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Emerging Europe: Erste faces €800 million annual loss

€627 million Romania write-down; Recapitalization looms

Andreas Treichl, Erste chief executive

Andreas Treichl says he has taken radical action to prepare Erste for uncertainty

Austria’s Erste Group is expecting its first yearly loss since 1988 after charges and write-downs of €1.6 billion in the third quarter. The results stems mainly from operations in Hungary and Romania, where losses in part prompted fellow Austrian lender Volksbank to announce last month a possible 2011 loss of as much as €1 billion.

Erste chief executive Andreas Treichl said his bank, the biggest lender in Central and Eastern Europe after UniCredit, had taken "radical action... to prepare for a prolonged period of uncertainty". Erste now expects a 2011 loss of between €700 million and €800 million.

The biggest single contribution relates to a write-down on goodwill of €627 million from Erste’s Romanian operation, the firm’s biggest ever purchase. Analysts say a goodwill write-down from Romania had been expected since 2008 but the eurozone debt crisis meant it could no longer be delayed.

When Erste bought BCR, Romania’s biggest bank, after privatization in 2006, BCR was valued at €6 billion, some six times book value. Erste’s buyout of minority shareholders in BCR this September, however, valued the bank at just €1.6 billion. Erste retains €1.1 billion of goodwill in Romania after the recent write-down.

Renewed liquidity constraints at global and regional lenders will hit Romania relatively hard, as the average loan-to-deposit ratio is, at 120%, much higher than in other countries in the region such as Russia, Poland, or the Czech Republic (all below 100%). Finnish mobile phone manufacturer Nokia announced it was closing its Romanian plant in late September, depriving the country of its second-largest exporter.

In Hungary, where Erste is the second-biggest bank, Treichl expects a 2011 net loss of €500 million thanks to government attacks (including taxes) against a banking sector dominated by international firms. Erste is writing down €312 million in goodwill from Hungary related to its 2003 acquisition of Postabank.

Erste is making a €200 million provision in Hungary for a government scheme announced in September to allow early repayment of foreign-currency mortgages at government-decreed discounts (the loss assumes a participation rate of 20% and a currency loss of 25%). It is providing an extra €250 million in Hungary because of weakened economic prospects, allowing coverage of bad debt in Hungary to rise to 62%. The bank will subsequently recapitalize its Hungarian operation with €600 million of new equity.

Capital-raising concern

Erste’s pre-emptive announcement of losses prompted fellow Austrian bank Raiffeisen, one of Erste’s main rivals in Central and Eastern Europe, to affirm that it still expected to make a profit in 2011. It said it would provision €100 million for the government mortgage scheme in Hungary but said it had no goodwill booked in Romania and only €3.5 million in Hungary.

Erste’s losses, according to the chief executive, are covered by retained earnings. Furthermore – as with Raiffeisen – Erste’s repayment of participation capital given by the Austrian government in 2009 can be delayed. Nevertheless, Central and Eastern Europe’s main regional lenders – Erste, Raiffeisen, and UniCredit – are all expected to need extra capital in the coming year because of new EU capital requirements and the region’s deteriorating economic environment.

Late in October Austria’s financial regulator said Austrian banks would need to raise €2.9 billion by mid-2011. It said the biggest need might be from Volksbank, which sold its Central and Eastern Europe operations, excluding Romania, to Russia’s Sberbank earlier this year.

Emerging Europe’s regional banks are now faced with the prospect of raising new capital when their share prices in some cases are languishing below book value. Analysts say getting write-downs out of the way as soon as possible might be a good strategy to prepare for new investors next year.

Even so, given the competition for extra capital across the EU, some lenders will need to resort to government support, according to Gunter Deuber, head of emerging Europe research at Raiffeisen. An alternative for smaller banks, particularly in poorer countries, could be a reversion to equity participation by the regional development bank, the European Bank for Reconstruction and Development.

In October the EBRD indirectly supported Slovenia’s biggest bank, Nova Ljubljanska Bank, by offering support to a bid by Croatia’s biggest retailer, Agrokor, for its Slovenian equivalent, Mercator, which is partly owned by Nova Ljubljanska.