The Hungarian banking system has been a thorn in the Hungarian government's side for quite some time. A large proportion of it is foreign-owned, which makes it more likely that there would be outflows of capital and restriction of essential lending activity in a crisis. And, of course, it's more difficult to coerce foreign-owned banks into doing things that the government wants, such as cheap lending to favored borrowers and buying up government debt.
Not only are many of its banks foreign-owned, they lend foreign currencies too. A high proportion of Hungarian mortgages are in euros or Swiss francs. Banks extended foreign-currency mortgages to Hungarian households at a time when the exchange rate to forints was favorable. But since then the international value of the forint has fallen, mainly due to a sustained period of monetary easing by the Hungarian central bank. This has improved economic conditions but left Hungarian households struggling to pay their foreign-currency mortgages.
The Hungarian Curia (or Supreme Court) judged this to be “unfair”. Quite how a loss on a foreign currency mortgage arising from a falling exchange rate due to central bank policy can be described as “unfair” is perhaps difficult to understand. But anyway, the Curia says it is, and it is the highest judicial authority in Hungary. And as a consequence, the losses will be forced on to the banks. Banks will be obliged to repay to borrowers any losses incurred as a consequence of adverse exchange rate movements in the calculation of interest and loan repayments.
Clearly this is going to be costly to the banks. The Hungarian National Bank estimates the total cost of this compensation at 700-900bn HUF. The worst affected foreign bank is Erste Bank Hungary, a subsidiary of Austria's largest bank, which estimates that it will lose 93bn HUF (298m EUR) - about 50% of its equity. Provisioning against this potential loss has contributed to its parent's predicted full year loss.
Other banks are also affected. Raffeisenbank – also Austrian-owned - estimates 37-50bn HUF (118-160m EUR), and Belgium's KBC estimates 49bn HUF (157m EUR). But if the Hungarian government was hoping only to hurt foreign-owned banks, they've miscalculated. OTP, Hungary's biggest bank, has also been lending foreign currencies to Hungarian households. In fact it has lent more than any other bank and faces an estimated compensation bill of 137-147bn HUF (438-470m EUR).
And it doesn't end there. To avoid further losses and ongoing compensation, the government now plans to force banks to convert these mortgages into forints at a rate somewhat below the prevailing market rate. Conversion is expected to take place in early 2015 and the costs are currently unknown. Nor will this conversion be limited to mortgages: small business loans are expected to follow in due course.
Exactly how the banks will afford this is unclear. The Hungarian National Bank will support liquidity with additional reserves as needed. And some banks may need recapitalization, either by private sector or – more likely – state investment.
The Hungarian government has said it aims for 50% of the banking sector to be in Hungarian ownership. Currently Hungarian ownership is thought to stand at around 40%, so this doesn't seem difficult to achieve. But recent statements from the Hungarian government indicate another agenda, according to the Hungarian newsire Portfolio:
Sára Nemes, state secretary in charge of asset policy at the Development Ministry, later said that "the acquisition of MKB could play a role in the executive of government strategy aimed at strengthening the banking sector. [...] She noted that "in an ideal case the state should have at least a 30% share in the local banking sector, as that would already give it a decisive role."
It seems the Hungarian government intends to build up a dominant presence in the Hungarian banking system. And it has already started down this road with the planned buyout of BayernLB's Hungarian arm, MKB.
The German Landesbank BayernLB has been looking for a buyer for MKB for some time. Bailed out in the financial crisis, BayernLB is required to dispose of MKB by the end of 2015 to comply with EU rules regarding state aid. This deal will be concluded by the end of September 2014, well ahead of the EU's deadline. The Hungarian state's agreement to buy MKB was described by BayernLB's CEO as a “huge relief”.
But BayernLB had to sweeten the deal considerably. MKB has a history of bad lending and heavy losses: its capital position is weak and the quality of its loan portfolio is poor. And it probably faces further losses from the conversion of foreign currency loans. The Hungarian state is paying 55m Euros for MKB – but BayernLB is providing an additional 270m Euros in capital. That amounts to paying the Hungarian state to take MKB off their hands. And it's worth noting that OTP, which had been interested in buying MKB, appears to have pulled out. This might have been due to political pressure from a Hungarian government that clearly intends to increase the proportion of the banking system that is owned by the state. But would the Hungarian government really have outbid a firm offer from OTP? To me, OTP seems to have pulled out rather readily - which suggests that the new owners could be in for some nasty surprises.
To be fair, the Hungarian government knows it is taking on a basket case. It is setting up a state “bad bank” into which, it seems, it plans to put MKB's portfolio of non-performing loans. But even so, I fear it may be some time before MKB becomes the vibrant state asset that the Hungarian government wants it to be, and its turnaround could be expensive.
But if this deal goes ahead, then others will follow. Indeed the MKB deal could be regarded as setting up a blueprint for further Hungarian state buyouts of distressed subsidiaries of foreign banks. Raffeisenbank has already indicated that it would be interested in selling its Hungarian arm at the right price.
The conversion of foreign currency mortgages is likely to spark a general sell-off of Hungarian banks by their foreign owners. From the Hungarian authorities' point of view, this is exactly what they want: but if the sell-off turns into a rout, causing rapid capital outflows and currency collapse, they might not be so pleased. They would be wise to proceed cautiously with the loan conversion program – and with the nationalization program, too.
