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Germany's Bayerische Landesbank said November 13 it plans to split up its troubled Hungarian unit MKB Bank, hiving off the non-performing corporate debt into a newly created "bad bank", in a bid to help sell the remainder of the lender. However, the list of potential suitors for any Hungarian bank at the moment is short.

BayernLB told a conference call, according to Portfolio.hu, that it now plans to break up MKB to improve the chances of a sale. The discussion followed the release of third quarter results showing MKB lost €181m while its core business contributed €602m in pre-tax earnings. BayernLB has until 2015 to offload MKB under a 2012 agreement with the European Commission in relation to a bailout from the State of Bavaria in 2009, but is clearly struggling as the Hungarian sector struggles due to punitive government policy.

"We have achieved a great deal in the past few years. The transformation process at BayernLB is well underway and large parts of it are almost complete. However, our Hungarian subsidiary MKB is still the group's problem child for which a solution will have to be found," said CEO Gerd Haeusler, according to Portfolio.hu.

Under that "solution", MKB's retail and corporate banking activity will be bundled into one unit, while problematic corporate debt - mostly connected to real estate - will be spun off. "It has turned out that MKB cannot be sold as a whole," dpa cited CFO Stephan Winkelmeier as saying. Parts of the Hungarian subsidiary will be transferred into a so-called "bad bank", which will make the sale more "digestible".

The "bad bank" will most likely affect MKB's project finance division. CEO Pal Simak told Portfolio.hu in the spring that these real estate loans are mostly of a long maturity (3-10 years) and the size of the portfolio was around €2bn. That represented nearly 40% of MKB's full corporate exposure at the time.

BayernLB agreed to sell MKB's Bulgarian unit last month, and is in talks to sell its Romanian unit, but the Hungarian subsidiary itself has proved much harder to offload. While all three of those markets are struggling with bad debt due to previous lending policy and current economic conditions, Hungarian banks are being additionally battered by the government.

BayernLB noted that MKB operates in an economic and political environment that remains difficult. "The sluggish economic recovery in Hungary and a cautious climate for consumer and capital spending dampened operating income, as did a sharp drop in the base interest rate and a weaker local currency," the earnings report said.

However, the banking sector has been additionally weighed down since Prime Minister Viktor Orban and his Fidesz party took office in 2010 by special taxes that the banks say are the highest in Europe. On top of that, a financial transaction tax was introduced last year. Meanwhile, the government is pushing to reduce household debt denominated in foreign currency. A scheme in late 2011 cost the banks huge losses, and another plan is being built.

"[T]he Hungarian government is planning more political interventions with regard to outstanding foreign currency loans while for another, additional restructuring at MKB will result in further charges," BayernLB's report noted. "To comply with the EU Commission requirements, the stake in MKB must be sold in full. To achieve this, more work on MKB's shareholding and loan portfolios will be necessary."

Slow exit

The exit of foreign banks to give Hungarian companies a greater role in the sector is a clearly stated goal of the PM, who appears unperturbed by the fact that lending has ground to a halt. In a scenario that looks to resemble the ongoing push to rid the utilities sector of foreign players, the plan now seems to be to hammer down valuations to the point where the state can afford to buy them out.

After pledging repeatedly they are in for the long haul, foreign banks are slowly coming out of the woodwork to admit they've had enough. Italy's largest retail bank, Intesa Sanpaolo, said in March that it might call it quits, and the likes of Raiffeisen Bank International has announced severe cuts in investment. However to date, just one deal has happened: Italy's Banco Popolare agreed to sell its small subsidiary to Hungary's MagNet Bank for just €500,000 in April.

Others are ready to go, the central bank claimed on November 7. "If this situation [low profitability in Hungary] becomes permanent, the consolidation of the banking sector could accelerate," Marton Nagy, the central bank's managing director, told reporters, according to the Wall Street Journal. "Big banks are deleveraging massively and shedding their external exposure," he said, without specifying which banks may leave the country.

However, the exodus will take some time while balance sheets are unwound, he admitted. Foreign parent banks currently hold around €10bn at their Hungarian units to finance operations, he said, and that is clearly too large an amount of capital to withdraw suddenly. Therefore, banks will only be able to sell once they deleverage, meaning any consolidation of the sector is likely to be gradual. The rest of Emerging Europe is still busy fighting deleveraging, which was earmarked as a prime channel by which the Eurozone crisis would hit CEE.

At the same time, the list of suitors to buy the likes of MKB - which as Hungary's fourth-biggest bank could be worth as much as €1bn according to some estimates - looks limited. Most of Hungary's major banks are foreign-owned. The one exception is OTP, the country's biggest lender, which was reported to be in talks with Bayern LB, as well as the foreign parents of several other smaller lenders, back in May. However, news flow surrounding OTP's hunt for acquisition targets has fallen by the wayside in recent months.

Formerly seen as close to Orban, OTP CEO Sandor Csanyi has had a very public falling out with the ruling Fidesz party over its plan to revisit the foreign exchange debt issue. Csanyi has issued alarming warnings - far more nightmarish than those from any of his foreign peers - about a potential meltdown in the Hungarian banking sector and the wider economy, and he and many of his OTP cohorts have dumped huge volumes of OTP shares.

The central bank's Nagy offered a hint of the state's plan in his presentation to reporters, noting that while the country's large foreign-owned banks continue to struggle, smaller and partly state-owned banks are fairing better. Most are avoiding losses this year, he claimed, crediting the central bank's interest rate cuts and its "Lending for Growth" stimulus programme.

Such lenders include Takarekbank, he noted, which is controlled by the state with a 55% stake. The savings cooperative bank was recently beefed up by being handed control of the country's huge network of small municipal banks. Granit Bank and Szechenyi Bank, both 49% state owned, were also mentioned.

These banks will replace the big ones quitting the market, Nagy said. "The question is whether the small banks and Takarek will be able to beef up their liquidity, capital positions and personnel to grow up to that tall order," he added. Budapest has pledged to inject HUF100bn (€335m) into Takarekbank, although that may have to wait until after elections in spring next year, with the government needing funds ahead of the vote to keep a lid on fiscal indicators.