Hungarian banking sector. The 2014 conversion agreement on the country’s foreign exchange (FX)-denominated loans suggest that an end to Hungary’s FX mortgage saga is in sight – a development that should help reduce the banking sector’s high number of non-performing loans (NPL). Moreover, a memorandum of understanding (MoU) between the government, the European Bank for Reconstruction and Development (EBRD) and Hungary’s Erste Bank brings with it hope that there will be a reduction in the bank levy and, more generally, an improvement in sentiment towards the industry.
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For years, Hungary's banking sector has been plagued by losses on loans, especially mortgages denominated in Swiss francs and euros, as exchange rate fluctuations following the collapse of Lehman Brothers in 2008 made borrowers’ repayments exorbitant. Customers, many of whom chose FX loans over the forint-denominated equivalents as they offered much lower interest rates at the time, ended up with much higher monthly repayments than they had anticipated when they signed their loan agreements. A subsequent eviction moratorium for FX debtors meant that banks saw their non-performing assets soar.
FX loans saga
In an attempt to end the FX lending saga, in 2014 the Hungarian government passed the Fair Bank Act and HUF Conversion Act – legislation that requires banks to compensate customers for what the government has deemed ‘unfair’ interest rates demanded in the past, and offer FX loan customers the option to switch to forint-denominated products with fair interest rates.
“It is a huge logistical challenge for the banks, but also a financial challenge because it is not just about conversion but also repayment of the bid-ask spread and retroactive repayment of the interest rate increases that took place between May 1, 2004 and the end of last year,” says Radován Jelasity, CEO at Erste Bank Hungary. “I am looking forward to the day when I can say that all FX mortgage loans are now forint-denominated, which [will put] us in a completely different financial perspective.”
The cost of these new rules were high for the country's banks. Lenders had to make significant provisions for the financial year 2014 for the expected repayments related to the Fair Bank Act, which mean most banks expect to report losses in the year. However, the decision to set the conversion rates for the FX loans in November allowed the country to dodge a bullet that has hit central and eastern European countries as a result of the Swiss central bank's decision to lift its peg to the euro in January: a soaring Swiss franc.
“Hungary has been spared from the worst,” says Heinz Wiedner, CEO at Raiffeisen Bank in Hungary. “For all the Swiss franc mortgages, practically all of the FX risk has been eliminated because the conversion rate was fixed with the national bank [in November].” In Hungary, the exchange rate was set at Ft256.47 per Swiss franc, compared to the market rate of Ft287.54 as of March 10, 2015.
The conversion agreement might hurt now, but banks are expected to benefit from it in the future. Expectations within the industry are for a return to profit in 2016. In the long term, the Hungarian central bank projects that banking sector profitability will be between 10% and 12% when it comes to return on equity.
Combating NPLs
One of the drags on banks' performance in recent times has been high NPLs, and especially those related to FX mortgage loans. The work out of these bad assets was problematic as a moratorium on FX mortgages did not allow banks to foreclose, and even tempted some customers who were able to pay their instalments not to do so.
“There was a certain moral hazard [in the system] because the government kept promising interventions to the benefit of retail customers and some customers just stopped paying, waiting for the solution,” says Hendrik Scheerlinck, CEO at K&H Bank. “So we hope that after this settlement and conversion act the bulk of the moral hazard will disappear from the system, and that there will be improvements in the NPL ratios because of that.”
In Hungary, banks are largely trying to work out loans in house, and the increasing certainty over the recovery potential in the non-performing portfolios should make the process easier. The principles and interest rates will be lower and so will the servicing burden on customers. Plus, there will be a principle reduction in NPLs, which should lead to more joint solutions with customers.
Increased certainty is also attracting strategic investors. “We are now seeing interest from investors from the region in buying distressed assets in Hungary,” says Csaba Ember, head of banking and finance at law firm Gide Loyrette Nouel in Hungary. “That would be the first time we would see purchases of distressed loan portfolios in Hungary by foreign investors. People were waiting for regulations to come into effect as a prerequisite, and now we expect to see the business of buying distressed portfolios develop further.”
