This is not a great time to be a bank in Hungary. Since returning for a second stint as premier in May 2010, Viktor Orbán has barely attempted to conceal
his disdain for financial services firms in general and foreign-owned ones in particular. In December 2013, his close ally and pick as central bank governor, György Matolcsy, warned that at least four major foreign lenders would quit the country entirely by mid-2015.
That process has already started. In July, the government struck a deal to buy MKB, one of the country’s largest commercial banks, with more than 80 branches, from struggling German lender BayernLB. The sale marked the end of a long and rutted road for the Munich-based Landesbank, which recouped just €55m from the sale, and wrote off €270m of loans.
The deal also marks the “first step” in boosting domestic state ownership of the country’s banking sector, Hungary’s economy minister Mihály Varga said after wrapping up the acquisition of MKB. Premier Orbán previously stated his intent to see “at least” 50% of the domestic banking system revert to Hungarian hands by the end of next year.
Which foreign lenders, then, are next in the firing line? For BayernLB, the sale was, in many ways, a no-brainer. MKB had been bleeding red ink for years, losing €409m in 2013. Moreover, its German parent had been under pressure to divest the unit since 2012, when the European Commission made the sale a condition for BayernLB receiving state aid.
Beyond MKB, the picture looks far more clouded. Apart from OTP, the most international of Hungarian lenders, the remaining leading players are Austrian pair Erste Group Bank and Raiffeisen Bank, Italy’s Intesa Sanpaolo and KBC of Belgium. Over the past several years, as growth in the central European nation stalled and new and costly regulations permeated the local market, each of the industry’s leading players, bar OTP, has been under pressure to justify its position in Hungary — pressure from parent companies and the government’s determination to continue nationalising parts of the banking sector.
ACUTE CHALLENGE
The challenge facing foreign lenders, though, is both acute and nuanced. On the one hand, Hungary has for some time been a tough place for banks to make money. Raiffeisen’s Hungarian unit posted a post-tax loss of €100m in the first six months of 2014, a 20% year-on-year rise.
On the other, this is far from being a typical, struggling member of the central and eastern European (CEE) group of sovereign nations. Hungary’s economy grew by 3.9% year-on-year in the second quarter of 2014, the fastest pace of expansion in eight years, boosted by rising car production. Industrial production jumped 11.3% on an annualised basis in June. The economy ministry, following the release of the data on August 14, tipped gross domestic product (GDP) to “exceed 3%” in 2014. In regional terms, Hungary’s success story stands in stark contrast to a stagnating Czech Republic, a contracting Romania and slowing growth in the CEE’s most developed economy, Poland.
Thus, having first puffed and wheezed through the worst of the financial crisis, then having navigated Europe’s torpid economic recovery, foreign lenders are reticent about exiting the one CEE nation that continues to shine. “Banks know that there is the potential to make money [in Hungary],” says Ivan Bokhmat, head of equity research, emerging market banks at Barclays in London. “The economy is doing better, foreign direct investment is still rolling in and the country has low labour costs and a high level of education.”
Henry Worthington, lead economist at London-based consultancy Oxford Economics, says: “Hungary may have a relatively immature banking market but there is more growth visible there than there is across the CEE or, at present, across the eurozone.”
Yet despite its potential — or perhaps because of it — this remains one of the odder and trickier economies in which to operate, particularly for foreign lenders, who remain persona non grata in the Orbán administration. “There is no doubt that since coming to power, this government has taken an anti-financial-services stance,” says Oxford Economics’ Worthington.
The bone of contention among banks is the imposition of regulation designed retrospectively to penalise lenders for loans stretching, in some cases, all the way back to 2005. In early July, Hungary’s Supreme Court forced through a new bill, the Overcharge Repayment Law (ORL), which ruled that banks should recompense customers for “unfair conditions” placed on loans denominated in foreign currencies, notably euros and Swiss francs.
Those loans, similar to those offered to Icelandic borrowers in the years before the financial crisis, boasted lower interest rates but a big potential currency risk. When, post-crisis, the Hungarian forint tumbled in value against the euro, borrowers struggled to meet rising repayment costs, undermining Hungary’s economy. Governor Matolcsy reckons that around two-thirds of outstanding loans are priced in foreign currencies.
