Foreigners find it a struggle

Croatia does not feel like a country recovering from civil war. The people are still elated about their national soccer team’s long run to the semi-finals in this summer’s World Cup and bars in Zagreb are buzzing with Prada-clad teenagers waving red-and-white chequered flags. Sales of Mercedes cars and mobile phones are soaring. And with GDP expected to grow by 7.5% this year, the trade deficit down to $1.5 billion and the budget now in surplus, economists are optimistic.

But foreign bankers working in Croatia reckon themselves somewhat lonely and neglected guests at the party. “Croatia has been very disappointing,” gripes one. “When I first came here, everything looked good. The political situation was stable. The economy was growing. The government seemed committed to reform. Laws and regulations seemed to be in place. But when I began to look beneath the surface I found that the situation on the ground was very different. The pace of reform was very slow, the economy was very politicized. It is not easy to do business here.” One western European banker says Croatia is more bureaucratic than Russia.

As a result, several international banks have postponed plans to set up offices in Croatia. Commerzbank (which had hoped to establish a full branch) is now only setting up a representative office. ABN Amro is believed to have cancelled its plans altogether.

Since Croatia declared independence in 1991, six foreign banks have set up shop: Raffeisen, BNP/Dresdner, Société Générale, Austria’s Volksbank, Bank Austria Creditanstalt and Cassa di Risparmio di Trieste.

Individual strategies have varied considerably. Société Générale (which set up its operations in February 1997 and now has 25 staff) is focusing on lending to large corporate customers with proven track records. “We are targeting the top 20 companies,” says Pierre-Yves Grimaud, SocGen’s general manager. “We believe we have an advantage because as part of an international group we can afford to lend at very competitive rates.” Deutsche Bank, which only has four staff in Zagreb, is expected to follow a similar approach.

BNP/Dresdner is also involved in corporate lending (again to large customers) but is concentrating on trade finance and project finance. “Croatia has around 100 companies which export a large percentage of their turnover,” says Thomas Grosse, general manager of the bank’s Zagreb office. “So far they have had limited access to sophisticated forms of trade finance.” Bank Austria has focused on retail finance where margins remain extremely high at around 5% compared with 2% or 3% in western Europe.

Since it set up an office in Zagreb in 1994, Raiffeisen has grown quickly to become Croatia’s 13th largest bank. “We lend to around 127 companies at present,” says Lovorka Penavic, a member of the bank’s board. “Now we are looking to spread our risk by approving loans to small and medium-size companies.”

Slow start

But are foreign banks making any money in Croatia? Predictably, few will say although there are rumours that most are making losses. “I don’t think many are making a profit,” says James Oates, a leading eastern European analyst formerly with UBS. It is still early days, of course, and Raffeisen (the first foreign bank to set up shop in Croatia) made a net profit of Kuna33 million ($5.14 million) last year according to its annual report.

The difficulty for foreign bankers is knowing how fast to push and in what areas. Corporate lending and trade finance should be one area where they have a clear advantage. “Local bankers are not particularly sophisticated,” says a foreign banker. “They think they understand investment banking but they don’t. Most don’t even know how a forward works.” At the same time, Croatia’s local banking sector is in something of a mess, with many banks labouring under significant amounts of bad debt.

Exploiting these weaknesses in investment banking is not easy, however. The largest companies already have close links to Zagrebacka Banka and Privedna Banka, the two major banks, which between them control 80% of the market, and have by and large solved their bad-debt problems. And the smaller companies (which are in dire need of capital and would welcome the attentions of foreign firms) are often loss-making and in urgent need of restructuring. “It is easy to find business but not so easy to find good business,” complains a foreign banker. “The accounts are often incomprehensible.”

The retail business is also a hard nut to crack. It is difficult to lure most Croatians away from local banks, not least because their national loyalties have been intensified by war. And what is currently profitable retail business may not remain so for long. Few employers have begun to restructure. If and when they do so, unemployment could rise and there would then be a significant increase in retail debt defaults.

The local banks’ ability to hold off foreign competitors will probably be enhanced by improved capitalization and stricter lending policies. Following the collapse of one bank, Dubrovacka Bank, in March, the national bank and the government have drawn up new banking legislation. Under the new law, the minimum capital requirement is being raised from Kuna3.6 million to Kuna20 million. Tighter limits on lending to connected person and shareholders are also being introduced. Significantly, the new law will permit the central bank to withdraw a banking licence without the permission of the supervisory board. In a separate move to bolster public confidence, the central bank has pledged to guarantee deposits of up to K100,000.

Some local bankers reckon the new laws could give a much needed kickstart to the consolidation of Croatia’s overpopulated banking sector. “Change will come as a result of the new banking law, which will force banks to accept higher standards,” says Zdravko Cuculic, senior international banking adviser at Zagrebacka banka. Croatia currently has 63 banks, about 40 more than is needed in a country with a population of around 5 million.

