Hungary special report 2015: Good times are here again

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Hungary’s banking sector is one of the region’s most exciting and innovative, stimulated by greater competition and government moves to tackle bad debts.

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Hungary's financial sector is on the move again. After years of slow growth and tepid profits, leading lenders are again preparing for a bright future.

Over the past year, a bloated banking sector has been winnowed down, with a brace of foreign investors departing the scene. In December 2014, Budapest Bank, an SME-focused lender previously owned by GE Capital, was absorbed by the state. Five months earlier, MKB, a far larger and better-known banking brand that ran into trouble in the dark days following the financial crisis, was folded into government ownership, having been acquired from Germany’s BayernLB.

Bright future

There are many good reasons to point to a bright future for one of the region’s most exciting and innovative banking sectors.

First and foremost, there is the prospect of greater competition. In the wake of the election of Viktor Orban as premier in 2010, domestic lawmakers, keen to inject fresh impetus into a lagging economy and a sluggish banking sector, wrestled with an industry boasting too many inactive players, many of them sitting on their hands rather than jostling for new business.

Some banks were clearly committed to a market with vast economic potential lying at the beating industrial heart of Central and Eastern Europe (CEE). Others were less determined. BayernLB, having received state aid from the German government following the financial crisis, already had one foot out of the door, while GE Capital had long flagged its global determination to focus on fewer markets. Thus the acquisition of both MKB and Budapest Bank by the state made good and timely sense.

Hungary’s government has made clear its lack of interest in retaining a controlling stake in either – or indeed any – commercial lender.  In December, financial policy minister Gábor Orban told Euromoney in Budapest that the state was “conscious of the risks of running a bank”, and did not intend to retain control of either bank. The two outfits will likely be merged, to create the country’s second largest lender, before being sold to private local investors or listed on the Budapest Stock Exchange, with the government retaining a minority stake.
Pter
Péter Virovácz, Századvég Economic Research Institute

Complete overhaul

The likely creation of a freshly-minted lender combining the heft of MKB and the nimble flexibility of Budapest Bank will also encourage rivals to work hard to secure new business. One of the aims of whittling down the number of powerful local lenders, says György Matolcsy, governor of the Central Bank of Hungary (MNB), is to “create a far more competitive banking system”. He adds: “The entire industry needs a complete overhaul. We need far stiffer competition.”

Financial policy minister Gábor Orban points to the need for another round of consolidation, to take place during 2015, with one or two more foreign lenders likely to exit the domestic market. An industry boasting eight large banks, each with a single-digit market share, is “unsustainable”, the minister says, noting that the number of viable domestic banks will, in the medium term, be whittled down to five or six.

This creates a future scenario in which a select group of lenders emerges, capable of helping build and guide Hungary’s economic future. Most domestic and international analysts believe the winners will prove to be Budapest-based OTP Bank, the largest domestic lender, and a coterie of foreign-based peers, notably Austria’s Erste Group Bank, UniCredit of Italy, and Belgium’s KBC Bank, owner of local unit K&H. A few other names, including CIB Bank, owned by Italy’s Intesa SanPaolo, and Vienna-based Raiffeisen Bank International (RBI), may have to up their game to remain part of Hungary’s banking scene.

New taxes

Orban’s government has played a clever and balanced hand in dealing with the banking sector. A brace of new taxes imposed since 2010 - one directly imposed on lenders, the other levied on all financial transactions, including ATM withdrawals - helped shore up the
state’s budget, generating HUF140 billion ($520 million) in annual earnings. Banks grumbled, but the levies were necessary for both the country’s general financial health and that of the banking sector as a whole. In December 2014, premier Orban suggested that the state may trim the windfall tax in 2016 and 2017, noting that he wanted a “new chapter” to start soon for banks, with the state seeking to make their debt burdens bearable.

Another clear focus of the government is to begin the process of unclogging a banking sector still struggling with a backlog of non-performing loans (NPLs). In the years leading up to the financial crisis, many banks directed cheap funding into a raft of industrial projects, many of them in the residential property space. With the onset of the financial crisis, many of those projects faltered or failed. Households had also borrowed at a record pace before 2008, taking out mortgages and retail loans denominated in foreign currencies such as euros or Swiss francs. For some, the financial crisis proved ruinous, as the local currency, the forint, tumbled in value, leaving households facing spiraling debt repayments.

The outcome was disastrous for all parties. Consumers, struggling to repay their debts, cut spending, crimping economic growth. Banks, faced by rising NPLs, reined in lending, further dampening output and undermining government attempts to get the economy moving again. The reaction from Orban’s government has been unorthodox and unconventional but, equally, carefully considered and compellingly decisive. It has transformed Hungary’s economy into one of the most vibrant in the region, infused the banking sector with a new lease of life and created a new wave of economic growth.

Ending the debt torment

Two particular financial reforms stand out. The first, designed to relieve Hungarian consumers from their endless cycle of debt torment, was approved by parliament in November 2014. During the first six months of 2015, lenders that disbursed around €9 billion ($10.65 billion) worth of foreign currency loans to consumers in the pre-crisis years will convert them into forints at the most customer-friendly of two exchange rates.

Gyula Pleschinger
Gyula Pleschinger,
Monetary Council, MNB

Markets reacted positively to the news. Lenders will take a hit, typically losing around $400 million a year in earnings due to lower interest income. But, in the end, everyone gains. Banks can get back to their traditional job of making loans to happier customers who, released from their debt obligations, will be free to spend, boosting economic growth. In its latest Hungary Quarterly Outlook, published in December 2014, Barclays noted that by ensuring an equitable solution for all parties, households will see their average monthly foreign exchange loan repayment costs fall by 30%, freeing cash to be saved or spent elsewhere.