Depending on whose view you take, the ORL is either further evidence of anti-bank vitriol emanating from the government, or a reasonable reaction to the need to clear a pile of bad loans off the books of leading lenders and to get Hungarian consumers spending again. The new law is designed, Barclays said in a July 11 research note, to “reverse the burden of proof”. Before, customers were required to take banks to court to secure refunds on individual loans — a financial burden few borrowers could afford to bear. By contrast, the ORL demands that banks “prove that each unilateral interest rate adjustment was justified”, Barclays said. “This will limit the number of lawsuits and make it harder for banks to justify their actions.”
VICTIMS
Of course, the new law has its victims: in this case, a banking sector that continues to profess its innocence, pointing to the fine print contained in every loan contract.
Hungary’s currency concerns, which peaked in 2011 and 2012, were due in large part to the turmoil affecting a wider European economy beset by rising sovereign debt and uncertainty over its single currency, which had its roots in rapacious pre-crisis bank lending.
But some of the blame can be placed at the feet of Hungary’s authoritarian premier. Orbán’s confrontational style with the International Monetary Fund and his determination to emasculate and control leading state institutions resulted in higher credit default swaps, a more uncertain business environment and wary foreign investors. That resulted, far down the financial food chain, in higher repayment costs on retail loans.
As of early September, banks were yet to see the ORL’s final draft, but they are preparing for the worst. The general consensus, including projections set out by the central banks, is that the banking industry will wind up facing a total bill of between Hfr600bn and Hfr900bn, or up to E3bn, as it seeks to settle bid-ask charges on foreign exchange repayments and to refund borrowers for unilateral interest rate rises.
In July, MKB said it would put aside Hfr5.1bn as coverage against potential losses stemming from the legislation, adding that it was prepared to fight the ruling in court. The following month, OTP issued a profit warning, advising investors that mandatory refunds to borrowers “could be higher” than government estimates. Barclays reckons that OTP could be forced to absorb losses of up to Hfr334bn on the affected loans, or 26% of its issued equity. Raiffeisen expects to be hit with an “expected one-off charge” of up to €160m. Banks would see a “significant cut” in 2014 profits, Barclays warned, forcing lenders to liquidate some of their holdings of government securities.
Hungary’s government also has other financial matters on its mind. During October, it is expected to unveil a “bad bank” that will allow commercial lenders to offload unresolved toxic commercial property loans stretching back to the financial crisis. The National Bank of Hungary announced in July that it will buy back project loans with a value of more than Hfr500m and foreclosed real estate loans worth in excess of Hfr200m.
The government is also eyeing a few worrying forecasts, pointing to a possible deterioration in economic sentiment as the year draws to a close. The past 18 months have been good to Hungary’s economy, with retail sales surging in the first four months of 2014. But consumer spending growth dipped over the summer, slowing to 2.3% year-on-year in July, against 4.1% the previous month, according to the Central Statistical Office.
FINANCIAL LEEWAY
Bank fines relating to pre-crisis loans should give the government some financial leeway in the months ahead, with the authorities expecting all charges to be fully settled by February 2015. But the country’s longer term outlook is far from certain. “We are bearish on Hungary’s economy,” says William Jackson, emerging market economist at London-based Capital Economics. “It has performed well in recent quarters and is one of the fastest-growing economies in Europe. But a lot of that was driven by strong government programmes and some of the growth props fade away in the months ahead, so problems could return.”
Jackson points to a sharp decline in the share of total investment to GDP, which fell to less than 18% in 2013, from 22% in 2009, one of the lowest rates of any European nation. “That will hurt the economy’s long term development. It means you aren’t getting enough investment in infrastructure or enough capital expenditure by corporations,” he says.
Some of this, he adds, had been caused by the perception that the stability and predictability of Hungary’s policymaking environment had “deteriorated” under Orbán. No doubt many of the banks struggling to make a buck in Hungary, beset by new regulations and a resentful and retaliatory government, would feel the same way.