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International banks rushed this week to confirm guidance on their financial performance in Hungary, despite a warning from the country's biggest lender that the costs of the government's forex loans scheme are likely to rise. However, a Moody's downgrade of two local units on August 12 illustrates the mounting pressure on the banks.

Moody's issued downgrades for Hungarian bank FHB as well as Erste Bank Hungary (EBH) - the local unit of the CEE region's third largest bank. The ratings agency said the move was prompted by a perceived increased risk of losses stemming from Hungarian government measures on foreign currency loans. Both banks were cut to B3 from B2, with a negative outlook.

The Hungarian government passed legislation last month that will force banks to refund borrowers for what it says are unfair spreads used in calculating installments. It also promises further action by early next year to wipe out forex loans altogether. The pace of that programme, and the rates to be used to convert debt into forints, has yet to be clarified.

"In addition to the measures announced in July 2014, the Hungarian government may introduce, in the fourth quarter of 2014 or first quarter of 2015, new measures aimed at converting foreign-currency retail loans into local currency, based on an exchange rate benefiting the borrowers," Moody's notes as it explains its downgrade. 

Holding out

Erste was one of two Austrian lenders that insisted to Reuters the same day that they are to maintain their guidance in the face of an additional profit warning from OTP - Hungary's biggest bank - that the costs of the refunds could be even higher than feared. OTP said losses could spike by as much as 50%. 

That followed a proposal from the National Bank of Hungary (NBH) that the judged overpayments on forex spreads should reduce the principal in the cost calculations of banks. OTP said its earlier forecast of a HUF110-120bn (€350m) loss on the scheme would increase to HUF177bn under those conditions. "The pre-tax cost for OTP will increase by some HUF71-81bn," note analysts at Erste Group. "Its effect on the fair value is some HUF 200 per share."

However, Raiffeisen International Bank (RBI) and Erste both, for the meantime, rejected suggestions they could be hit harder than previously thought. "Erste Bank guidance remains unchanged," the lender said when asked about OTP's comments by Reuters.

"RBI confirms the guidance previously communicated of an expected one-off charge of between €120m and €160m for 2014 resulting from legislation relating to foreign currency loans and unilateral rate changes in Hungary," RBI said in response to an enquiry from the newswire. "At this point in time, it is anticipated that the charge will come in towards the upper end of the range."

Stuck

However, the proposal from the NBH - which is very closely aligned with the government - is likely to make it into the legislation. Budapest has lost little sleep over complaints or warnings from the banks as it continues its push against the sector - which is widely seen as a means to force foreign parents to sell up to domestic buyers at bargain prices. 

Meanwhile, as Commerzbank analysts note, no Hungarian bank has so far launched a lawsuit to contest the refunds "This is mildly surprising because banks are required to prove the fairness of their rate hikes [by a] deadline [of August 27]. After this window, they will have to pay full compensation. We expect to see at least a few defences launched."

However, as Moody's says, huge uncertainty continues to haunt the country's banks. "Policy unpredictability towards the banking system will likely continue, constraining the bank's financial performance and growth perspectives," the analysts write of Erste. 

Foreign owners have been lining up to insist they intend to stay in Hungary ever since Fidesz came to office in 2010 promising to tax the sector heavily. The forex loans relief scheme only piles on the pressure. Moody's points out that even just the first phase of refunds could cut EBH's Tier 1 capital adequacy ratio to below 6% from 12.5% at the end of last year, sparking a need for additional capital.

Both analysts and the government appear to believe some banks will eventually be forced to give up, the longer and harsher their treatment. "We expect Hungarian banks, including EBH, to continue deleveraging over the next 12-18 months," writes Moody's. However, hefty portfolios prevent them walking; EBH had total assets of HUF2,266bn as of year-end 2013. 

The uncertainty has hit the quality of those portfolios. With the wait for the relief scheme having gone on for over a year, non-performing loans have spiked. The share of such loans at EBH rose to 26.1% of gross loans by the end of 2013, compared with 24.5% 12 months earlier. 

"Moody's estimates retail FX loans at around 65% of [Erste Bank Hungary's] total retail loans at year-end 2013. Consequently, even a limited "haircut" to  the conversion rate could result in large losses for the bank," the ratings agency's report notes. 

The hostility and uncertainty also blocks potential suitors. All of which only serves to leave Hungary exposed to a banking sector with falling funding and highly unwilling to lend. The Moody's downgrades "remind[s] us that this topic has taken on a serious tone for the macroeconomy," notes Commerzbank. 

That has left the central bank as the only real driver of credit. The NBH reported on August 12 that increasing demand in July saw its Funding for Growth scheme expand its cumulative lending to HUF833bn.