Already, there are signs that Hungarian consumers are beginning to open their wallets. “This will help clear more soured retail loans out of the system, all of which is good for the health of the economy, and for the long-term profitability of the banking sector,” notes Péter Virovácz, head of the macroeconomic department at Századvég Economic Research Institute, a leading consultancy.

Creating a bad bank

The flip side to that coin is the bad debt stemming from failed commercial lending. Again, the government has a solution. A new bad bank is to be created in 2015, overseen by the central bank and designed to store failed or failing commercial real estate loans owned by leading lenders. In November 2014, the MNB said it had set aside $1.2 billion to buy failed so-called ‘project loans’ that remain a drain on the financial sector and the economy.

Few can argue with this point: at end-September 2014, the corporate NPL ratio stood at 18.5%. The new bad bank will process and sell those loans, further stimulating economic growth and fostering increased lending. “As an initiative the bad bank can play an important role in facilitating the reduction of NPLs,” says László Bencsik, chief financial and strategic officer at OTP Bank. He adds that, as the economic revival continues to strengthen and broaden, “there will be more opportunity to reduce the ratio of bad loans. And as the mortgages and commercial real estate sector starts to grow again, the NPLs in those sectors will be easier to clean up and restructure.”

Fair regulation

The final major change facing the banking sector this year is a bill tabled by the government in late 2014, designed to create a healthy banking sector capable of supporting the economy and providing financing for households and corporates. Many of the codicils girding the new fair banking law (FBL) have been in place for years but, notes Gyula Pleschinger, a member of the Monetary Council of the MNB, the new bill “ensures that the financial services sector is regulated for the first time in a proper, fair and transparent manner”. Adds financial policy minister Orban: “It will outline and define what is and isn’t fair. It defines the regime that a consumer loan should follow, making pricing transparent.”

Local and foreign lenders have embraced the new laws, recognizing the paramount importance of restoring credibility and fairness to an industry battered by the events of recent years. Lenders say the FBL is a step in the right direction, and it’s notable that even bank CEOs are universally supportive. “Fair banking legislation is positive in that it makes the rules on the financial sector clear, transparent and applicable to everyone,” notes OTP Bank’s Bencsik. “This is good for clients but also for the banks as it creates a very responsible banking system. The fair banking law creates a fair and level playing ground for all players in the banking industry and makes the rules clear and transparent for everyone.”

If it’s broke, fix it

What comes shining through in all of this is a government determined to fix a previously broken sector, to make the industry work for the good of everyone, and to ensure that the next boom does not involve a spike in the type of exuberant lending likely to burden borrowers with a new round of debt. By pricing loans clearly, the government has made it easier for customers to understand their commitments, and harder for lenders to insert clauses that, through accident or design, penalize uneducated consumers.


Real estate picks up

To the surprise of some (particularly in Brussels, which has remained sullen and tight-lipped in the face of the country’s remarkable turnaround) and the delight of many, particularly in domestic financial and economic circles, Hungary’s banking sector is showing strong and sustainable signs of life. A clear-headed government capable of thinking for itself (and showing a remarkable determination to stay the course) is a large part of the reason for this, as are the lenders that dominate the local banking scene. The likes of UniCredit, Erste and KBC recognize the implicit value in remaining integral to a rising central European manufacturing powerhouse wedded to the economies of Austria, Germany and the wider CEE region.

Retail lending is on the rise again, signifying a turnaround in the long-embattled real estate sector. After consecutive years of very low rates of investment in the property space, there is a conspicuous shortage of newly built houses. That should lead to an expected spike in new project lending in 2015, first in residential real estate and then in commercial property, bank chiefs say. Consumption rose sharply last year, with household spending up thanks to robust real wage growth. Add to this a low inflation environment and banks expect retail lending demand to increase this year and next.

Indeed, banks see momentum building across the entire financial services spectrum. OTP Bank’s Bencsik says corporate loan activity rose sharply in 2014, with the lender taking its share of the market to 13%, from 8% prior to the financial crisis. “We will continue to extend our lending activity with Hungarian corporates, with loan growth to domestic corporates rising by between 5% and 10% year on year in 2015,” Bencsik says. “We have higher aspirations with SME corporates, where our loan growth target in 2015 is close to 10%.”

Focus on the middle

Indeed, a rising slice of incremental loan demand this year is likely to come from mid-cap corporates: fast-growing Hungarian firms – the local equivalent of Germany’s famed Mittelstand companies - that lack access to global markets, and for which the primary source of funding is the local banking sector. “From our perspective this is now a major focus for us,” notes Bencsik. Adds economic consultancy Századvég’s Virovácz: “For banks, going forward you will see more profitability being sourced out of the SME sector, as well as the household and the corporate sectors.”

Demand for fresh borrowing is also pouring out of resurgent or long-underutilized or neglected sectors from tourism to auto manufacturing, and pharmaceuticals to agriculture. A fresh influx of EU funds over the next seven years will largely be directed into areas such as infrastructure – creating huge new construction projects – as well as supporting smaller corporates and broadening the manufacturing base.

Equally vital to the banking sector’s turnaround has been a Funding for Growth Scheme (FGS) modelled on a Bank of England project and designed to get banks lending and mid-cap firms borrowing again. Hungary’s FGS plan, divvied up into two tranches totalling $6.5 billion and extended to the end of 2015, channels funding directly through the banking sector, allowing lenders to extend credit to viable corporates on very competitive terms by cutting the cost of funding to zero.

Hungary’s financial services sector has come through great hardship in recent years, as has the broader economy. But after a long winter, spring is finally here. Profits are up, banks’ loan books are expanding again, and lenders are operating in an economy which, thanks to government foresight, and the willingness of lenders to make short-term sacrifices for long-term gains, hasn’t been this sustainably strong in living memory. In Hungary, it’s a good time to be a bank.