Stick, twist or fold? That’s the question facing western European lenders most heavily exposed to central and eastern Europe (CEE). The answer has perhaps never been less clear, nor the stakes for those involved greater. The past six years have been hellish at times for large swathes of the eastern half of Europe. Capital fled a region ravaged by the financial crisis, sucked back to core markets by Austrian, French and Italian lenders.
Only the Vienna Initiative, fronted by taxpayer-funded multilaterals and development banks and supported (somewhat belatedly) by private lenders, staunched the bleeding. Growth in the region’s economies and banking sectors stalled — but things could, for the former Soviet bloc, have been far worse. Many of the banks that remained committed to the region — notably the Austrian pair of Erste Group Bank and Raiffeisen Bank International, along with Italy’s UniCredit and, to a lesser extent, Société Générale of France — are finally starting to reap the rewards of their loyalty.
Economic momentum has returned to much of the region, with GDP growing faster in, say, Poland and the Czech Republic than France or Italy. In December 2013, Fitch Ratings tipped the weighted average GDP growth of eight leading CEE nations to hit 2% this year, up from 0.6% in 2013 and 0.5% in 2012.
Gianni Franco Papa, head of the CEE division at Milan-based UniCredit, the largest pan-regional lender by assets and earnings, tips the broader CEE economy to swell by 2.3% this year, thanks largely to the return to economic form of Germany, the leading buyer of CEE-produced goods and services. By contrast, the European Commission in May predicted full year 2014 economic growth across the 18-nation eurozone to come in at just 0.8%, weighed down by low inflation and tensions with Russia.
And there are other reasons, based on structural and economic data, to be cheerful. Industrial production rose sharply through 2013. Regional indebtedness remains on the low side: debt to GDP levels averaged 55% in 2013, against 93% for the eurozone. “We are coming out of the crisis, and the sun may well be coming out for CEE. It’s a nice spot to be in right now,” says Michael Buhl, co-chief executive officer of the Wiener Börse, Vienna’s flagship stock exchange.
Then there’s the broader banking sector. Fitch Ratings in December summed up the industry’s prognosis as “stable but bleak”, a phrase that seemed to stick in the minds and the craw of regional banking leaders and policymakers. It certainly appeared to gainsay the increasingly conventional wisdom that a return to growth across the CEE should lead ineluctably to a sharp revival in the fortunes of the region’s banking sector.
WAITING FOR THE ALL CLEAR
Yet macroeconomic and financial data often fail to tally in logical ways. Wage rises often lag economic cycles, just as banks can surprise by posting sharp spikes in non-performing loans long after growth has returned. Thus, in spite of stronger economic data across large parts of the region, the banking sector remains uncertain about its future.
Underlying data, so far at least, looks reasonably promising. Total gross loans across the CEE region rose 14.6% year on year in the three months to the end of September 2013, according to UniCredit research, up from 12.7% year on year the previous quarter, with total deposits up 14.7% and 13.9% respectively over the same periods. UniCredit’s Franco Papa says that robust deposit growth “continues to support the gradual shift towards the ‘new’ banking model, characterised by strengthened liquidity and higher capital buffers”.
Yet few bankers are convinced that broadly positive regional economic data is being converted into asset growth across the banking industry. Gernot Mittendorfer, chief financial officer at Vienna-based Erste Bank, notes that while banking sectors are growing in some countries, others continue to deleverage, a process that began shortly after the onset of the financial crisis.
“The current rate of regional loan demand is flat but this will change as deleveraging comes to an end, and in many CEE nations the net demand for loans has now turned positive,” Mittendorfer says.
UniCredit’s Franco Papa is caught between two worlds, vacillating between sunny optimism and fingernail-chewing pessimism. He points to “signs of mild credit recovery” across the region, thanks to “moderately accelerating” economic growth since mid-2013, but then adds a rather bleaker rider, noting: “Without doubt, the business environment for CEE banking has become much more challenging than it was before the crisis.” Banking sector profitability is, he warns, “being put under pressure by numerous factors, [including] lower net interest margins and the need to comply with new regulations”.
This is where the stick or twist interrogative comes into play. Western European lenders still dominate the region, a situation that’s unlikely to change any time soon.
