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Winners and losers in the downturn

One of the world’s fastest-growing regions during the boom years, eastern Europe became one of the major victims of the credit crunch as aggressive lending strategies turned sour. But there are still plenty of banks in a position to thrive. Writer Jan Cienski in Warsaw.
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If Jan Krzysztof Bielecki radiates satisfaction as he sits at his conference table, decorated with a bust of Adam Smith, it is because the head of Poland’s largest bank has been proved right.

For years, Mr Bielecki, CEO of Bank Pekao, a unit of Italy’s UniCredit, warned that his fellow bankers were making an enormous mistake by peddling loans denominated in foreign currencies, mainly the Swiss franc. His bank only offered Polish zloty loans, which left it handicapped in the fast-growing, lucrative mortgage market during Poland’s recent real estate boom.

But over the past couple of months, the banking environment in Poland has changed dramatically. Many of the most aggressive banks have scaled back or eliminated foreign currency lending, increased their margins, and dramatically ramped up downpayment demands from their customers. Low-interest Swiss franc loans are now difficult to arrange and many Poles, spooked by the recent falls in the zloty against the franc, are much more eager for a zloty loan.

Changing customers

“We’ve been waiting for five years for this to come to pass, to be able to show what a conservative bank really is,” says Mr Bielecki, who served as Poland’s prime minister in 1991. “We haven’t changed, it is the customers who have changed.”

In the tally of winners and losers among central Europe’s banks, that is enough to put Bank Pekao in the former category – although that has not prevented its shares from falling by about 50% this year.

Mr Bielecki’s conservative approach has left the bank with 6bn zlotys (€1.5bn) in cash-in-hand, and a loan-to-deposit ratio of 85%, something he does not plan to change.

“We will increase our credit depending on the increase in deposits,” he says. For the first three quarters of this year, the bank reported a net profit of 2.8bn zlotys, 2% higher than the same period a year earlier, and a return on equity (ROE) of 24.3%.

At the other end of the scale in terms of risk-taking sits Leszek Czarnecki, one of Poland’s wealthiest men, and the owner of Getin Bank, one of the most aggressive players in recent years on Poland’s mortgage market.

Getin, the country’s 10th largest bank and one of the few that is not foreign-owned, has a loan-to-deposit ratio of 111%, and about 97% of its loans are denominated in Swiss francs, favoured by many Polish borrowers because of their lower interest rates.

Until now, that strategy has paid big dividends. In the first three quarters of this year the bank’s holding company reported a profit of 443m zlotys, a 41% increase on the same period in 2007, and an ROE of 29%. In 2006, the bank had a profit of only 123m zlotys. But the credit crunch has hit the bank hard. It has withdrawn from offering foreign currency loans, and even for zloty loans will only offer a 70% loan-to-value ratio.

“We have strongly limited our credit action and we are also attracting new deposits,” says Mr Czarnecki. His bank used to be one of the most aggressive mortgage loan advertisers on the market – now it is just as aggressive about trying to attract deposits, offering a 9% annual rate for four-month deposits. “The bank is dramatically increasing its liquidity,” he says.

Squeeze on profits

The result is likely to be a squeeze on profits next year, and the bank’s shares have plunged by about two-thirds since the beginning of the year, but Mr Czarnecki is not worried, pointing out that Getin has one of Poland’s lowest cost structures.

That has not dissuaded rating agency Moody’s from changing the outlook on the bank to negative from stable, noting that its lending expansion was based on borrowed funds, and warning of asset/liability mismatching. The agency also downgraded another aggressive mortgage lender, BRE Bank, a unit of Germany’s Commerzbank, and Bank Millennium, owned by Portugal’s Millennium BCP, which had 80% of its loans denominated in foreign currency.

Overall, about 58% of Poland’s outstanding mortgage loans are in foreign currency, most in Swiss francs, although the ratio is expected to change as foreign exchange loans fall out of favour. “The question is whether foreign currency mortgages will be replaced by Polish zloty loans, which raises profitability issues for banks that had relied on foreign currency lending,” says Artur Szeski of rating agency Fitch. “Banks that have had less aggressive lending will do better in the potential downturn.”

Although Getin, BRE and Millennium are all at the riskier end of the spectrum, they are not considered at risk because of the general strength of the Polish economy, which is expected to record positive growth next year despite the crisis. The finance ministry forecasts growth of 3.7% and the central bank says 2.8% is likely – better than almost anywhere in western Europe.

“There is no financial crisis in Poland,” says Slawomir Skrzypek, Poland’s central bank governor. He adds that the banking sector “is already showing certain symptoms of improvement”.

Slowdown on cards

Even though a slowdown is likely, lending by Polish banks is continuing to rise, with consumer credit growing by an annual rate of 43% in October 2008 compared with the same month in 2007. Meanwhile, mortgages rose by 32%. For the first three quarters of the year, Polish banks earned a record 11.9bn zlotys, compared with 10.5bn zlotys a year earlier. Non-performing loans comprise 5.6% for commercial loans and less than 1% for mortgages.

“The quality of the credit portfolio is high,” says Mr Skrzypek, adding that average bank capital is 11%, far above the minimum requirement of 8%. The bank has also assisted with euro and franc swaps and liquidity boosts, and the government has doubled deposit guarantees to €50,000.

The strength of the economy also provides cover to Slovakia and the Czech Republic, which both have one of the highest ratios of foreign bank ownership in the world, at above 90%. Slovakia is a special case because it is due to adopt the euro next year and has been only slightly affected by the financial crisis. Although the country is overly dependent on the vulnerable car sector for the bulk of its exports, it is predicted to be one of the fastest growing economies in the EU next year with an expansion of 4.9%, down from 7.1% this year.

