Central Europe’s biggest lenders have had a wretched time since the global financial crisis morphed into a Eurozone sovereign debt crisis. As well as plunging income, surging non-performing loans and higher regulatory capital requirements, governments in the region saw them as a soft target for special taxes, as well as handouts to struggling borrowers.
Now, just as banks hoped that they were over the worst, politicians across the region threaten to launch a new wave of bank bashing, this time focused on bailing out clients who took out Swiss franc loans. The cash grabs will not only hurt the banks but could lead to prolonged legal battles, and look set to hurt lending and investor sentiment, as Hungary’s earlier forcible conversion of euro-denominated loans has already proved.
Following the Swiss central bank’s decision to allow the Swissie to appreciate in mid January, it has risen by more than 10% against currencies such as the Polish zloty, pushing up repayments by borrowers, typically middle-class mortgage holders.
Their woes have proved too tempting for parties facing elections. Croatia’s Social Democrats pushed through a bill on compulsory conversion of Swiss franc loans in September, just ahead of November’s inconclusive general election. Meanwhile, Poland’s incoming populist rightwing Law and Justice government promised a similar measure before it won the October election, as well as a general levy on bank assets or financial transactions tax.
“This is very negative for the sector as a whole,” says Gunter Deuber, head of CEE bond and currency research at Raiffeisen Bank International (RBI) in Vienna. “The profitability of CEE banks is once again under pressure. From a sector perspective this is not a good thing.”
Bank profitability in the region is still fragile. In its “CEE Banking Report” in June, RBI reported that banking return on equity in the region in 2014 was around 6.9% – the lowest return since 2000 – and that this year it could even fall below Western European levels.
Governments have made only perfunctory attempts to justify the forced conversions, merely playing to populist sentiments that the mainly foreign-owned banks made huge profits in the boom years before the crash – when they allegedly failed to highlight the forex risks to customers – and they should now pay some of that back. “Enough is enough,” said Croatian Prime Minister Zoran Milanovic in September. “All these years there has been only one winner, the banks were the gold medal winner, and have done well, not only from the citizens but also from the Croatian state.”
Banks retort that governments and central banks did not object to foreign currency lending at the time, because it boosted long-term lending and central bank forex reserves (after banks swapped it for local currencies). “Before there was no long-term funding in local currencies,” Karl Sevelda, RBI’s chief executive, told bne IntelliNews in May, pointing out that even Hungary welcomed forex loans at the time.
However, Sevelda did concede that “maybe we stopped our forex lending too late”, with most banks only halting such lending when the global financial crisis made the loans too risky.
Banks now fear that other governments could be emboldened to make cash grabs. So far Romania – which has the largest Swiss franc portfolio after Poland – has resisted the temptation, though the country’s election is not until the end of next year. Parliament is, however, considering a proposal to allow mortgage borrowers to slough off their debts after foreclosure.
“We don't know of any [new measures], but if your wife cheats on you three times, you look at a fourth time to be more likely than if she has never cheated on you,” Erste Group's chief executive Andreas Treichl told analysts at his bank’s third-quarter results in November.
Banks regard the Croatian government’s behaviour as even more egregious than Hungary’s or Poland’s, though their losses will be much less because there are only some €3bn of loans involved. They complain that the government rebuffed their attempts to seek a compromise and has imposed the whole cost of converting loans on them.
“This solution is unique in some ways,” says Chrisoph Schoefboeck, chief executive of Erste’s subsidiary in Croatia. “It’s the only kind of government regulation that concentrates the burden completely on one side. In Hungary there was some kind of load sharing between customers, the state and banks.”
Swiss franc loans are a sizeable proportion of the market – representing 16% of all lending at the end of last year, and 38% of all mortgage loans. Since January, the Swissie has appreciated by 12% against the euro and 10% against the kuna, pushing up the amount of the outstanding loans and monthly repayments.
In an attempt to curry favour with voters before what was certain to be a very close election, the ruling Social Democrats passed legislation in September enabling the country’s 55,000 borrowers in Swiss francs to convert their loans into euros at the exchange rate prevailing when they took out the loan. Though the election outcome is still unclear, even if the rightwing HDZ ends up leading the new government, the conversion policy is unlikely to be reversed.
Banks had proposed to differentiate between individual customers, by prioritising real cases of social hardship caused by the increase in monthly repayments, but only if there were changes in personal circumstances. Nor was their preferred solution very generous: those hardship cases would have had their debts – but also their properties – transferred to the state or banks.
Yet the banks point out that many Swiss franc borrowers are wealthy and took out mortgages for second or even third homes. Non-performing levels of Swiss franc retail loans are in line with euro-denominated retail loans at around 12% for Erste and 16.5% for RBI. “The vast majority of Swiss franc borrowers are able to pay,” says Schoefboeck. “A good solution was absolutely possible within a short period of time,” he goes on. But there was hardly any discussion with a Croatian government that was in a hurry to get something in place before the November elections.
