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Knett: long-term bull on Croatia |
In early July, Ibrahim Dedic, the founder of Croatia’s Promdei Bank, was shot to death outside his home. Originally from Bosnia, Dedic started his financial career trading foreign exchange on the streets. He then built up Promdei Bank and opened affiliates in Belgrade and Sarajevo. In Zagreb, he managed to acquire capital of Dm100 million ($55 million).
Dedic was notorious for his forceful approach to banking. “He showed very strong behaviour towards his clients,” says an analyst. “If they couldn’t repay they were kept in the bank for up to two days.” Most prominent banks tried to keep their distance from Dedic and his business. On July 22, the Croatian central bank ordered Promdei Bank to appoint a temporary deputy to replace Dedic, after operating difficulties began to emerge and the bank proved incapable of making payments. The police are still investigating Dedic’s death.
Promdei is a particularly troubled example of a general banking crisis. Croatia is also confronting a looming recession and has been seriously affected by the war in neighbouring Kosovo. The conflict has resulted in an estimated 30% to 50% reduction in this year’s revenues from tourism, an important sector in Croatia, and has further damaged the climate for foreign direct investment. The finance ministry has started to rehabilitate banking through stricter regulation, bankruptcy proceedings directed at weak banks and a push to privatize the most desirable state-owned assets. But its approach has been criticized for being old-fashioned, too guarded and much too late in being implemented.
Rocked by crises
Several problems have hit Croatia in quick succession. First there was the Asia crisis, then the Russian devaluation. Neither had a direct effect but both harmed investor sentiment. There followed a very strict monetary policy from the central bank aimed at stopping depreciation of the kuna against the Deutschmark. Liquidity has contracted and many companies that leveraged their balance sheets during better times are now facing collapse. Banks have cut back on lending, intensifying the economic slowdown.
Croatia is overbanked and poor banking practice has been allowed to persist. Five million people are served by more than 60 banks, about three times more than are necessary. Many banks are small and poorly run, partly because operating licences have been given out freely. “Many banks don’t have any target,” says one analyst. “People just get together and say ‘let’s start a bank’. They are just a trading company to make money. They are not really banks.” Promdei Bank has a slogan that perhaps sums up this naive approach: “The possibilities are enormous. Let’s make money together.”
Banks’ accounting procedures are so inadequate that it is difficult for the central bank, let alone outsiders, to determine many firms’ true condition. Moody’s analyst Pavel Simacek says the central bank has still not supplied him with last year’s annual results from Croatian banks. Non-performing loans are a problem, but no-one knows their extent because figures are not forthcoming. Moody’s uses figures for Zagrebacka Bank, which has the most transparent balance sheet, as a proxy for the sector. Zagrebacka reports 13.8% of loans as non-performing but as it is Croatia’s leading bank, the figures for other banks undoubtedly are more alarming.
Struggling to survive
Reckless borrowing has not been monitored. “There are a lot of problems with banks’ founders,” says Nikola Carevic, managing director of Deutsche Bank’s representative office in Zagreb. “The shareholder does not think of himself as a shareholder but a credit holder.” Using the credit of banks under dozens of different names has been a continuous problem.
Many banks are now in trouble. Splitska Bank, one of the banks that the government has decided is worth saving, pitifully describes its struggle to stay afloat in a public pronouncement: “We went through many changes, we experienced the collapse of economy [sic], we experienced all difficulties resulting from an unstable currency, we looked for a way out escaping into foreign currencies, our inflation was measured by thousands of index points and we finally reached the huge wall of blockade, insolvency and illiquidity.” A similar story could be told by most of the nation’s domestic banks; all but one of the large ones have faced rehabilitation of some kind.
Everyone agrees that banking consolidation needs to be swift and drastic if the sector is to be saved. “The banking sector is slowly but surely going bankrupt,” according to an analyst. “The government should start with a concentration process by whatever measures, whether it be bankruptcies, mergers or forming banking groups. There should be a concentration on domestic banks with some strong regional players because there is not enough [room] for everyone.”
The banking crisis peaked at the end of last year and the government has since intervened to contain it. The key reforms have been stricter rules on bankruptcy procedures, stiffer loan-provisioning requirements and a ban on inter-group lending. The central bank now wields much stricter control and direction over banks.
