EBRD @25: Putting the seal on the Hungarian banking peace deal

EBRD @25: Putting the seal on the Hungarian banking peace deal
The central bank has said several times that it would like the EBRD to invest in MKB.
By Tim Gosling in Prague May 4, 2016

Hungary’s battered banks were mightily relieved in February 2015 when the government signed a peace deal with the EBRD and Austria’s Erste. The seal is finally set to be put on the treaty in the coming weeks, according to the development bank.

All parties are hopeful that purchases of separate 15% stakes in Erste’s local unit by both the state and the EBRD  – originally scheduled for June last year – will help cement the improvement in the banking sector’s stability since the memorandum of understanding (MoU) was signed. Under the deal, Budapest pledged to ease pressure on the banks – including cutting the controversial special tax on the sector - while Erste promised to raise lending.

However, the EBRD appears somewhat wary, despite persistent suggestions from Budapest that it is in talks with the international institution on other projects focussed on banking and the stock market. While the official line is that the deal is set to be signed, it looks like a very delicate touch will still be needed to bring it to the finishing line.

Graeme Hutchison, who heads the EBRD’s Hungarian and Slovak offices, confirms that the Erste stakes should finally be bought in the second quarter of 2016. “We’re hoping for plain sailing now,” he says, "based on the expectation that Hungary will adhere to the spirit of the MoU. Our view is that it is doing so."

The sunny outlook appears cautiously calibrated. The EBRD is being careful to ensure its message offers “encouragement” to those in Hungary that support the deal, sources claim to bne IntelliNews.

The leading edge of the MoU was a commitment by the ruling Fidesz to reduce the bank tax. Introduced in 2010 at a rate of 0.53% of assets, the move infuriated lenders. Not only was the levy far higher than those in other European markets in the wake of the crisis, but the Hungarian version was not planned to create a stability buffer for the sector, but to fill state coffers to avert austerity measures. Alongside forced conversions of forex loans and heavy fines and charges, the tax helped push the mostly foreign-owned sector into heavy losses.

As Budapest bids to revive lending by commercial banks, the tax was slashed to 0.24% for 2016. The government pledged on April 15 to lop another HUF20bn (€64mn) off the bill for next year, although it has not offered a firm tax rate.

That’s not the only reason the EBRD expects to finally seal the peace deal almost a year later than planned. The EBRD now feels Hungary is playing ball, suggests Hutchison. The official confirms it was Budapest’s push last year to make the banks pick up a huge tab from the collapse of the Quaestor brokerage that has slowed the deal.

It was estimated that Quaestor and two other fund managers had racked up around €1bn in losses from fraudulent deals when they collapsed early in 2015. The central bank forecast the case would cost the financial sector around HUF30bn per year for a decade under a scheme put forward to compensate investors. Once again, the banks were livid. They claimed the demand would wipe out practically all their gains from the lowered tax.

Erste said the scheme was a clear breach of the MoU “We made it very clear to the government that if that case is not solved amicably between the government and the banks, there will be no participation [in the peace deal],” CEO Andreas Treichl said in November.

“While the brokerage issue was unresolved it was seen as in defiance of the MoU,” says Hutchison. “However, the issue has been solved now to the banks’ satisfaction.” After the constitutional court struck down the parliamentary bill on Quaestor late last year it was watered down.

Changing spots

Such bumps in the road are the reason some suggest that the likes of the EBRD and Erste are naive to believe a leopard can change its spots. However, others say they now believe Budapest is genuinely on a new course.

Taking power in 2010, the Fidesz government inherited an economy saddled with a huge deficit and debt burden. It quickly leapt to start reducing external vulnerability, by fair means or foul. The banks were put in harness to help achieve that goal, but also to punish them for their perceived role in the financial crisis.

The global meltdown and the way the government “had come after them” left the banks “reeling”, says Hutchison. “Budapest blamed the sector for the severity of the crisis.”

However, with the state’s finances now in much better shape, “Orban has realised that solid economic growth needs healthy growing companies,” insists Tamas Mero at Concorde Securities.

“The whole aim of the MoU was an alignment between the banks and the government,” agrees Hutchison. “An effective bank sector is the key to growth.”

The government realises “Hungary’s unorthodox economic policy could be a drag on long-term growth potential,” suggests Gergely Tardos, head of research at the country’s largest lender OTP. “The country needs more capital and technological transfer. That is why some unorthodox measures are being scaled down. The government genuinely wants lending to return.”

However, lending continued to decline last year and remains anchored at around 50% of GDP, compared with levels of over 70% ahead of the financial crisis. Hungary is frustrated by the failure of lending volumes to rise more quickly. The Magyar Nemzeti Bank (MNB) has been driving credit to smaller companies over the past couple of years, but wants commercial lenders to take over, says Vice Governor Marton Nagy.

“It’s not healthy to rely on the central bank for lending, he tells bne IntelliNews. “The EBRD agreement offers confidence to the financial sector thanks to the drop in the bank levy and the move to reduce NPLs [non-performing loans].”