The central bank says the conversion will cut the principal of the Swiss franc loans by around 30%, costing banks around €1.05bn, representing three years’s of profits. RBI took a one-off charge of €75mn in the third quarter for this, while Erste took one of €145mn and Italy’s UniCredit – the market leader – took a €205mn charge.
This comes at a time when profitability in the Croatian banking sector is already feeble, with non-performing loans still very high at around 18% of all loans, according to Erste. Return on equity in the sector is less than 5%, the bank says, well under the cost of capital, and now profits will in effect be wiped out for the next two years.
The conversion, which is already being looked at by the country's Constitutional Court, is likely to lead to a prolonged legal duel between the government and banks. Erste, RBI and Hypo Group Alpe Adria of Austria, UniCredit and Russia's Sberbank are said to be considering bringing the case to an international arbitration court under bilateral investment protection treaties.
One insider says that banks have been inundated with offers from US and other legal firms to take the case on a success fee only basis. “The Croatian proposal is very high-handed and from a legal perspective it is even more dubious than Poland,” he says. “[Law firms] are very confident of winning this. Most likely we will see this case in the international arbitration court.”
The Croatian government has threatened to fight back if the banks take this step by imposing a banking levy. "I hope the banks will not open any confrontation with the government because thus they would jeopardise their own business as the state is the biggest and most reliable debtor," Finance Minister Boris Lalovac – who himself has a CHF mortgage – told a Reuters conference in September.
"The fiscal risk [from legal action by banks] hardly exists, because the state always has instruments to compensate for costs, like by introducing taxation on banks' assets which already exists in some European Union member states," said Lalovac.
If Croatia and the banks do go to war, it could hamper the country’s sluggish recovery from six years of recession. “A turnaround in growth is only possible when you have a stable legal framework,” says Schoefboeck. “This might lead to an adjustment in investor appetite.”
“This country needs constant access to finance in the next few years,” says another banker more bluntly off the record. “Let’s see how they get all this finance when they have a very negative reputation in the banking community. The willingness to put any more money into the market is already very limited.”
A failed Croatian bond auction at the end of September – when the treasury rejected all bids for the first time for at least five years – gave a sign of what might be to come, prompting Lalovac to repeat his threat. “Being spiteful is not a good strategy,” Lalovac said. “Should banks continue to act spiteful, we have prepared measures to counter that, including a tax on assets.”
The bill for banks looks likely to be even bigger in Poland, though the shape of the new government’s proposal is not yet clear.
The Law and Justice party plans to fast track implementation of either a financial transaction tax or a levy on banking assets, with which it hopes to raise between PLN1.7bn and PLN5bn a year. But it is also looking at a Croatian-style plan of converting the country’s 550,000 Swiss franc loans into zloties at the exchange rate prevailing when the loan was taken out, with the cost borne entirely by the banks.
Even more than in Croatia, such a proposal would be pure populism as the rate of non-performing Swiss franc loans in Poland was just 3.4% at the end of 2014 and has barely gone up since. In the third quarter this year, RBI’s non-performing Swiss franc loans represented just 2.8% of its total Swiss franc loans.
The bill for this conversion could reach PLN30bn (€7bn), according to the Association of Polish Banks, though the KNF regulator estimates it could be as much as PLN60bn (€14bn). “The sector would not be able to shoulder it,” KNF chairman Andrzej Jakubiak said in November.
“This would definitely be a blow to the larger banks,” says Deuber. The banks most at risk from the bill include mBank, Getin Noble, PKO, BZWBK, Millennium, BPH, and Raiffeisen Polbank. General Electric of the US (owner of BPH) and Germany’s Commerzbank (owner of mBank) have already threatened to take legal action against an earlier version of the conversion plan when it was being considered by the previous parliament.
Uncertainty over the shape of the conversion has also frozen dealmaking in the banking market, with the sale of RBI’s Polbank and GE’s BPH effectively on hold until the situation becomes clearer. “The transactions market is to some extent in standstill - everybody is waiting for what the new government will come up with when it comes to the banking tax and regulations regarding Swiss franc borrowers,” said Andrzej Klesyk, chief executive of insurer PZU, which is seeking acquisitions.
Yet the Polish market still remains much more profitable and attractive than Croatia. Polish banks made a net profit of PLN16.2bn (€3.98bn) in 2014, according to the Polish statistics office, so the conversion bill is likely to be less than two years’ profits. “In Croatia I don’t see any buyers at all,” says Deuber. “But in Poland I still see banks that are interested in the market.”
Banks, moreover, still hope to persuade the new government to compromise, though this might turn out to be wishful thinking given its aggressive start. “Polish authorities face very hard resistance from big European banks,” says Deuber, pointing out that there are some much larger players in the Polish market than elsewhere in the region, such as Commerzbank. “These banks have a certain lobbying power in Brussels.”