Budapest-based OTP Bank is the only CEE lender with scale, and even then its influence is felt only at the margins. It’s a situation that’s far from ideal: a new financial crisis is likely to create the same conditions that forced policymakers to create the original Vienna Initiative.
But you play with the cards you’re dealt, and CEE leaders could do worse than sit around the table with several of the eurozone’s bulkier banks. UniCredit, with €136bn ($188bn) in CEE assets at the end of June 2013, posted regional earnings of €1bn in the first half of 2013, according to company data. Its CEE chief Franco Papa insists that the lender remains a fully “committed long term investor” across the region.
A TOUGH SLOG
Yet the year ahead — and perhaps the one after that — look like being a tough slog for UniCredit, which has placed its faith primarily on growth in Czech Republic, Russia and Turkey. Of these, perhaps only the former, with rising economic growth and industrial production data, looks a sure near term bet. The other two have problems: Turkey is likely to face yet more political unrest in the run-up to presidential elections in August, following the country’s most turbulent year since 2001; Russia, meanwhile, faces international opprobrium as sanctions relating to its Ukrainian intervention bite and economic growth slips, possibly into negative territory.
Erste Group Bank has a clearer view of its immediate future. CFO Mittendorfer insists the Austrian lender’s dedication to the region is as strong as ever. “We didn’t change our strategy — we kept our commitments” even at the height of the financial and eurozone debt crises, he says. “Our strategy is to be the leading retail bank in the eastern half of the European Union.”
A few markets, though, are providing some cause for concern. EGB sold its Ukrainian unit in 2013 for $83m, booking a $200m loss on the divestment — the bank later depicted the sale as a strategic move based on concerns about Ukraine’s economic and political future.
The other sovereign source of concern both for Erste Bank, and for other western lenders heavily invested in the region’s economic future, is Hungary. Once seen as the likely long-term epicentre of CEE growth — it was, after all, the country most directly connected to western Europe pre-1989 — it hasn’t kicked on as expected, at least when compared to more reform-minded countries like Poland and the Czech Republic.
Hungary also offers a set of specific and rather contrary challenges to foreign-owned banks. Since returning for a second term as premier in 2010, Viktor Orbán, in spite of his worryingly authoritarian tendencies, has overseen a surprisingly resilient economy, while doing his best to undermine the interests of foreign investors, including in the banking sector.
That leaves western European lenders in a tricky situation: stick or twist, and make the most from a rising economy while you can, or fold, on the basis that life as a foreign lender in Budapest may sooner or later become rather unpleasant. “If a government tells you that you are not welcome, or makes it abundantly clear, as Orbán has, that local banks will be preferred to you when decisions are made on key deals, it leaves you having to make some unpalatable decisions,” notes one senior CEE-focused banker.
Raiffeisen meanwhile has opted for a path between Erste Bank and UniCredit, choosing to focus on “six core ‘focus’ markets” — namely, Russia, Poland, the Czech Republic, Slovakia, Romania and Austria — says a senior bank executive who declined to be publicly quoted.
There’s sound logic in treading this middle ground. The region hasn’t escaped the crisis just yet. While loan growth and banking sector profitability have picked up in relatively resilient countries, notably Poland, Slovakia and Czech Republic, credit growth, noted Fitch in its December 2013 report, was “likely to be slow at best, impacted by weak demand and cautious supply”.
The ratings agency also pointed to persistent asset quality issues in more fragile nation states. In its latest annual outlook, published in January 2014, UniCredit was in agreement, warning that asset quality remained “the one major downside risk” in the region, with “improvement expected to be gradual in 2014”. Impaired loans as a share of total outstanding loans stood at 29.7% in Romania at the end of 2013, according to UniCredit research, the highest level in the region, followed by Ukraine (27%) and Hungary (19.5%), with Poland, Slovakia, Turkey and the Czech Republic the only countries in single digits.
Having seen out the worst of the bad times, eurozone banks most heavily exposed to the region have rightly opted not to fold. But neither are they gambling heavily and broadly on the region as they once did. Even lenders like RBI, Erste Bank and UniCredit are investing carefully and cagily in key markets, in what can perhaps be described as a cautious twist.