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May 2000

Uphill struggle to make profits





KBC Bank of Belgium and Dutch ABN Amro have not had an easy time in Hungary. After KBC took a strategic stake in Kereskedelmi és Hitelbank (K&H) in 1997, the bank lost Ft8.3 billion ($12.58 billion) in 1999. ABN Amro's Hungarian subsidiary was in the red by Ft19.8 billion last year despite a $96 million capital injection.
The losses hurt. Hungary is strategically important for both banks. KBC has made central Europe a key market. Of all western banks, it has invested the most in the region. ABN Amro has turned Magyar Hitelbank, the local commercial bank it purchased in 1996, into one of five "pillar" institutions around the world that offers a full range of banking services. Its Hungarian operation is the largest ABN Amro bank now in terms of balance sheet total in the central Europe, Middle East and Africa region. Foreign banks, which hold about 48% of the banking market in Hungary, are battling to solidify their position amidst increasing competition. Bank watchers say a consolidation is coming; the only question is who will swallow whom. K&H and ABN Amro rank among the five largest banks in Hungary in terms of balance sheet total, but they could still be vulnerable.
"Some players will throw in the towel," said István Préda, spokesman for ABN Amro in Hungary. "We are convinced that we will be a winner in the consolidation game." Both K&H and ABN Amro say the worst is over. Their losses result from large investments improving branch networks, updating IT systems and provisioning for bad loans. Now they can focus on building their client base, especially in the growing small- and medium-size enterprise market.
KBC showed its commitment to K&H by putting up Ft10 billion for a capital increase and recently announced a public offer for shares in the bank that will give it a majority stake. Irish Life and Permanent, which presently owns 23% of shares, is expected to sell out to KBC later this year.
"1999 was a year when we wanted to clean out the balance sheet and provide for all potential losses in a realistic fashion," says Tibor Rejtö, chief executive oYcer of K&H. "Now our energies have been liberated to a great extent and we can start building the business."
The road to this point has not been easy. A number of skeletons fell out of the closet, ones KBC had not foreseen when buying into the bank. The biggest was Nádor, a company that got a Ft5.7 billion loan from K&H in 1995 after it had signed a contract with the then socialist government to provide security equipment. In 1998 the centre-right Fidesz government came to power and cancelled the order.
"At the time of privatization, the loan was still performing and was believed to be fully guaranteed by the government," says Rejtö. "It turned out to be something different." K&H has been dogged by bad loans that originate from the socialist period when creditworthiness wasn't always the crucial ingredient in granting a loan. The bank had about Ft70 billion worth of bad loans in 1994, says K&H chief financial oYcer György Geiszl. Now that number has fallen to around Ft11 billion.
ABN Amro also had its share of surprises. In 1999 it had to make a Ft3.6 billion provision after bondholders, claiming they had been duped, sued their brokerage firm, which was majority owned by Magyar Hitelbank, the bank ABN Amro had bought in 1996. Both banks also attribute their 1999 losses to large expenditures revamping IT systems. When K&H was privatized, the bank's IT network was more like a Byzantine maze with over 250 separate systems.
"It was one of the least integrated IT systems, even by Hungarian standards," says Geiszl. Now K&H has cut that to under 100 and is spending Ft12 billion to further harmonize systems. ABN Amro has spent Ft10 billion to integrate and modernize its systems. Unlike K&H, which inherited 180 branches and then cut it down to 125, ABN Amro has spent Ft12 billion adding 35 new branches, bringing the total up to 104 in order to build up a strong retail banking network.
Both institutions have had to turn poorly run socialist commercial banks into universal institutions offering the full range of products from life insurance to brokerage services. To do this ABN Amro had to launch a life insurance division, a pension management company, a leasing company, and an asset management firm from scratch. Both banks are attempting to capitalize on their branch networks by using them to sell add-on products such as life insurance and brokerage services. They can do so with little extra fixed costs.
Both banks have also made mistakes. KBC made the error of leaving the old management in place for a year after the bank was privatized. During this period K&H lost market share, operating losses grew and bad risk management was rampant, says Geiszl. ABN Amro put so much effort into building out its branch network and restructuring the bank, it neglected customers. Prèda said this was the price the bank had to pay for concentrating on making the bigger restructuring moves.
Banks also had not expected the Hungarian market to be so competitive. The competition has been particularly intense on the corporate loan market, where spreads have been lower in Hungary than on western markets. As some local players were intent on getting market share at any price, this led to a situation where firms such as Hungary's oil company MOL and telecom provider Matáv got funds more cheaply than large international AAA rated companies. ABN Amro sees its Hungarian outfit making a profit in 2001 or 2002. Geiszl of K&H said the bank has been profitable on the operating level since November of last year and Rejtö expects the bank to be profitable this year on a net basis.






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