There is only one way to describe the banking sector in central Europe: too small. The banks in Poland, the Czech Republic and Hungary are too small and too few to meet the growing demand for capital from corporate and retail customers and they are not big enough to survive without outside help if the three states join the European Union.
According to analysts in the west, there is only one effective way to deal with this problem: sell the banks to foreigners. “The local banks don’t have the power, the skill or the knowledge to help develop a fully functioning and transparent capital market,” says an analyst at one of the major foreign banks involved in the region. “This is partly because of the lack of equity capital at the banks.”
Compared with the situation of five years ago, however, the banking sectors in all three countries have improved enormously. Banks in each country must now observe strict lending limits and reserve requirements (although still not enough, in the case of the Czechs), and can act as brokers and asset managers, as well as developing their corporate and retail services.
But the feeling is that there is still a long way to go. “The local banks are strong competitors for the business we conduct here,” says one head of treasury at a west European bank. “But there is no indigenous dealer community in eastern Europe and although they have a huge customer base they don’t know how to take calculated risks. This, and their very limited experience in forex and money markets, has a direct effect on liquidity.”
The Czech Republic provides an obvious example. When the currency crisis hit in April and May, it was the domestic banks that suffered most. The big-four local banks all reported a huge drop in profits for the first six months of the year, while most of the foreign banks located in Prague made handsome profits.
For acquisitive foreign banks, this presents an ideal opportunity. “Eastern Europe is fundamentally under-serviced by its banks, especially the retail sector,” says Edward Marrinan, head of fixed-income credit research at JP Morgan. “For western banks there are few, if any, ways of significantly increasing their earnings streams because their core markets have matured. So they can expand into a region which needs the services they offer; and the banks they buy or start a joint venture with benefit from both the experience and the international reach of the western bank.”
How much the foreigners are allowed to influence the banking sector depends on the country. The Poles have taken a selective approach. Initially, only those western banks willing to enter into twinning arrangements with local banks were allowed to set up branches in Poland. But two local banks now have majority foreign holdings, Bank Slaski and Wielkopolski Bank Kredytowy. There are other strategic investors, such as Commerzbank, which is about to increase from 32.9% to 49% its stake in Bank Rozwoju Exportu. And JP Morgan took 12% of the shares of Bank Handlowy during the recent IPO of Poland’s largest bank (Swedbank and Zurich Insurance each took a further 6%).
But the government is also prepared to cap foreign institutions’ involvement. When the tender for PBK-Warsaw was announced there were two bidders: one was a consortium of five Polish financial institutions, the other the Korean group Samsung. Apparently Citibank, having also expressed an interest, was told by the government that it would not win, although Citibank denies any involvement. “The rumour was that the government hinted to them that they had no intention of selling the bank into foreign hands,” says one western banker in Poland. Samsung stuck with its bid until the whole tender was cancelled. But it too complained of the government’s overt support for the local bid. In the event the Polish group was unable to come up with the cash to conclude the deal, so PBK-Warsaw is now to be privatized through an IPO.
Hungary has taken a different approach. The government has effectively decided that the banks are best off in foreign hands. Of the three banks spun off from the national bank, Budapest Bank is now 60%-owned by the Eurpean Bank for Reconstruction & Development (EBRD) and GE Capital; ABN Amro owns 99% of Magyar Hitel Bank; and 25% of Kereskedelmi es Hitel Bank has just been bought by Belgium’s Kredietbank. This leaves OTP (the state savings bank) and Posta Bank as the only large banks still in Hungarian hands. The former is gradually being brought to the stock exchange, but it may be too sensitive to sell to foreigners outright, as it has the major share of retail savings accounts, underdeveloped though the market is at present.
Posta Bank is simply not ready to be sold. “The problem with the management of Posta Bank is that they’re more interested in acquiring power than restructuring the bank,” says an equity analyst. “They own a publishing firm and have their fingers in most of the major newspaper organizations, as well as other non-banking-related businesses. It’s not a structure which would appeal to strategic foreign investors.” What is more worrying, the bank had a severe liquidity problem at the start of the year, opening its doors to find queues of people wanting to withdraw their deposits.
