Lenders in Eastern Europe Bet on Recovery

By Stefan Wagstyl and Patrick Jenkins

The Financial Times

Leading banks investing in central and eastern Europe are betting the region will this year start to recover from the economic crisis.

UniCredit of Italy plans to open 100 branches across central and eastern Europe (CEE); Austria’s Raiffeisen International is launching an internet-based banking service; and Erste, also of Austria, is opening 70 branches in Romania, home to its largest CEE business.

These moves come amid signs of a slight pick-up in credit growth in some countries, such as Poland, in late 2009, which bankers hope will continue. Federico Ghizzoni, head of UniCredit’s CEE operations, says: “I would see 2010 as a year of transition with the first signs of recovery coming.”

But confidence is fragile, with credit agencies highlighting dangers ahead. Fitch this month warned that banks face possible “event risks” such as a devaluation, a run on an international bank active in CEE or “social/political pressures arising from economic conditions”.

Capital Economics, a research group, says “the region’s banking sector is not yet out of the woods”.

The financial disaster that threatened the region a year ago has not materialised thanks to public support led by the European Union and the International Monetary Fund, better-than-expected economic performance in key countries and the resilience of western banks in CEE.

Last year the region plunged into recession, with an average drop in gross domestic product of around 7 per cent. While economists are cautious about 2010, they are upgrading growth forecasts slightly to almost 2 per cent. There will be no quick return to the pre-crisis boom. But total financial collapse now seems most unlikely. Poland, the Czech Republic and Slovakia are coming out of the crisis in particularly good financial shape. A recent 5.1bn zloty (.8bn) successful share issue by Poland’s state-controlled PKO Bank Polski, the country’s largest, illustrates investor confidence.

But elsewhere the outlook is more difficult. The Baltic states are in deep recession. Hungary, which was in economic trouble even before the global crisis, is still struggling to regain investors’ confidence. Romania and Bulgaria, where the global crisis came late, face continuing recession in 2010. So does Ukraine, with policymaking crippled by political infighting.

In these states, banks are struggling with mounting non-performing loans. According to Capital Economics bank NPLs now total 9.5 per cent of assets in Hungary, 11.2 per cent in Romania and 14.5 per cent in Latvia. And things could get worse. In a stress test last month, Austria’s central bank assumed CEE loan-loss provisions would jump to 16 per cent (from 4.6 per cent at the end of September).

As the tables show, banks are well capitalised, but there are other key differences between countries. In Poland, the Czech Republic and Slovakia, liquidity is good, with deposits close to or exceeding loans. But in Hungary loans are 150 per cent of deposits and in Latvia 280 per cent. Foreign exchange loans, which add an extra dimension of risk, are negligible in Slovakia, which has joined the euro, but are more than 90 per cent of all loans in the Baltic states.

Mr Ghizzoni does not expect NPLs to rise much, since the rate of increase was already slowing in late 2009.

Herbert Stepic, chief executive of Raiffeisen International, says that while NPL growth is slowing overall, it remains high in countries still in recession. “But, what we have now in CEE is a success story because, unlike many banks working in the west, we are still working profitably despite the difficult repercussions of the crisis on the region’s economy.”

Nonetheless, growth this year will be modest – “below 10 per cent” in terms of credit expansion, according to Mr Ghizzoni – which Piroska Nagy, a senior adviser at the European Bank for Reconstruction and Development, attributes to “the heightened risk perception of banks”.

There are sharp differences in performance among banks. The most significant casualties have been among locally-owned, non-state banks, headed by Parex, the Latvian lender that has been rescued and nationalised and will be offered for sale. A string of Ukrainian banks, including Prominvestbank, one of the largest, ran into trouble. OTP, the region’s biggest non-state locally controlled lender, received government aid but is now repaying it. Among western banks, only one has so far required rescuing because of its CEE exposure – Austria’s Hypo Group Alpe Adria was nationalised last month.

Austria remains the most exposed western country, with its banks’ assets in CEE at 70 per cent of Austrian GDP. Among individual banks, Austrian lenders also top the exposure lists, with Raiffeisen having 100 per cent of assets in CEE at the end of 2008 and Erste 53 per cent. By contrast, UniCredit was at 10 per cent.

These three all continue to invest, for example in new branches, but they are taking care with capital and costs. Raiffeisen had cut its balance sheet by 10 per cent by the end of September and its staff by 8 per cent to 58,600.

By the same date, UniCredit’s balance sheet was down 4 per cent and its CEE payroll by 4,000 to 73,400, with most jobs cut in Ukraine. Erste says it has made no crisis-linked employee cuts but reduced staffing at BCR, its Romanian subsidiary, from 12,000 to 8,900 due to post-acquisition restructuring.

Where western groups are trying to sell chunky assets it is largely because of difficulties at home. KBC of Belgium and Ireland’s AIB, both big investors in CEE, are cutting assets following state-financed rescues.

KBC is planning to sell a minority stake in CSOB, its Czech subsidiary, this year and preparing for disposals elsewhere, including Hungary. AIB’s possible sales include its 70 per cent stake in Poland’s Bank Zachodni WBK.

Even in the face of big pressures, some banks are still resistant to pulling back. Greek banks have so far shown no signs of withdrawing from Bulgaria or other neighbouring states, despite their domestic economic crisis and a reliance in the region on the kind of wholesale funding that is under attack from regulators.

But analysts expect regulatory pressure to spur divestments if proposed international rules from the Basel Committee on Banking Supervision are implemented unchanged. With virtually all western banks’ exposure to the region held via stakes, rather than full ownership, the profitability of those operations could be hit by tougher capital rules requiring parent companies to take responsibility for the whole of a local operation’s capital, even when there are other minority investors.

“For a western bank to retain an east European subsidiary, their assumptions about profitability have to be big enough that they are happy to take the capital hit,” says Magdalena Stoklosa, analyst at Morgan Stanley.

Additional reporting by Chris Bryant in Budapest, Jan Cienski in Warsaw and Andrew Ward in Stockholm

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