Banks with a confident air

A SUPPLEMENT TO EUROMONEY/APRIL 1998: EASTERN EUROPE

Hungary is beginning to reap the reward for its decision to clean up the balance sheets of its leading banks and then sell major stakes to strategic foreign investors. That strategy is now nearing completion – of the major institutions only Postabank is still in the public sector and almost all of the others are partly or wholly owned by international banks. The result has been a dramatic revival in an industry that only three years ago was near collapse and was, say bankers, “suffering from a lack of internal controls and audits and damaged by corruption and loans made against kickbacks from borrowers”. The sale to foreign owners has provided an influx of fresh capital and a significant investment in technology. There is tougher competition and more dynamic management while the introduction of western banking systems and controls is starting to mean fewer poor-quality loans, more efficient services and fewer but better trained staff.

Corporate customers are already benefiting as the local banks vie for business with international institutions that set up new operations in the late 1980s and early 1990s. Retail customers should also start to gain as the banks diversify from the increasingly less profitable corporate side. “There is no question that privatization has further sharpened competition, which has been very tough in the last two years,” says Sander Seebok, executive director of Inter-Europa Bank. “That competition took place mostly in pricing which was good news for corporate customers.”

Despite tight market conditions and a painful transition, there is an air of confidence in the banks of Budapest, many of which have been refurbished in a curious mixture of traditional design and modern architecture. This mood has been reinforced by bank results that show a steady return towards profitability. ABN Amro’s local operation (created when the Dutch bank bought Magyar Hitel Bank) made a $27 million dollar profit on its traditional banking operations, though this was turned into a $3 million loss by its $30 million investment in upgrading technology, training staff and launching consumer banking and an insurance company.

Further evidence of the private financial sector’s health came from the flotation last October of the remaining 25% stake in Hungary’s largest bank, OTP, formerly the state savings bank. The government received $213 million, compared with the $90 million it was paid by foreign and domestic investors for a third of the bank in 1995. This price, reflecting the share’s strong showing, was achieved even though many bankers feel that, with over half the retail banking sector and no strategic foreign shareholder, its customer base will be energetically pursued by other banks.

Few now dispute the decision taken by Gyorgy Suranyi, president of the National Bank of Hungary (central bank), to restructure and then sell the banks. He had no doubt that they had to be privatized by direct sale to foreign institutions.

Suranyi told Euromoney: “Privatization was essential to accelerate economic restructuring. It was not our plan to sell at any price to a foreign strategic investor. Our starting point was that everything, whether in the financial or manufacturing sectors, had to be privatized. Real privatization meant that we had to have responsible owners able to increase efficiency and competitiveness and help the Hungarian economy become more flexible. Through direct sales we have been able to get these owners, able to bring in fresh capital and new management – not necessarily foreign but with new habits. Managers are now accountable in a way missing before. Once we opted for outright sales, particularly in the financial sector, foreign capital was inevitable because of the lack of domestic investors”.

Suranyi is equally adamant that the state had to take over responsibility for the bad debts of the banks. Some had been incurred under communism but the deterioration had accelerated in the early 1990s and had been exposed by the introduction of tough bankruptcy and accounting legislation. As a result the government had to bail out the banks at a cost equivalent to 7% to 8% of GDP. To minimize the risk of moral hazard – shareholders, managers and depositors believing the government would always bail them out – the new owners, says Suranyi, had to be “responsible with a strong capital base, and that meant a foreign strategic owner”.

The combination of the bail-out and better management is also bringing bad debts under control. The National Bank governor says “the proportion of qualified assets is now 8%, of which the share of bad loans is 1%. In 1993 the comparable figures were 29% and 14%. These figures show a really fast improvement in the quality of assets and that the bad loans are well provisioned”.

He argues that the record so far has proved wrong the fears that international owners would not take account of the interests of the Hungarian economy. In his view: “Being in this country, they are Hungarian players wherever their shareholders come from.” He also says benefits are being felt across the economy. “The presence of strategic professional investors has contributed to the increased effectiveness of the financial system. The services of the banks are fast improving because of competition. It has been true for corporate banking and we hope it will also be so for the retail sector. The reality is that if you had liberalized the financial markets as we had to do to prepare for EU membership while insisting on state ownership of banks, the domestic institutions would have lost their market share because they would not have been competitive”.

Privatization is now on the final lap. OTP has been floated and Magyar Hitel Bank (MHB) sold to ABN Amro. Budapest Bank has been bought by GE Capital and a strategic stake in Magyar Kulkereskedelmi Bank (MKB) has been sold to Bayerische Landesbank and the European Bank for Reconstruction & Development. Kereskedelmi es Hitelbank (K&H) is 47% owned by Irish Life and Kredietbank, with the EBRD holding 18% and the remaining 28% to be floated after the election in May. Of the commercial banks, only Postabank, which has a minority Austrian shareholder, remains publicly owned and, having rejected restructuring, it is unlikely to be fully privatized soon.

Bankers in London and Budapest are unstinting in their praise for Suranyi, who is considered a serious candidate to be the next EBRD head. Tibor Rejto, managing director of ING Barings in Budapest, says: “Suranyi does not vacillate but sees what direction we should hold to. He has the integrity to stand up for what he believes in. But he is also a skilled politician who does not antagonize the ministry of finance.”

That enthusiasm is reflected in the amounts that new foreign strategic stakeholders are committing to Hungary. Zsigmond Jarai, chief executive of ABN Amro in Budapest, notes: “The bank has spent $230 million on acquiring MHB. That included the price of $90 million plus a capital increase of $100 million and a $40 million subordinated loan. We are financing our new technology from the capital increase. We have spent $85 million on technology, refurbishing the bank and creating new services, including developing retail banking and establishing a life insurance operation.”

Investment on this scale is essential as the banks fight increasingly hard to gain a share of an ever more competitive market. Margins have been squeezed from 8% to 3.5% over the past three years and will probably narrow further. “The biggest problem for banks is that profitability is going down. You have to increase your portfolio just to maintain profitability,” says Seebok.

The result is likely to be a further shake-out. “Today there are 40 commercial banks and a few investment banks and in line with international trends there will be some mergers. I don’t think 40 banks will be able to survive in five to 10 years,” says Suranyi.

Says Seebok: “To meet the challenge, you need to invest and those who don’t will lose out and will gradually get out of the market. Those foreign banks which came here to do business with big corporations and multinationals will not be able to live on just this. They either have to target other companies – for example small and medium-size firms prepared to take bigger risks – or move on to retail. But you can’t do that with one HQ in Budapest.”

The survivors will be those able to make the biggest inroads into retail banking, at present dominated by OTP and Postabank. These are regarded in Budapest as the least efficiently managed and thought most likely to lose market share. There is no doubt they are being targeted. Diversification is on the lips of virtually every banker in Budapest.

ING Barings bought and modernized a near bankrupt local bank two years ago to get into the retail market and Inter-Europa is diversifying through buying leasing, factoring and broking operations and extending its telephone and computer banking.

“In five years, the structure of banking will be very different,” says Csaba Pasztor, deputy chief executive at K&H. “The market will be dominated by a few institutions with Ft100 billion to Ft500 billion [$478 million to $2.4 billion] in their corporate portfolios. Then there will be the strong medium-size banks and then the rest. It will rapidly become and remain a market dominated by the six to eight largest institutions.”