Municipal debt nightmares coming to life for Hungarian banks

By bne IntelliNews November 1, 2012

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Hungarian banks' worries that they may be facing yet another broadside from Budapest - this time on municipal debt - look like they may play out, as an official confirmed on October 31 that the government wants to discuss mitigation of part of the HUF612bn (€2.15bn) consolidated by the central government. The move is also likely to put Budapest further out on a limb with the IMF, and even the ratings agencies.

Lajos Kosa, vice president of the ruling Fidesz party, told the M1 TV show that six banks will be summoned to mitigation of part of the debt taken on by Budapest. Following up the words of Prime Minister Viktor Orban at the weekend -- which sent a chill down the spine of the country's banks having been hammered repeatedly since he came to power in 2010 - Kosa asserted that the loans have provided "windfall money" for the sector, which is heavily populated by foreign-owned lenders.

The officials comments followed reports earlier the same day that the central government is looking for a discount of 20-25% on the municipal debt it takes over. To add insult t injury, Internet portal origo.hu added Budapest will seek to service the debt in government paper instead of cash.

The level of mistrust between the banks and Budapest is reaching new heights - Erste's CEO said on October 30 that he wouldn't make any profit forecast at the Austrian lender's Hungarian unit because that would merely be an invitation for another government tax - and further eases the choices of struggling European banking groups trying to decide in which CEE markets they should pullback investment.

It will also take Hungary another step further from agreeing a bailout with the IMF, Should Budapest push this latest hit to the banks through, it would appear to confirm reports last week that the international lender will not be back for more talks this year. The IMF has regularly complained Budapest should stop implementing erratic one-off tax measures - a trend that has targeted the banks more than most - and carry out structural reform instead.

All of which will put more pressure on Hungarian assets, as well as further limiting lending into the recession hit economy. After the government announced earlier this month that it will not honour a promise to halve the special banking sector tax from next year, Orban claimed the move would make no difference to the economy as "the banks aren't lending anyway."

Erste analysts suggest: "If the news is correct, this means roughly a HUF 150bn loss for the banking sector, or about 0.5% of GDP. This would again be negative for investor sentiment, would hurt the banking sector again, and might damage the lending market further; thus the GDP outlook might also deteriorate further."

Meanwhile, analysts at Citi ponder if "[a]pplying haircuts on municipal debt may also be negative for the sovereign rating. From a technical viewpoint, if the haircut is applied prior to the takeover of the debt, it would not meet the definition of default. Nonetheless, the measure may still impact Hungary's credit assessment negatively as it provides more evidence of an unstable institutional environment," they write. "Recall that the household FX mortgage prepayment scheme that has forced banks to write off about 30% of prepaid household FX debt has contributed substantially to Hungary's credit rating downgrade to junk in late 2011."

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