Foreign currency lending was unknown in the Czech Republic because interest rates have long been below those of the European Central Bank. As in Poland and Slovakia, local banks did not dabble in exotic securities that have since turned toxic.

Low exposure

“The financial sector has a lot of local profit opportunities, so Czech banks did not have to hunt for higher yields with structured assets,” says Zdenek Tuma, governor of the Czech central bank. “We have a very low exposure to toxic assets, I can hardly imagine any need for recapitalisation.”

So far, the country’s banks have proved to be resilient in the face of the crisis. Ceska sporitelna – the republic’s largest bank, owned by Austria’s Erste Bank – reported a record profit of 14bn korunas (€537.7m), a 2bn korunas increase over a year earlier. “We are in a better situation than in many other countries,” says Gernot Mittendorfer, Ceska’s CEO. The bank has a 67% loan-to-deposit ratio, similar to most other Czech banks.

The so-far solid position of Poland, Slovakia and the Czech Republic has proved to be a boon for their foreign owners. Erste Bank has placed an enormous stake on the region, together with Raiffeisen, and Bank Austria, now owned by UniCredit. So far those bets are paying off. Raiffeisen reported a consolidated income of €861m in the first three quarters of the year, up by 38%, while Erste reported a net profit of €271.9m, a 34% increase.

“We have done reasonably well and we will continue to do reasonably well,” says Manfred Wimmer, Erste’s CFO. “With the exception of Hungary and Ukraine, all of our markets will grow substantially more than in western Europe.”

Michael Steinbarth of Fitch Ratings says that central Europe has proved to be a solid bet for Austrian banks, accounting for more than half of their profits.

The flipside of enjoying the still-solid growth of some of central Europe is the increasingly dilapidated state of some other economies, particularly Hungary and the Baltics, and the banks with a large exposure to those markets are likely to feel the full force of the financial crisis.

‘There will be no growth in Hungary this year,” admits Mr Wimmer. In an analysis of the region, rating agency Standard & Poor’s (S&P) has revised upward its banking industry risk assessment for Slovakia, Slovenia and Poland, while lowering it for the three Baltic countries and placing Hungary under review.

While groups such as Erste, Raiffeisen and UniCredit can balance their exposure between shaky countries and strong ones, local banks with no strong foreign parents are much more exposed, none more so than Hungary’s OTP.

OTP reported a strong profit in the first nine months of this year, although taken alone, the third quarter showed an 11% drop in profits, and the bank increased its bad loan provisions and lowered its profit guidance for the whole year as the economic crisis in Hungary begins to bite. Hungary has had to be rescued with the help of a $25bn package led by the International Monetary Fund (IMF).

Hungarian banks are particularly exposed because about 85% of their mortgage loans are denominated in foreign currency (mainly Swiss francs) and borrowers have been hit hard by the forint’s steep decline.

OTP had been very active in foreign currency lending and had recently dabbled in the extremely risky practice of lending in Japanese yen. In a recent call with analysts, OTP’s chief financial officer, Laszlo Urban, said that the bank is moving away from foreign currency loans. “Going forward, the composition will certainly change.

Swiss franc-denominated new issuance is extremely limited and probably the yen practically also ceases to be extended any further,” he said.

OTP has been downgraded by rating agencies, with S&P noting: “We expect the financial profiles of OTP, the largest domestic bank, and its mortgage subsidiary, to come under increasing pressure from its operating environment.” Although the bank has been expanding its international operations to diversify exposure outside Hungary, it has moved into countries such as Russia and Ukraine, whose economies have also been affected by the crisis – Ukraine has also approached the IMF for financial help.

Despite the turmoil, Mr Urban says that Hungarians proved to be quite resilient during their previous economic crisis, just two years ago. “We can give some room for our clients to continue to service their loans properly, without having to increase their monthly debt service during these very critical one or two years that are coming for the Hungarian economy, resulting from a very likely macroeconomic recession,” he says.

Banks in the Baltics are also being burned as double-digit growth rates turn into recession. The hardest hit is Latvia’s Parex, nationalised after a high level of withdrawals led authorities to fear a run on the bank. Its troubles have raised questions about other small, locally owned banks in Latvia and Estonia.

“In a global context, the Baltic banking sectors are considered to be riskier than average. They also compare poorly within central and eastern Europe,” says S&P.

Scandinavians survive

Parex was long seen as one of the most vulnerable banks in the region because it had relied on non-resident deposits from Russia and the rest of the former Soviet Union, but then had loaned aggressively, putting itself at risk in the event of a capital outflow. This was what happened when the local economy deteriorated and falls in the Russian stock market hit non-resident depositors.

“Clearly, they are a loser in this scenario,” says Mark Young, managing director of Fitch’s financial institutions team. He adds that the banks that will do best are the deeper-pocketed Scandinavian banks, which dominate the region.

The banks that have been least successful are those in the countries that have done the worst – that is Hungary and the Baltic trio. In countries such as Poland, the Czech Republic and Slovakia, which have so far escaped the worst of the financial crisis, the banking sector has not yet been subjected to the extreme stresses that could cause some of the banks with a higher risk profile to stray into real danger.

“"Poland, the Czech Republic and Slovakia’s banking systems are looking best placed, while there are concerns about Hungary and the Baltics, which look the most vulnerable. There are also growing concerns about Bulgaria and Romania, with warning signs beginning to flash,"says Mr Young.

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