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RegulationsJune 1 2008

Peripheral but a pool of potential

Banks have made little impact on the Hungarian economy. Is that what is keeping US players interested in the market? Nick Kochan reports.
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Will they, wont they? The question is all the buzz in Budapest at the moment as it has long been rumoured that two US-owned banks in Hungary will quit the city. Now the buzz about GE Money’s Budapest Bank and Citibank Hungary is at fever pitch. According to local bankers, US investment banks are touting these banks around the existing larger players in Hungarian banking, in particular OTP, Raiffeisen and Erste. One banker went so far as to say that the US parent of one of the two banks had hired Goldman Sachs to sell it.

Local banks say they do not understand why the US banks stay in so peripheral a market, in the centre of Europe, with a small population of just 10 million and a slow-growing gross domestic product (GDP). Budapest Bank has a niche client base of small and medium-sized enterprises (SMEs) and retail clients, while Citibank offers some treasury products to larger corporates and issues credit cards. They each have about 5% of the entire market and prop up the table of substantial players in the market. The Hungarian market is dominated by OTP, which has about 30% of market share. ­Raiffeisen and Erste have about 10% of the market each. Other significant players are CIB and UniCredit.

Against the Americans

Edit Papp, chief executive of Erste Bank in Hungary, leads the charge against the Americans. She asks: “Is GE going to sell or close. It is not increasing its market share. What is its strategy? Why is it here?”

Another banker, who did not want to be named, says: “I keep hearing the rumour that GE Capital will have a change of mind about staying in ­Hungary. We are a relatively small country performing below average and it won’t change in a big way over the next couple of years. There are more banks than is necessary to serve the market. Budapest Bank definitely ­doesn’t meet the yield requirement that GE demands from its financial services subsidiaries and this has been the case for the past 15 years. One wonders how long it will put up with this.”

The same banker also has doubts about the willingness of Citibank to maintain a presence in Budapest, although he gives it more credit for its performance to date. “Citibank is different from Budapest Bank. It is doing a good job in terms of return on equity and profitability but it is not an important local bank. If Citi has the ambition to be important, that goal is not achieved in Hungary,” he says.

He says that Citi is a “very lean, basically mono-product type of organisation, with credit cards and consumer loans. It services a very narrow segment of treasury and custody and is a very niche player. Citi’s Hungarian operations amount to no more than a rounding difference on the balance sheet from the perspective of its headquarters in New York. These groups are heavily affected by subprime, and they are taking a very harsh look at all their operations.”

Long-term commitment

The rumours are speculative and ­fallacious, insists Dmitri Stockton, president and chief executive of GE Money CEE. He says categorically that GE Money is not planning to withdraw from the Hungarian market. “This is a core strategic market and we are committed to investing there for long-term growth. GE Money plans to invest $200m in 2008 in the central and eastern European region, including approximately $55m in Hungary.”

The money will be spent on IT in the Hungarian market, adds Mr ­Stockton. And he insists that “there is not going to be a change in the ownership of Budapest Bank and we have not been approached by other banks regarding a merger. The emerging mar­kets of central and eastern Europe are critical to GE Money’s growth strategy”.

Mr Stockton says that the bank grew above the market average in SME and consumer lending last year, and annual asset growth was more than 20%. “We have built a strong position in the market and intend to remain there,” he says.

Citibank is no less robust in asserting that its position in Hungary is secure. Laszlo Balassy, managing director of Citi markets and banking in Budapest, says that suggestions that the bank might pull out of the country are “ludicrous”. “Citi is about having a global presence and global network. It is one of our core propositions to serve global clients. We are very liquid, we are doing incredibly well here. We are expanding our branch network,” he says. He also points to the absence of visible preparations for any withdrawal from Hungary. “You would see certain signs when you get ready for a sale process, and the signs aren’t there. Quite the contrary, we are expanding our consumer business.”

Local fears

Mr Balassy attributes the rumours to fear among local banks that are concerned that the US banks are preparing for a surge into the Hungarian market. “A lot of people would like to see us leave, and not get it more right than we have so far. It is scary to look at all the things Citigroup can do if it just had a bit more local focus. This will hopefully come with our recent international restructuring. There are people in the market who are a bit frightened,” he says.

He admits that the bank has underplayed its position in the market. “We have been ambling along at 5% market share and 30% return on equity for quite some time,” he says. “People have been asking why we don’t focus on this or that. Now we are starting to get more focused. Other people are starting to worry that we are waking up and getting more proactive and investing more. They are getting nervous and want us to leave.”

Citigroup has stayed out of the booming Hungarian real estate market as a deliberate policy, says Mr Balassy. “The Hungarian market has fallen in love with certain products that Citi doesn’t like to do. Citi participates in real estate advisory and larger transactions, but we don’t fund construction projects.”

Market attractions

Changes are taking place in the market that favour the Citi offering, says Mr Balassy. Hungary has developed from a post-transition market in which banks were seen simply as depositories for cash and places to borrow. Customers and corporates are now looking for products that will improve their internal rates of return, he says. In particular, he anticipates a growing interest in financial products, such as foreign exchange, cash management, derivative transactions, hedging and risk management.