Another potential new buyer of NPLs, specifically bad commercial real estate loans, is a vehicle being worked on by Hungary’s central bank. This new asset management company received a €1bn credit line but it has not started working yet, according to Ádám Balog, deputy governor of Magyar Nemzeti Bank, the central bank of Hungary, as the best framework for it is yet to be found.
“This company will act like a market player and will buy impaired loans, claims and foreclosed real estate from the banks,” he says. “In all cases, the original asset was a commercial real estate loan but the assets might have become real estate in the meantime. The project loan part of the NPL portfolio is much more concentrated among banks – we are talking about a couple of hundred assets on the banks’ balance sheets.”
Government intervention
Another game-changing development is the MoU between the government, the EBRD and Erste Bank.
“We committed ourselves not to acquire a majority stake in any banks that play a systemic role in the country,” says Mihály Varga, Hungary’s minister for national economy. “So, the fear of foreign banks that the Hungarian state wants to swallow everyone is unjustified. The proportion of the banks with majority Hungarian ownership is about 50%. That is a healthy balance between foreign and domestically owned banks, and we do not plan to introduce anything to change this equilibrium.”
This comes after the state’s acquisition of Bayern LB’s subsidiary MKB Bank and GE Capital’s Budapest Bank last year – both of which were previously foreign-owned banks. The acquisitions were in line with the government's strategy to see at least 50% of the banking sector in domestic hands.
The two institutions are expected to be merged, which would make the consolidated business “sizeable enough to be profitable and able to compete with other market players,” according to Attila Gyurcsik, head of research at Hungarian financial services provider Concorde Securities. He adds that MKB was a corporate bank with project loans accounting for the vast majority of its portfolio, and the majority of these bad, while Budapest Bank was a half-retail, half-corporate bank.
“Ideally, in three years’ time, the Hungarian banking sector should have five or six bigger banking groups that compete with each other and have the economies of scale to generate profit,” he says. “That would remove a lot of issues.”
In the MoU, the government has committed itself to “privatise assets in state-owned banks in the next three years”, says Mr Varga. “In order to give enough incentive for the banks to provide loans”, the bank tax will be decreased – first in 2016, and then further between 2017 and 2019. The government will not initiate any legislative changes without having previously given information on the changes to the banking association.
“In exchange, the EBRD, as well as Erste Bank, have made serious commitments to boost lending activity,” says Mr Varga. “Without lending, there is no investment, there are no new jobs and we don’t have growth. The time has come for this co-operation because interest rates are now low, FX loans will soon cease to be problematic and we have stable public finances and balances. The central bank's FX reserve is at a good level, so now we are in an economic situation that has allowed us to come to such an agreement with the banks.”
The agreement also includes the option for the government and the EBRD to each acquire a 15% stake in Erste Bank’s Hungarian subsidiary. The funds from such a purchase would then likely be earmarked for Erste’s bid to acquire Citibank’s retail operations in the country, according to Mr Gyurcsik, which have been put up for sale.
Competitive market
Erste and the EBRD have pledged to support the Hungarian economy over the next three years through a €550m loan disbursement programme, which includes a €250m complete financial package for public sector employees, a €100m lending package for energy efficiency programmes and a €200m loan facility to primary agricultural producers.
Erste is the country’s second largest bank in the retail segment and it is looking to expand through portfolio acquisitions, according to Mr Jelasity. Its main competitor, market leader OTP, is also looking to grow – both organically and through acquisitions.
OTP has by far the largest share in Hungary's retail banking market – about 30% – and has increased its share in corporate lending from 7% at the end of 2008 to 13% at the end of 2014. “In corporate, for us, the most important target strategically is the small and medium-sized enterprises,” says László Bencsik, chief financial and strategic officer at OTP Bank. “We have a particularly strong focus on the agricultural sector, where we have very aggressive targets to achieve a 20% market share in a few years.”