On paper, the new regulatory framework seems strong enough to punish banks that break the rules but there is concern over whether it will work. It now has to be implemented by the banks. The bureaucratic legal system could make enforcement difficult and protracted. “The legal system is fantastic, not quite as fantastic as Moscow but close,” says an analyst. “The average lifetime to make a decision is six to eight years.”
Eleven banks, including Dubrovacka Bank and Glumina Bank, are now under forced government control and are at various stages of rehabilitation or pre-bankruptcy. Three others – Rijecka Bank, Splitska Bank and Privredna Bank – are in the final phase of rehabilitation and are scheduled for privatization. The state owns 70% to 80% of each of these banks and is looking for a strategic foreign shareholder for a partial stake. Foreign advisers have been appointed for each bank: ABN Amro for Privredna, Daiwa Bank for Splitska, and Deloitte & Touche and HSBC for Rijecka. Some Italian banks, such as Banca Commerciale Italiana, have shown an interest in Splitska and Rijecka. Austria’s Raiffeisen ZentralBank (RZB) has expressed an interest in Rijecka and formal proceedings were due to begin in September.
Croatia’s central bank is not as free-handed as many would like. It wants to keep a majority stake in Privredna Bank. “It is critical that the government is not going beyond 50%,” according to one analyst. “It is harder to sell to a strategic investor who will have to buy less than 50% with lots of problems.”
Zagrebacka is the only important bank to have escaped a rehabilitation programme. It stands out because of its size, its broad branch network and its transparent balance sheet. It is the largest privately owned bank in Croatia, accounts for over a quarter of total banking assets and has captured about a quarter of market share. It is listed on the London and New York stock exchanges. “It is a good bank,” says Moody’s Simacek. “It is much better than the sector and the economy it is in, which we find remarkable.” If the sovereign is upgraded, Zagrebacka will probably be upgraded with it.
The sector has been volatile but Zagrebacka has kept its leading position. Last year it lost some market share to newly established and fast-growing domestic banks such as Glumina Bank and Dubrovacka Bank. Many of these competitors have since gone through bankruptcy proceedings and Zagrebacka has regained its lost share.
The effect that stricter banking regulations will have on Zagrebacka is of some concern to Moody’s which nevertheless believes that ultimately good banking practice will protect the bank. “Zagrebacka Bank seems to be ahead of the game,” says Simacek.
Foreign banks have had little effect on its dominant position. “We were afraid two years ago of the entrance of the big market players from Europe to the US,” says Zagrebacka vice-chairman Nikola Kalinic. “They could afford to give relatively cheap capital to our best customers. But they have withdrawn. They might return but they have left us more time to be prepared.”
Zagrebacka’s closest domestic competitor is Privredna Bank where rehabilitation started in late 1996 and finished at the beginning of 1998. The restructuring focused on downsizing of operations and investing in technology. In 1998, with a new managing board in place, its return on equity was 5%, compared with 1.7% in 1997. Privatization will involve bidding by international strategic investors and completion is expected before the end of this year.
Privredna is still the largest bank in Croatia and has the most extensive branch network. Historically it was an investment bank serving the state and state-owned companies but under rehabilitation it has changed its policy to include retail business. It is one of the few rehabilitated banks that has kept its good name and has the greatest hope of being privatized.
Zagrebacka Bank is not too worried about the competition. It is confident of its grip on the sector and thinks that Privredna Bank has a lot of catching up to do. “We remember how many years it took us to get here,” says Kalinic. “We know what a big effort it took to reach a high level of quality.” For the past two years it has had a twinning arrangement with Allied Irish Banks which has included training programmes that have helped in the implementation of western banking operations.
Austrians lead foreign incursions
Foreign banks have not been hugely successful in Croatia. The strongest players have been the Austrians, including RZB, Bank Austria Creditanstalt and Erste Bank. Other foreign banks include Germany’s HypoVereinsbank and Société Générale, BNP-Dresdner and Cassa di Risparmio di Trieste.
