Tuesday 1 May 2012

Credit - Hungarian Borscht

"A great empire, like a great cake, is most easily diminished at the edges."
Benjamin Franklin

Given Hungary has been our pet subject in relation to the study of systemic risk diagnosis (Modicum of relief):
"A liquidity crisis happens when banks cannot access funding (LTRO helped a lot in preventing a collapse). A solvency crisis can still happen when the loans banks have made turn sour, which implies more capital injections to avoid default (hence the flurry of subordinated bond tenders we have seen). Rising non-performing loans is a cause for concern as well as rising loan-to-deposit ratios."

We thought it would be appropriate, to follow up on our "Hungarian Dances" post with some update on the situation relating to the ongoing stand-off between Hungary and the EU and IMF and, of course, credit conditions.

According to Unicredit and as reported by Bloomberg, Hungary may not obtain aid from the IMF and the European Union before the fourth quarter. It would only happen before that date under severe market drop.

Also reported by Agnes Lovasz, from Bloomberg: East European Deleveraging May Hurt Economic Growth, RBS Says:
"Western European lenders will continue to reduce their eastern exposure to meet stricter regulations, curtailing access to credit and economic growth, Royal Bank of Scotland Group Plc said.
“Distressed deleveraging will likely slow, but European banks are still likely to want to reduce balance sheets,” RBS emerging-markets analysts Timothy Ash and David Petitcolin wrote in an e-mailed note yesterday. “Loan books will continue to shrink in aggregate, which would suggest still a very weak credit growth channel across the region, which will continue to act as a broader drag on growth and recovery.”

Indeed, the ongoing restriction of access to credit is already putting Hungary's economic growth under serious strains as reported by Zoltan Simon in Bloomberg on the 26th of April:
"Hungary faces the rising risk of a credit crunch because of the withdrawal of external funds and the high ratio of non-performing loans, the central bank said.
Lenders replacing external funding with “risky” foreign-currency swaps may be another trigger for a credit crunch and the Magyar Nemzeti Bank will consider regulating such transactions, the rate-setting Monetary Council said in a statement today.
A loan agreement with the European Union and the International Monetary Fund, which Hungary requested in November, may help reduce the probability of a severe credit crunch as it may include the commitment of foreign banks to their Hungarian units, the central bank said. The European Commission authorized Hungary to start bailout talks on the 25th of April. “The risk of a severe credit crunch, mainly in the corporate segment, has increased recently, given the weakening in the banking sector’s lending capacity, in addition to its persistently low willingness to lend,” the Monetary Council said."

Of course the European Union and the IMF have started bailout talks, because, end of the day, the fall of the Hungarian financial system would undoubtedly wreak havoc on Austrian banks and European banks highly exposed to Eastern Europe (Erste Group Bank AG, Raiffeisen Bank International AG, UniCredit SpA, Bayerische Landesbank AG, KBC Groep NV, and Intesa Sanpaolo SpA).

As we have long argued in various conversations, it is after all a game of survival of the fittest. In fact in our conversation "Hungarian Dances", Deutsche Bank already had highlighted the five most vulnerable countries in EMEA in December 2011:
"EMEA dominates our list of the most vulnerable countries. Five countries (Hungary, Ukraine, Romania, Poland, and Egypt) show up as highly vulnerable, though for different reasons. Egypt’s underlying vulnerabilities, for example, are fiscal first and external second. Ukraine’s risks are mostly external. Hungary’s vulnerability reflects a combination of risks in all four areas."

Therefore it wasn't really a surprise to us to learn about the fall of the Romanian center-right government on the 30th of April as political turmoils sank the currency, the Leu. As reported by Irina Savu in Bloomberg:
"The turmoil triggered a sell-off in the country’s currency, which fell to an all-time low against the euro today and may force Romanian policy makers to shield the leu by keeping rates unchanged after lowering borrowing costs one percentage point to boost faltering economic growth."

From the same article:
“Given Romania’s heavy burden of foreign-exchange debt, the exchange rate is a critical factor in the National Bank’s decision process,” Neil Shearing, chief emerging-markets economist at Capital Economics in London, wrote in a note to clients on April 27."

We have heard this story before for Hungary about foreign-exchange debt weighting heavily on households, representing significant headwinds for banks, not only to provide much needed access to the real economy by providing credit, but also hindering in effect the deleveraging process and the healing process of households balance sheet in these countries.

The Romanian Leu depreciated to a record low of 4.4140 per euro in Bucharest, the biggest intraday slum since February 20. Romania secured a 5 billion euro precautionary loan from the IMF and the EU in 2011 to protect it from the debt crisis, triggered by foreign-exchange debt similar to what we have been seeing in Hungary.

We believe a credit crunch is unavoidable in both countries:
"The ratio of non-performing corporate loans reached 17 percent at the end of 2011, a 4 percentage point increase from a year earlier, the central bank said. Including restructured loans, about a quarter of corporate loans were impaired, the bank said. The ratio will probably rise through 2013, the central bank said.
The ratio of non-performing household loans rose to 13.1 percent in 2011 from 9.5 percent in 2010 and will probably peak this year, according to the report." - source Bloomberg, Zoltan Simon - 26th of April 2012.