Below are the stories of three foreign banks that have made successful acquisitions in central Europe.
Poland’s Irish connection
Several names routinely come to mind when a bank takeover in emerging markets is mentioned. Dutch houses ABN Amro and ING are obvious candidates, as are some of the German banks; even Citibank was rumoured to be looking into buying one, PBK-Warsaw, although it denies the story.
But Allied Irish Banks is a surprise. Although outside Ireland AIB has a decent-sized franchise in the UK and US, it is hardly a global player. But since early this year it has held 60% of Wielkopolski Bank Kredytowy (WBK), one of Poland’s best regional banks.
Historically and economically, there are few ties between Ireland and Poland, but AIB, which already owns a couple of fund-management firms in Asia, has identified core central Europe as its next area of growth. “We’d got to the stage where we were happy with our development in our core markets of Ireland, the UK and the US, and we want to start to expand further,” says David McCrossan, managing director of AIB European Investments. “We saw core central Europe as a region whose laws and regulations are developed enough for a somewhat conservative institution such as AIB. So I was basically given a blank sheet of paper and asked to go and search for suitable projects to invest capital in.”
And this is no recent development. AIB has been active in the region virtually since the overthrow of the totalitarian regimes in 1989. “They got in there early as one of the first,” says Marrinan at JP Morgan. “They had already built up a solid reputation as consultants and advisers before looking to buy anything.”
In fact the first potential acquisition entertained by AIB was in Hungary. In 1994 it was one of the parties which expressed an interest in buying a stake in Budapest Bank. In the end, GE Capital and the EBRD took a 60% stake in the bank in 1995.
At the end of 1994 the opportunity arose for AIB to take a stake in WBK. It had already been acting as a consultant to the Polish bank through a twinning arrangement which had been in place for two and a half years. Then WBK asked AIB to underwrite its second share issue (the first had been in 1993). But the timing could not have been much worse: “The stock market had reached some dizzy heights by mid-1994, but as soon as WBK published their prospectus the market crashed,” says McCrossan.
The Polish bank had set a timetable of six months in which to complete its second share offering but by November it still had not happened and time was running out. “When they asked us if we’d underwrite the deal, they initially needed an answer within a week, so I said no,” says McCrossan. “Then they said they had until mid-January, and it struck me that this would be an ideal time to invest some of our own capital.”
AIB’s management board reached a decision in mid-December to buy a stake, and McCrossan took a team to WBK’s headquarters in Poznan to carry out the due diligence. “We were sitting in their offices on New Year’s Eve going through the final arrangements,” he recalls. “And by mid-January the share offer had taken place and we had acquired a 16.3% stake.” The EBRD had also agreed to buy some 24% of WBK, a stake on which AIB had a call option. It was when it exercised the option earlier this year that it gained management control of the bank. The other 20% stake was bought in a government auction in June 1996.
AIB has managed to get a good bank at a low price. As one of the nine regional commercial banks created in 1989 – when the National Bank of Poland decided to limit its role to that of a central bank – WBK has had an effective monopoly over western Poland, one of the country’s more prosperous regions. And AIB has acquired its 41 million shares for less than two-thirds of the present market price. “The total cost of acquiring 60.2% in WBK amounts to I£96.3 million ($139 million),” says Matthew Czepliewicz, bank analyst at Salomon Brothers. “At the current share price, assuming the exchange rate is Z5 to I£1, the value of the holding is I£150 million.”
AIB’s steadily growing stake has not stopped WBK from concluding its own acquisitions. There was a great deal of consolidation in the Polish banking industry last year; for its part, WBK bought two smaller Polish banks. The first was Gliewicki Bank Handlowy, based in Upper Silesia. This bank had begun operations in the early 1990s and had run into financial difficulties. Then in September WBK bought a branch of Bydgoski Bank Budownictwa, located in Bydgoszcz, 250km northwest of Warsaw, and holds one third of the shares of the whole company.
There are enough similarities between the Irish parent and its Polish acquisition to make the deal a good fit. Neither is a large bank but both have received various awards and accolades for the quality of their work. In recent polls in Poland asking which banks had the best reputation, WBK was voted second by retail and institutional clients.