The mid-cap sector has seen an increase in lending activity in 2014, thanks to the central bank's Funding for Growth programme, which provides banks with funding at no cost to lend to mid-caps at a low margin. “This instrument has a very well-designed structure and has helped a lot to kick start growth,” says Mr Bencsik. “I believe, this programme made a strong contribution to the spectacular 3.6% GDP growth [Hungary] saw last year.” (See interview with Mr Varga.)
K&H, the second largest bank in the country by assets and Tier 1 capital as of 2013, is also focusing on organic growth. The Belgian-owned bank has increased its market share in lending from 8.5% to 9.6% between 2013 and 2014, with an increase from 8.3% to 10% in corporate lending.
“If certain portfolios are put up for sale we would probably take a careful look at them, but the strategy is organic growth, for that we have the capital, the support of the parent bank and the liquidity,” says K&H's Mr Scheerlinck. The bank also has a very successful asset management business, the funds of which recorded average compounded annual growth of 10% last year, he adds.
Beating a retreat
Raiffeisen Bank has decided to step back from mass retail banking in Hungary and instead focus on corporate customers, affluent customers and private banking, where it already has the second largest market share in the country behind OTP and enjoys a good reputation, according to Mr Wiedner. “You need scale in mass retail banking in Hungary, then you can make good money with it,” he says. “For us, there were two options: either acquire more or focus on targeted segments on the retail side – and we opted for the second option.”
Mr Wiedner adds that Raiffeisen’s retail operations are sizeable, and still contribute more gross income than its corporate business, which is why portfolio sales or a complete exit from the sector is not on the agenda. However, the new focus means that the bank does not need all of its 115 branches, and it has said that it would consider selling or closing some of these.
Raiffeisen is also strong in export financing – it had a 40% market share in 2014 – and the bank is further refining its focus in this area by targeting large and medium-sized companies.
Affluent private customers and corporate clients are also being targeted by UniCredit. “We are the number one bank for multinationals,” says Mihály Patai, chairman of the management board and CEO at UniCredit in Hungary. “For example, in our custodian business and in global transaction banking, we have a 30% to 40% market share in Hungary, which speaks for itself and we want to keep this.”
The Italian bank is one of the institutions that are likely the least affected by the FX mortgage saga, thanks in part to its traditionally corporate-oriented business mix and its more cautious policies relating to FX lending.
Maturity mismatch
For all its positive impacts, the conversion of the FX loans to forint also revealed a weakness in Hungary's banking sector: a significant maturity mismatch owing to a lack of long-dated funding in forint. To combat this, the central bank is working on additional macro-prudential regulation.
“We need to set up certain requirements for the future – in about one year – to say what the required level of long-term forint funding is that the banks will have to have,” says Mr Balog. “The clear way forward is for banks to sell longer mortgage bonds, but that is an area that is in massive discussions at the moment. It is important to mention that this is not additional funding but a structural change in the funding, from shorter to longer term funding, which may be a little costly but less risky.”
While there is a maturity mismatch, banks’ funding bases have changed significantly, having moved from the liquidity-import years before the financial crisis – with, at times, inflated loan-to-deposit ratios – to ratios of less than 100%. It could be argued, under these circumstances, that there is no need for the planned regulation, but the maturity mismatch could cause risks.
“Without a mortgage bond market, banks will offer short-term loans [to customers], and that creates a lot of interest-rate risk, given that interest rates are very low now,” says Mr Gyurcsik. “It is absolutely rational to revive the mortgage bond market and in that way provide savings for the bank and breach the duration gap.”
He expects the central bank to provide the liquidity to support this market at first, but says that it would “create itself sooner or later”.
As of March, only OTP, state-owned mortgage bank FHB and UniCredit’s mortgage banking business were allowed to arrange such mortgage bonds, which could bring additional revenues for the three banks. Plans might still be amended, however, and mandates to arrange such securities might yet be extended to more or all banks.