It is unlikely, however, that the law will force change directly. Only three banks have capital of less than K20 million ­ Convest banka, Hypobanka and Neretvanska gospodarska banka. What may have more impact is the return to business of the four rehabilitated banks: Privedna Banka, Splitska, Rijecka banka and Slavonska. The EBRD and Hypobank bought 35% of Slavonska bank earlier this year and Bozo Prka, former finance minister and now chief executive of Privedna Banka, reports that his bank is back in business. “The rehabilitation process was formally completed in January 1998, and we are back in profit,” he says. “We are now working with the Bank of Ireland to improve credit procedures and liquidity management.”

Hunting the mandates

With retail banking not a particularly attractive prospect, some foreign banks may conclude, as Bayerische Vereinsbank and ING have done, that it is possible to win corporate lending business without local representation. But investment banking work may require a local presence. Deutsche has enjoyed some success in winning mandates, such as those to advise Koncar, the engineering group, and Janaf, the oil pipeline company.

Outside traditional commercial banking, there is a fair amount of privatization and project finance and M&A advisory work coming up over the next four to five years. The rebuilding of Croatia’s shattered infrastructure continues apace. In April 1998 US company Bechtel won a $600 million motorway construction contract. More contracts are to be awarded later this year. Mergers and acquisitions have so far taken place on a mainly local basis. But as competitive pressures increase, many local companies are expected to look for international partners. Under current plans, the government is hoping sell around $9 billion of state-owned assets including telecoms company HPT, which is valued at around $8 billion. Around 1,100 state-owned companies have already been sold, often to employees and management. But the government (or the funds and companies it controls) still retains stakes in a further 1,300, including energy group INA, HPT, and four banks (Privedna Banka, Slavonska Banka, Rijecka banka and Splitska Banka). Analysts estimate that these holdings’ value could exceed $10 billion.

The finance ministry has published a list of companies which it says are up for sale (see table), and has even gone as far as to appoint banks to advise on their disposal. Deutsche Bank has the mandates for the sale of engineer Koncar and pipeline company Janaf. But despite regular statements about the government’s commitment to privatization, very little has been transferred to the private sector. “It is more of a wish list than a real list of companies being sold,” says Alistair Kilgour, a Croatian specialist at Lazard Capital Markets.

The problem is part-ideological, part-commercial. Many Croatians remain uneasy about private, let alone foreign, ownership of large Croatian companies. At the same time, most of the companies under state control are in dire need of restructuring. “It is a question of value,” says Kilgour. “Most of the companies owned by the state have problems they need to solve before they can be sold at the price the government wants.”

But the privatization programme does appear to be moving at last. In June, the state privatization fund began to divide its assets between the seven voucher funds set up for widows, war veterans and the dispossessed. According to Damir Ostovic, assistant minister of privatization, all of the state fund’s assets will have been transferred by the end of September 1998, allowing the voucher funds to be listed on the Zagreb Stock Exchange by the end of the year. “We have auctioned off shares in 471 companies worth an estimated $2 billion,” says Ostovic.

In July 1998, the sale of HPT moved one step closer when parliament approved a law permitting its separation from the post office businesses. The move, though widely expected, has encouraged analysts to conclude that the government is getting serious again about privatization. “I am quite bullish about Croatia,” says Oates, the eastern European analyst. “I think we will begin to see major privatizations happening by the end of this year.”

Some of these should prove popular with international investors. HPT will be of particular interest. Since 1991 it has invested Dm200 million ($113 million) a year upgrading its telecoms system and laying fibre-optic cables. Analysts estimate it could be worth anything between $5 billion and $10 billion.

European multinationals are looking closely at many of the assets. Swiss foods mutinational Nestlé is said to be interested in chocolate maker Kras. German electrical engineer Siemens would like to buy Koncar, or at least its elevator-production business.

But these foreign companies may not get a look-in. Though the government realizes that Siemens, for example, can and will pay more for Koncar than a local entrepreneur, it is known to favour local buyers over foreign ones. Flotation may prove the easiest compromise, with a large chunk of shares being sold on the local market and 20% or so sold internationally (more perhaps for HPT).

Institutional investors may be interested in the voucher funds. Local brokers predict that many of the 200,000 voucher holders will sell their shares as soon as the funds are listed, thus substantially depressing prices. But voucher-fund managers such as Slobodan Bukvic, managing director of Expandia (one of the largest Croatian funds), warn that many of the companies are of poor quality. “About 200 of them are basically bankrupt,” he says. Moreover, few funds own majority stakes in any of these firms, making restructuring difficult. Bukvic hopes that by swapping stakes with other funds, Expandia will be able to build up a big enough position in some companies to either sell the stakes or float the companies.

That’s quite a gamble.