AIB sees considerable potential for synergy. “All the areas which WBK already operate in, and the areas they want to expand in, are businesses in which we already have a great deal of experience,” says McCrossan. “Our aim is to help them develop into the sort of bank we are by providing access to our expertise in all areas.” WBK has already started to prove its worth as a broker. The bank acted as the domestic broker on mining company KGHM’s $454 million IPO. “They did a very efficient job placing the shares on the domestic retail offer, which had 10 million extra shares clawed back to meet demand,” says David Dwek, vice-president at UBS, joint global coordinators of the deal with BZW.
But it is retail and commercial banking which is seen as the long-term aim for WBK. As in other central and eastern European countries, the Polish retail banking sector is severely underdeveloped, even after the threefold increase in branches since 1989. WBK has 90 branches and is planning to open 30 more by the end of 1998. Demand from retail customers should easily support this level of development – last year WBK reported an increase in loans to individuals of 110%.
ING expands Slaski
Like WBK, Bank Slaski was a spin-off from the reorganization of the National Bank of Poland in 1989. It was the first bank to get a listing on the Warsaw Stock Exchange and still has the honour of being the IPO which attracted the greatest number of subscribers – around 500,000. ING bought a 25% stake at the time at Z75 a share. Within two weeks the value of the holding had shot up from $60 million to $800 million.
“There was an awful stink soon after ING bought their first stake in Bank Slaski,” says an analyst at one of the foreign banks in Warsaw. “They got it very cheap and the ministry of finance soon came under attack for mispricing the deal.”
After the Warsaw stock-market crash in 1994 that stake today is worth just under $200 million. ING has since increased its holding to 54%, valued at about $400 million.
Bank Slaski’s core base is in Silesia, in the southwest of the country, and it has about 120 branches there. “The plan now is to open up more branches,” says Eli Leenaars, deputy country manager for ING Barings in Poland. He talks in terms of “a few hundred branches”, and many of these would be located in the north to broaden the reach of the bank. But there is no intention to challenge the largest branch network, run by PKO BP, which has over 1,000 branches. “Things move so quickly here that there is no need to invest too much in bricks and mortar,” says Leenaars. “Electronic and telephone banking could well develop fast enough to bypass the need for a huge branch network.”
As with most of the banks born from the National Bank of Poland, Bank Slaski is more focused on corporate banking than retail, but this is something which the bank and its new parent intend to change. In fact the only ING employee on the board of Bank Slaski is there to develop the retail network. Partly this is being done through the introduction of credit-card services, a small market but one in which Bank Slaski has taken an early lead.
Slaski’s strength in domestic corporate banking is something ING intends to exploit. With 300 staff, the Dutch bank is one of the largest foreign banks in Poland, and has been at the forefront of developing local debt instruments such as QVIT, a domestic commercial paper programme. It has also taken a lead in marketing Euro commercial paper. “Having Slaski’s network means that we can sell international corporate banking services to their clients,” says Leenaars.
How much all this will cost is another matter. At a recent press conference, Brunon Bartkiewicz, Bank Slaski’s president, talked of investing “a few hundred million dollars”. Pushed to be more precise, he said: “Well, I don’t want to give too much away, but it will be closer to $100 million than $900 million.”
He has certainly learnt something from the bank’s western parents.
The battle for MHB
When Zsigmond Jarai joined Magyar Hitel Bank (MHB) as chief executive officer in March 1995, it quickly became clear that much was about to change. Offered a top-of-the-range Mercedes as his company car, Jarai declined. Instead he opted for an Opel Astra, a car more suited to a novice insurance salesman than the head of a bank. He also sent back all the works of art which MHB had on loan from Hungary’s National Gallery.
These were not the actions of a skinflint, but of a man who just a year earlier was not even convinced the bank could survive. In 1994 MHB recorded losses of $10 million, and had not even begun to make provisions for all the bad debts on its books. “It was bankrupt at that point,” says Jarai. “There were many who thought that it ought to be liquidated, including me. But it had the benefit of a government guarantee, and the government wasn’t prepared to see the bank go under.”