The two leading foreign banks, and the only ones turning a significant profit, are RZB and Bank Austria Creditanstalt-Croatia. RZB, under the name Raiffeisenbank, was the first foreign bank in Croatia in 1996 and is so far winning the battle for market penetration. Despite the recession and a difficult market environment it has had impressive results. Last year it reported assets of Dm539 million ($288 million), which increased 33% from the previous year. Its return on equity reached 24.3% which was significantly higher than the leading domestic banks.
“We don’t seem to have the same strategy as other foreign banks – they are active mainly on a corporate level,” says Zdenko Adrovic, chairman of Raiffeisenbank in Zagreb. It has tried to focus on four business areas from the beginning: international corporate clients, retail banking, international payments and investment banking. In retail, it has granted 25,000 loans to Croatian citizens and has captured 40% of the car-loan market. It has a 10% market share in international payments and is still growing in investment banking. It is one of the top five brokers on the Zagreb stock exchange. By next year it will have seven full-service branches across the country.
Bank Austria Creditanstalt-Croatia was the second foreign bank to enter Croatia, in 1997. It has used a top-down approach and initially saw the market as a “missing unit in our network” according to Anton Knett, the chairman of BACA-Croatia. It began by serving international clients and selected corporates and then moved into retail banking to attract depositors. Last year it opened Croatia’s first building society. Its operating profit last year was Kuna24 million ($172.7 million).
Knett brought his experience from Prague where he set up the Bank Austria Credit- anstalt-International operation in 1990. The strategy has not been as aggressive as Raiffeisen’s but the bank has expanded and increased its profits. It expects an operating profit of Kuna30 million this year. In the long term Knett is bullish on Croatia but in the short term he is not so sure. Retail banking is a focus for the future and the bank is planning to open additional branches, including one in Split. But Knett knows the national mentality: “Customers don’t rush from local banks to foreign banks, they don’t even have a choice if they are in a smaller city. They trust their local banks even if some go bankrupt. Or they put their money under their mattresses.”
The primary draw to operating in Croatia is high interest-rate margins, which reached 10% in 1998. Ask a banker what the other benefits of doing business in Croatia are and there tends to be a long silence. But there is a handful of good companies in Croatia. These include: Pliva, emerging-Europe’s leading pharmaceuticals company; Podravka, the country’s largest food producer; and Ina, the leading oil and gas company. On the retail banking side, mortgage lending is a profitable business. Banks can lend in kuna and fund in Deutschmarks, and since there is always a guarantor, there is very little risk. “The way to settle the bills is in kuna but the Deutschmark is the name of the game – it is a Deutschmark country,” says Raiffeisen’s Adrovic.
No significant deals have emerged from Croatia in the past year except the sovereign’s Eurobond issue in February. The seven-year e300 million ($320 million) issue, which was lead-managed by Credit Suisse First Boston and Dresdner Kleinwort Benson, got to the market before war broke out in Kosovo. About a week after the bombing began, on June 11, the sovereign also signed a four-year $75 million term-loan facility, and a 14-year $228 million US Ex-Im Bank guaranteed facility to finance a section of the Bregana-Zagreb-Dubrovnik motorway.
Deals in the pipeline
The government is keen to privatize some banks. It is also trying to sell stakes in leading state-owned companies, including 25%-36% of national telecoms company Hrvatske Telekomunikacije (HT). Bids have come from Deutsche Telekom and a Scandinavian consortium of Telia and Telemora. It also wants to sell a significant stake in Croatia’s biggest insurance company, Croatia Osiguramje. Privatization is accelerating, but Telecoms companies tend to be the easiest to sell. Banks, especially those with non-performing loans, are harder to dispose of.
Zagrebacka Bank expects $100 million- worth of shares of pharmaceuticals company Pliva to be sold when the time is right. And Ina and Mol, The Hungarian oil and gas company, have announced discussions exploring a possible merger.
Major change is unlikely before the elections at the end of this year, so most market players are trying to hold on until then. Early economic predictions of what a new government will bring include a possible devaluation of the kuna, which might hurt banks with kuna assets and Deutschmark and euro liabilities, and a reduction in value-added tax by up to 50%. But it is structural reform that the banking community hopes for – it must be significant and immediate if the sector is to improve. Existing regulation and scheduled privatizations mark an important first step but the banks are waiting to see if this is lip service or the start of true improvement.