The EBRD said in a new strategy for Hungary released on April 11 that it will help “strengthen banking sector resilience and its capacity to lend” by providing direct long-term funding through bond issuance and mortgage-backed lending. It is also open to helping with the ongoing clean-up of lenders following years of growing bad debt.

However, Hutchison downplays the impact of Mark, the central bank’s newly launched ‘bad bank’ that has HUF300bn to buy toxic real estate loans from lenders. The Magyar Nemzeti Bank hopes the acquisitions will help revive bank lending and give the commercial real estate mark a jolt. “We’ve not seen much happening with Mark yet to be honest,” says the EBRD man. The bad bank has yet to agree valuations with lenders.

Unsurprisingly, the banks are keen to offer the peace deal all the encouragement they can, and claim they expect lending to finally perk up this year. Lenders insist they’re happy to return to business as usual, but that credit activity is constrained by demand. “The banks have a huge amount of excess liquidity,” Tardos points out. “They want to lend, but clients are very cautious.”

Still, they’re talking the talk. "The seven lean years are over for the domestic bank sector," Mihaly Patai, CEO of UniCredit's Hungarian unit and chairman of the Hungarian Banking Association, said in April as a Reuters poll revealed the majority of the country’s biggest banks expect to return to profit this year.

On top of that, bank loan quality should continue to improve this year, following a 26% fall in NPLs last year, Fitch Rating’s said in a report published in April, thanks to accelerated efforts by the banks to write off and sell bad debt.

Shooting themselves in the foot

Still, NPL ratios remain elevated at 11.7% of total loans, and there’s no little uncertainty still doing the rounds. Despite the EBRD strategy noting the institution could take part in M&A deals and consolidation of the Hungarian banking sector, it clearly wants more clarity.

“Full implementation of the deal, including the government’s commitment to creating a predictable and business-friendly tax and policy environment for the banking sector, will be critical,” the document reads.

The MNB has said several times that it would like the EBRD to invest in MKB – formerly Hungary’s fourth largest bank – which was sold by the state to a consortium of private equity funds in early April. Hutchison confirms talks are ongoing, but says the international institution won’t dive in at the moment. Speculation abounds that PE funds Metis and Blue Robin Investments are in fact cover for an acquisition by the MNB itself.

“We certainly won’t invest in MKB unless we know who the buyer is and what they bring to the table,” the EBRD official states.

There’s a similar ambiguity concerning talks with the central bank over getting involved in efforts to revive the Budapest Stock Exchange, which the MNB took over late last year. “We’ve had some initial discussions but at this point there is a lot to understand regarding the strategy envisaged by the MNB and the role the EBRD might be able to play” Hutchison says.

The EBRD official is surprised when asked if the central bank spoke to the institution before taking control of the bourse. “This is the MNB” he replies. “They don’t talk to us about their plans.”

While the government and central bank are clear that such issues are domestic, the banks are a headline issue for Hungary’s efforts to revive foreign investment. FDI has been struggling, as investors continue to eye the country’s erratic policymaking. Breaking the peace deal would only likely put Hungary further behind its neighbours.

“If attractiveness for foreign capital is weak, then capital accumulation will be slower than in our CEE competitors,” says Tardos. “Private sector investment is clearly weak right now; FDI is … low in a regional context.”

The peace deal is also key to efforts to finally regain investment grade after four years in ‘junk’. Both the markets and Budapest started the year convinced that 2016 will be the year; hopes are pinned on Fitch, which is scheduled to review the country in May.

“I think they were close to an upgrade last year. Quaestor did not help their cause,” says Hutchison. “They may get it in 2016 if there are no more shocks.”

However, the shocks are piling up, and doubts are growing over the likelihood of an escape from junk. A review from Standard & Poor’s in March surprised somewhat as it issued a stern warning over the opaqueness of the six foundations the MNB set up last year. It is these foundations that are suspected of surreptitiously buying MKB.

The response from Budapest has not been promising. A bill to remove the foundations’ spending from public scrutiny was struck down by the constitutional court in early April. Before the end of the month, records showing the foundations handed out billions of forint to friends and family of the ruling Fidesz party and MNB hierarchy piled huge pressure on Governor Gyorgy Matolscy.

The government quickly closed ranks. Prime Minister Viktor Orban insists his “right hand man” has no case to answer. On April 26, an amended bill seeking instead to remove public access to the spending of companies established by the foundations was passed by parliament. No concrete evidence has been revealed showing the MNB is behind the acquisition of MKB.

However, there’s plenty of smoke for investors and the rating agencies to ponder, while there’s also planned fiscal slippage to mull, as Fidesz revs up for 2018 elections.

“Hungary’s favourable risk perception has definitely weakened a bit during the past week with a deteriorating fiscal outlook for 2017,” noted analysts at Raiffeisen Bank International at the start of May. “Many market participants see the long-awaited return of Hungary to the investment grade club in May at risk.”

This is part of a series of articles marking the 25th anniversary of the foundation of the European Bank for Reconstruction and Development.