There were two main reasons for the bad debts. First, MHB, along with Kereskedelmi es Hitel Bank and Budapest Bank, was established in 1987 when the ruling communists decided to create a two-tier banking system. The National Bank gave up its role as lender except to the government, and handed its loans portfolio to the three new banks. MHB took on 50%, the remainder split between the other two. The majority of borrowers were companies unable to compete after Soviet domination of the region ended. This left the banks with a significant volume of bad debts.
To compound their existing debt problems, at the start of the 1990s the banks were pushed by the government into lending to new enterprises, run by people with little concept of capitalist-style management. The majority of these loans went sour as well.
Jarai, who had spent the previous five years working for James Capel, hatched a plan to restructure MHB and get the bank back on its feet within three years. Rejecting the Mercedes and returning the works of art were not his most dramatic steps. At the end of April he chaired his first meeting with the senior managers of the bank – 170 in all. For many of them it was to be their last meeting.
“What the bank needed was a complete shake-up of staff and management. There were too many staff and far too many senior managers for a bank of MHB’s size,” says Jarai. “So I decided to tackle this issue first, and rigorously. I went into the meeting and told them they were all sacked, and pointed to a list on the wall. There were 45 positions on that list, and I said that they were all free to apply for the jobs.” In the event, of the 170 managers only 25 were re-employed at senior level; the other 20 places were filled by external applicants.
Since then staff numbers have been cut by 40% to 2,600, which has contributed significantly to a drop of almost 50% in costs. But the main task has been to sort out the mess left by the bad debts. “Effectively we created two banks, a good one and a bad one,” says Jarai. “We put all our equity stakes in defaulting companies into the bad bank in order to liquidate them. We had over 140 stakes, ranging from advertising companies and hotels to furniture businesses.”
With that process under way, the next stage was to define a strategy for the future. That strategy, decided the new management, lay in broadening the customer base away from MHB’s traditional focus on corporate banking towards the relatively neglected area of consumer banking and insurance, with an emphasis on introducing information technology to the bank.
But one essential part of the equation was missing: money. Government ministers had already made clear that there would be no more finances forthcoming from the state and the bank had only limited resources given its liquidation process. Still, the bank managed to invest something on its new projects, though only Ft1.5 billion ($770,000). But its spending has not been enough to compete with OTP, the state savings bank.
The obvious answer was to privatize MHB, and at the start of 1996 the Hungarian government announced that the bank would be put up for tender. Initially, Jarai was not convinced this was a wise option, a surprising reaction from a man who had held the post of privatization commissioner at the ministry of finance between 1989 and 1990 before moving to James Capel. “I’d pushed for the banks to be privatized then,” he says. “But virtually all my colleagues were against the idea, which is why I left.” By January 1996 the roles were reversed.
In part, Jarai’s reluctance stemmed from the events of a few weeks before, when GE Capital concluded a controversial deal, with the support of the EBRD, to take a controlling stake in Budapest Bank. The government had given guarantees to the new shareholders to cover potential loan defaults worth almost as much as they had paid for their stake. Some at MHB feared that the government wanted to erase the memory of that deal by focusing attention on another bank, but that it was doing it too soon and too hastily. This time nearly 90% of MHB was to be sold, and to one bidder only.
Furthermore, Jarai was not sure that his bank’s restructuring plan had been given enough time to take effect. “Essentially, all we had at the start of 1996 was a beautiful idea on how to take the bank forward and I thought then that we needed more time to develop it.” Jarai concedes that he was worried that a new owner might simply ignore and overturn his ideas.
In May the first potential buyer came to the offices to conduct what Ildiko Juhasz, deputy director at MHB, calls pre-due diligence. An American with Hungarian parents, she first came to Hungary in 1990 on a six-month programme with Aisec, the student business association. She then spent several years at Citibank’s Budapest office before moving to MHB in March last year to oversee the day-to-day privatization process.
“It was a torrid time,” she recalls. “Everything happened so fast. But at the same time we wanted to make the process as transparent and honest as possible. After the recent scandals involving the APV [the privatization agency], and the controversy following the Budapest Bank sale, it was imperative that our sale was seen to be wholly proper and above board.”