The same trends are perceived at Erste, which has recently established an investment banking operation in the country. “Customers will be more quality sensitive and they will be able and willing to pay for quality services. So the fees will be more important. More sophisticated products will come into the picture,” says Ms Papp. Erste has started to offer some structured bonds and structured deposit products in Hungary.

“Customers are getting more sophisticated about buying loans and credit. It is still a cash-focused country, but transactions and direct debits are becoming more important. Customers are willing to pay for the services,” she says.

Ms Papp believes there is a wider opportunity in the retail and consumer sector more generally. “The retail banking market is going to grow, the economy is growing, GDP per capita is going to grow, because banking penetration is growing, because the products that clients use are going to grow. Clients will take more products, they are quite price sensitive.”

Wealth management products are also becoming increasingly significant. They form part of a strategy for many local banks to build a fee-based business aimed at a growing number of individuals in the region who have a significant amount of private wealth. Tamas Schenk, a director in the strategy and economic research directorate at OTP, says: “Banks are rebalancing their consumer portfolios” to target high-net-worth individuals.

Room for growth

Banks have made relatively little impact on the Hungarian economy and bankers believe there is much to play for in terms of launching products and reaching clients. “The banks have a low penetration and there is a lot of room to make progress. Hungary is at the same level in terms of credits and loans as Portugal and Spain were in 1995, before they entered the eurozone,” says Mr Schenk. He expects Hungarian household lending to grow by 5% of GDP every year.

At present, the ratio of banking assets to GDP is 80%, against 300% of GDP in western Europe, says Mr Schenk. “It is perfectly possible it will move from 80% to 150% in the next five to 10 years. We won’t close the gap with western Europe for a very long time, but it will narrow.” He expects this growth to be dominated by consumer lending.

In the short term at least, this could be a pipe dream, says Peter Felcsuti, managing director of Raiffeisen Bank in Hungary. He foresees considerable strain on the Hungarian banking sector as it struggles with the credit crunch and domestic economic hurdles. “The banking industry has had seven fat years. Consumption picked up after Hungary joined the EU and there was a huge demand for consumer and corporate banking services,” he says. “The banking industry exploded in reaction to the demand. The industry had all the skills to react to the demand and was the most dynamic and profitable segment of the economy. The fat years could not last for ever.”

Saved by austerity

Mr Felcsuti says that the downturn in consumer demand was triggered by austerity measures introduced in 2006 by the Hungarian government as it grappled with an exploding fiscal deficit. This curbed GDP growth from 5% to less than 2% in the course of a year. The measures, however painful, saved the country from the full impact of the subprime crisis and the subsequent liquidity squeeze by reducing the levels of external debt that needed ­refinancing.

Even so, ratios of loans to deposits in the country are 1.3x to 1.5x, and Mr Felcsuti says banks are struggling to make up the differential on wholesale credit markets. “International liquidity is expensive, scarce and not available for longer term. That is a strategic challenge for banks active in the region,” he says.

The banks in some less developed emerging markets have barely begun to extend consumer credit, so they can continue to fund new loans purely from deposits. But Hungary is already a more mature market with a lower prop­ensity to save. “There remain serious quest-ions about the banks’ business model. This is the biggest challenge facing Hungarian banking,” says Mr Felcsuti.

Margins are under pressure in the local market, he says, although many institutions have a cushion of reserves built up during the seven ‘fat’ years. “Banks have been very profitable over the past couple of years and some will decide to give up part of their profit margin to win market share. The industry is moving in that direction,” says Mr Felcsuti.

Softer subprime impact

An underdeveloped mortgage market protects banks from the worst excesses of defaults threatening some of the country’s western European partners. Bankers say that Hungary has been spared an asset bubble because its lending processes have been conservative. They point to the relatively low price of flats in Budapest against those in Bucharest, the capital city of Romania, where lending was less controlled.

Even so, the market will not escape the impact of international conditions and Erste and Raiffeisen have added some provisions for an increase in non-performing loans. According to Ms Papp: “We have added to provisions in both the consumer and business side. But we are a very conservative bank and merely see these as cushions. We don’t expect to need to draw on them.”

Moreover, in contrast with the struggling consumer sector, the SME and even large corporate sector may offer opportunities to win new business. Ms Papp says that Erste regards SMEs as an important target market and she pinpoints some key sectors. “Machinery is performing well, especially where they target exports. However, the building sector has been hit by government cuts. Agriculture has stagnated but agricultural companies are financially sound. Credit worthiness has not deteriorated in terms of clients going bankrupt and we have not required many more provisions than in the previous year.”

Positive signal

As for large companies, there are few opportunities in a market where consolidation is far from complete. But one deal indicates that US players are still very active in the country’s investment banking scene, specifically Goldman Sachs. The bank is defending local oil distribution company MOL in the face of a takeover bid from OMV, the ­Austrian oil company that is largely owned by the state and a Gulf sovereign wealth fund.

The defence has won considerable acclaim in the local market. Goldman has harnessed the efforts of the government, which regards the company as a strategic asset. But the bank has also orchestrated an impressive number of institutions as share buyers, including the Oman oil company. Observers say that Goldman has energised a local market that was previously dormant.

It is understandable why US banks would regard their operations in this smaller market in central and eastern Europe as peripheral. But equally, there may be enough indicators to believe that Hungary has potential waiting to be unlocked when more favourable economic conditions spread across the region.

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