End is nigh for foreign currency loans in CEE

By bne IntelliNews October 29, 2008

Nicholas Watson in Prague -

This financial crisis will cause the demise of many things - businesses, banks, hedge funds and wealth, lots of wealth - and October 23 marked the beginning of the end for foreign-currency loans in Central and Eastern Europe. The fallout from the decade-long growth of these products is set to cause yet more pain for many of the region's already distressed banks.

On October 23, Hungarian Prime Minister Ferenc Gyurcsany announced that the government had reached a deal with commercial banks operating in the country to protect the interests of those who have taken out these foreign-currency loans. This is not an inconsiderable number - by some estimates over 90% of all new loans to Hungarian households this year were made in foreign currencies such as euros, Swiss francs or dollars, meaning that over half of all lending to Hungarian residents is denominated in foreign currency, which translates into something like €6.5bn in forex housing loans. Growth in such loans has been strong elsewhere in the region: in Romania, such loans grew at a compound annual growth rate of 51% in the period 2000-2007; in Bulgaria it was 42%.

Such borrowing was a cheaper way for these people to finance their loans, as their wages caught up with those in Western Europe and the value of local currencies appreciated against the euro. However, the broadening of the financial crisis into emerging markets has put paid to that notion: the forint and other emerging market currencies have been hammered down by as much as 10% against the euro, leaving borrowers with more expensive mortgages at a time when many are losing their jobs as the world faces a severe recession.

"Most of the risk and all the really bad news will come for these mortgage holders if the [Hungarian] forint were to continue to depreciate further against the Swiss franc. Will this depreciation continue? Well, even we economists don't really know the answer to that question, and certainly Hungarian householders have no idea at all, which is one very good reason why most of these clients may decide to get out now. Certainly, they will probably be uncomfortable with the realisation that they have suddenly all become day traders in the forward HUF/CHF swap market using their homes as security," says Edward Hugh, an independent and widely read economist.

A way out

Hungary's agreement with the banks - if it can be called that, since PM Gyurcsany indicated that if the banks didn't agree to the package, then he'd push through legislation to make sure they complied with it - comes in three parts. The first allows the borrower to extend his mortgage to spread out his payments so that the depreciation of the forint "does not place an unbearable burden on the debtors"; borrowers will be able to convert their foreign-currency loan to a forint loan without prohibitive charges; and if borrowers simply can't meet the payments because, for example, they have lost their jobs, they will be able to reduce or suspend them entirely.

Many of the details regarding this deal remain fuzzy - what rate of interest, for example, will be charged on the new forint mortgages - but what Hugh believes is the main thinking behind the policy is to provide a "temporary" window for Hungarian borrowers to convert their loans before the central bank reverts to its easing cycle to get the economy out of the mess its in and the forint starts diving. "Basically, when you have half your army trapped in an excessively advanced position, you need the heavy artillery to lay on some cover while you pull them back," says Hugh. "Once the troops are safely back under cover, then, in my humble opinion, we should anticipate a rapid easing cycle on the part of the [central bank]... and an attempt to 'jump start' a new export-driven Hungarian economy."

Just as the Irish and German decisions to offer a blanket guarantee for bank deposits set off a chain reaction of such moves around the EU, experts argue that governments in one CEE country after another will now find themselves with little alternative but to follow Hungary's lead.

In the firing line

The French brokerage Oddo Securities, which also believes that the bubble in foreign-currency loans is "ripe for bursting," has looked at which banks in its coverage universe are most exposed to these products.

UniCredit Group, the largest western lender in CEE, is unsurprisingly heavily exposed, something that's contributed to its shares falling about 65% since the beginning of the year. Oddo calculates that UniCredit could lose between 12 basis points (bps) and 74 bps of Core Tier-1 capital depending on the severity of the household defaults. Its least-worst scenario of a 12-bp reduction in Core Tier 1 and a 14% decline in net profit is based on a default by one in three CEE households, a 40% depreciation of local currencies and a 50% slide in property prices. "For a group that is already short of capital, this is an additional and not insignificant threat to its solvency," it warns ominously.

However, it's EFG Eurobank that the brokerage believes would be the worst hit under its various scenarios, with a negative impact on Core Tier 1 of between 28 bps and 212 bps depending on the assumptions adopted. It adds, though, that the true impact on this bank may be mitigated by its presence in Bulgaria, where the lev is pegged to the euro.

Italy's Intesa Sanpaolo would be the least affected in Oddo's universe, with a negative impact on Core Tier 1 capital of between 8 bps and 47 bps.

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