Creditanstalt, ABN Amro, Bank Austria and Citibank came to look at the books. The first three banks returned in September for six weeks when they were allowed full access to all files. This involved laying bare some of the bank’s more unpalatable secrets from the early 1990s and before.
“We had quite a few skeletons in the closet which any potential buyer had a right to know about,” says Juhasz. “There were lawsuits hanging over us from companies who were suing us after we had reneged on contracts with them – software companies, real-estate agencies and others. Mostly it was the result of the raging mismanagement at the start of the 1990s. Those who signed and broke the contracts have long since left the bank.”
Towards the end, the sale was almost scuppered by politically explosive revelations. On its books MHB had counter-guarantees given to the government concerning arms sales to countries such as Libya and Iraq. This would be unpalatable for any acquirer, but especially for the eventual winner, ABN Amro, which is the largest foreign bank in the US. Sorting it out proved nerve-wracking.
“There were some tough negotiations between us and the government on this,” says Juhasz. “Talks went on into the middle of the night. In the end the government realized it had to do something, and the APV [privatization agency] agreed to take the guarantees back.”
During this time, there were more than 300 non-MHB personnel running around the bank but normal business had to continue. With aid from the EU and advice from Barclays, the UK’s Crown Agents and the Bank of Ireland, MHB’s management continued to develop the restructuring programme.
This made life somewhat difficult for bank employees. “It was like getting on a Tupolev aircraft in Moscow and having to rebuild it completely in-flight so that when landing in New York it was a Boeing,” says Tamas Kalman, now head of the risk-management section but at the time assistant to the deputy chief executive.
In the event, just two of the interested parties, Creditanstalt and ABN Amro, submitted a tender by the deadline of mid-November last year. The Austrian bank lobbied the government as hard as it could. But on November 7 ABN Amro was announced as the new owner; the deal was formally ratified on December 18.
The Dutch group paid $89.23 million for 89.23% of the bank, or 222% of the book value of the shares. Of the remaining shares, 5% were sold to employees at 111% of book and ABN Amro then offered to buy these at 222%. The other 5.77% of the bank was held by diverse investors and gradually has been bought by the new owner to give it a holding of over 99%.
ABN Amro also agreed to inject $100 million of new capital into MHB and is continuing the restructuring plans started before the merger.
“I was surprised that an institution such as ABN Amro would buy a bank with low-quality services, virtually no capital base and staff which lacked training,” says Jarai. “But they like our ideas. We showed them a feasibility study for our consumer services and life-insurance products during the privatization process. They said to us: ‘Great, where’s the money coming from?'”
It is no small leap for ABN Amro either. With over 2,500 staff and the headcount growing as the new products are introduced, the Hungarian operation will be its largest outside the Netherlands and the US. And the Dutch bank is happy with the deal, says Michiel Helfrich, ABN Amro’s CEO during the sale and now deputy CEO at MHB.
“We’d never have bought it in 1994, but Jarai had introduced big changes and managed to sort out the balance-sheet problems within two years, not three as was originally planned. The liquidation of the bad assets began at the same time as the due-diligence process, and the bad loans have been fully provisioned, if not over-provisioned. And we expect to break even this year, which we’ll be more than happy with.”
From September 1, the bank officially changed its name to ABN Amro (Magyar) Bank. ABN Amro believes Hungarian banks have little heritage and its market research into the change revealed that most customers were neutral about it.
“People generally wanted better services, and if foreign banks can provide that, then so be it,” says Helfrich. “But they do seem to be adopting a wait-and-see approach.”
With the fast pace at which Hungarian banking is developing, ABN Amro considers it best to integrate MHB as quickly as possible. Most analysts expect the main players to have consolidated their positions in the Hungarian banking market by the end of next year, which will leave little room for new entrants afterwards.
But, for some, the change of name is too confusing already. “I had a clerk in one of our branch offices in the country ringing up recently,” says Juhasz. “An elderly customer had come to see her in a panic saying she wanted to close her account because she’d heard the bank was closing down.” Jarai and Helfrich must be hoping that this turns out to be an isolated incident.