Hungary Economic Sentiment - Erste Bank indicator - source Bloomberg:
Economic Sentiment indicator deteriorating in Hungary and standing at -19.30.

Rising Non-performing loans in Hungary now at 13.30% - source Bloomberg:

Troubles ahead for Hungarian banks given the rise of Non-performing loans is not accompanied by a rise in provisioning, on the contrary....down to 45% - source Bloomberg:

The ill-fated currency non-performing mortgages plaguing Hungarian households are still rising (in HUF millions) - source Bloomberg:

The impact of the start of the bailouts talks can be seen on both the Hungarian bond markets as well as on Hungary's sovereign CDS market - source Bloomberg.

As well as on EURHUF exchange rate - source Bloomberg:

As a reminder from our conversation "Modicum of Relief", Erste Hungary's lending capacity is deeply impaired by:
-loan-to-deposit ratio of 192%, the highest in the sector.
-the proportion of non-performing loans in the bank's portfolio rose to 20.5% in 2011 from 11.7% in 2010 (The rate in the retail portfolio increased to 16.3% from 11.4%, while the rate in the corporate portfolio climbed to 29% from 12.5%
We argued at the time:
"Rising non-performing loans is a cause for concern as well as rising loan-to-deposit ratios."

Erste Group AG published their results on the 30th of April, and not surprisingly, their results are affected by bad loans in both Hungary and Romania. Erste has therefore cut its outlook as reported by  Boris Groendahl in Bloomberg:
"Erste Group Bank AG said bad loans in Hungary and Romania will remain a drag on profit for longer than it predicted after they cast a pall over first-quarter results at eastern Europe’s second-biggest lender.
Bad debt charges will be about 2 billion euros ($2.7 billion), or about 10 percent more than it predicted Feb. 29, as asset quality continues to worsen in Hungary and Romania, the Vienna-based lender said in slides prepared for an analyst meeting in London today. That also means operating profit will be only stable this year, rather than rising “slightly” from 3.63 billion euros in 2011."

In both countries, about one in four loans on Erste’s Hungarian branch loan book is delinquent. Erste had its first loss since at least 1988 in 2011 because of write-downs in these two countries.

From the same Bloomberg article relating to Erste Bank's results:
"Risk provisions rose 26 percent to 580.6 million euros, more than the 22 percent rise analysts in the Bloomberg survey had estimated. The bank booked extra charges on corporate and real estate loans in Romania, and on Hungarian foreign-currency mortgages. Erste had predicted Feb. 29 that 2012 charges would decline to 1.8 billion euros from 2.27 billion euros last year."
Once again analysts are on the ball...Nice.

The IMF has recently cut Hungary's 2012 economic-growth forecast to zero from 0.3%, predicting a 1.8% growth in 2013. We don't see it happening with unemployment likely to reach 11.5% in 2012 from 11% in 2011. The budget deficit in Hungary may rise to 3.6% in 2013 from 3% in 2012 according to the European Commission, that compares to a target of 2.5% for 2012 and 2.2% in 2013. Was it again a case of "A Deficit Target Too Far"? One has to wonder...

As our good credit friend indicated back in March 2012:
"Credit dynamic is based on Growth! No growth or weak growth can lead to defaults and asset deflation."

In fact the Hungarian government is indeed in a bind and has been resorting to "Argentinian" tricks to bring in much needed revenue. On the 24th of November the Economy Minister Gyorgy Matolcsy nationalised private pensions, in a government drive to bring in 3 trillion forint (14.6 billion dollars), rolling back pension changes as indicated by Zoltan Simon in Bloomberg on the 25th of November:
"Hungary, the most indebted eastern member of the EU, is following the example of Argentina, which in 2001 confiscated about $3.2 billion of pension savings before the country stopped servicing its debt. The government in Buenos Aires nationalized the $24 billion industry two years ago to compensate for falling tax revenue after a 2005 debt restructuring."

Any similarities with actual events will of course be purely fortuitous, as the saying goes...

It is as well not a surprise to hear that recently the Hungarian government has been planning to levy a tax on phone and internet usage as reported by Zoltan Simon in Bloomberg:
"Hungary’s government plans to levy a tax after phone and internet usage, Origo news website reported, citing unidentified people at the Economy Ministry.
The government may raise as much as 50 billion forint ($222 million) from the new tax, which would be part of measures to plug budget holes next year, Origo reported."
Which, of course, led to a big sell-off in Magyar Telekom Nyrt. (MTEL) shares. Hungary’s former phone monopoly fell the most in more than three months after news website Origo reported that the government plans to tax phone and internet usage on the 20th of April.

On a final note, the ongoing delay for Hungary in securing a much needed bail-out funds linked to their ill-fated private sector woes plagued by currency mortgages issued by European banks is choking the economy - source Bloomberg:
"The CHART OF THE DAY shows Hungary’s monetary policy is the most restrictive since at least 2006, after holding the benchmark rate since December. The Monetary Conditions Index for Hungary, which assesses the effect of borrowing costs and currency strength on the economy, is 5.3 percent below its 10-year average, compared with 0.2 percent in the Czech Republic. A negative value shows a tendency toward contraction." - source Bloomberg.

"He who rejects restructuring is the architect of default." - Macronomics.

Stay tuned!

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