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West Europe’s taxpayers exposed to east’s loans

As emerging European currencies weaken by the day, the rising cost of loans taken out by people like him in foreign currencies such as the Swiss franc, the euro and the yen is pushing some of them into default.

Peter Mihalovits was just about to retire when the crisis hit. He had ignored warnings about borrowing in foreign currencies to take what seemed a risk-free, cheap route to a lifestyle he could otherwise not afford. Now the 59-year old must try to hang on to his job in the road haulage business to pay off his Swiss franc mortgage. The monthly installment has doubled," said Mihalovits. “I wanted to retire but now I have to work, otherwise we would not sustain ourselves even at lower living standards.”

As emerging European currencies weaken by the day, the rising cost of loans taken out by people like him in foreign currencies such as the Swiss franc, the euro and the yen is pushing some of them into default. As joblessness also increases, the mounting risk is putting emerging Europe’s banks -- and their increasingly state-backed Western parents -- under heavy pressure.

Western European banks, mainly from Austria, Italy and Germany, have bought up most of emerging Europe’s banks. Until recently this was seen as a blessing, protecting the region from sudden retreats by investors. Now the banks dominating the region -- topped by Italy’s UniCredit, Austria’s Raiffeisen International and Erste Group Bank -- are struggling with scarce funding for themselves, and reliance on them could trigger a credit crunch in the east.

For now analysts say stricter lending practices and lower loan-to-value ratios make a US-style subprime mortgage meltdown unlikely in eastern Europe. But currency weakness and job losses will squeeze bank earnings and erode portfolios. And as authorities increasingly urge their Western bankers to keep bail-out cash close to home to minimize the burden on taxpayers, the outlook darkens.

“In extreme loan-loss scenarios, the cost to western European taxpayers could be substantial,” Goldman Sachs analysts Rory MacFarquhar and Jonathan Pinder wrote in a note last week. “If western European governments refuse to allow their troubled banks to support ... subsidiaries, it would fall to the (emerging European) governments themselves to support the local banks,” said the note for exposed banks). “In this situation, many more countries would likely have to appeal to the IMF for assistance, and even so would have only a limited ability to escape a deep credit contraction.”

The International Monetary Fund warned last July that emerging economies in eastern Europe faced severe repercussions from a sharp retreat in oil prices, as they particularly benefited from petrodollar deposits from countries such as Russia, Libya, Nigeria and Angola. In contrast to the 1970s and 1980s when Latin America felt the pain of retreating Middle Eastern petrodollars, "the bulk of vulnerable countries is not Latin America but in emerging Europe," wrote IMF economist Johannes Wiegand at the time.


Data from the Bank for International Settlements released last week showed Austrian banks’ claims on emerging European clients totaled $277.6 billion, or nearly 75% of Austria’s GDP. For Sweden, claims mostly on clients in the Baltic countries of Estonia, Lithuania and Latvia represent 23% of GDP and for the Netherlands, exposed mostly to Polish, Russian and Romanian borrowers, this is just under 16%.

Since early last August Hungary’s forint has dropped about 28% versus the Swiss franc, 46% to the yen, and about 23% versus the euro. The Romanian leu has dropped 19% versus the euro while the Polish zloty has lost about 30%. In Hungary, whose economy was rescued only by a $25.1 billion IMF-led loan in October, a growing number of households face difficulty repaying their mortgages.

Mariann Lenard, a lawyer whose society assists troubled Hungarian borrowers, says her workload has shot up since last September. “We have registered a 10- to 15-times increase in the number of complaints since last September-October,” Lenard told Reuters, sitting in her small office. “Instead of the usual 20, we now get 128 emails a day and the same amount via post.”

Hungary’s total stock of foreign currency mortgages rose to HUF 2,374 billion ($10.26 billion), or about 9% of GDP by December.

Austria’s Raiffeisen Zentralbank, owner of Raiffeisen International, last week sought a state capital injection of €1.75 billion ($2.25 billion) to help it weather the credit crisis. Péter Felcsuti, CEO of Raiffeisen’s Hungarian unit and head of Hungary’s Banking Association, said the quality of households’ foreign currency loans was bound to deteriorate as the recession takes its toll and the currency weakens. “These impacts add up and this is definitely a concern,” Felcsuti said.

Raiffeisen is the No.5 lender in Hungary, where home-grown OTP is the biggest bank, followed by units of Belgium’s KBC, Germany’s BayernLB and Intesa Sanpaolo. CIB, Intesa’s Hungarian unit, said for the time being it could not see a rise in the proportion of non-performing loans but, looking at trends of rising unemployment, this could change within months.


If the forint (HUF) were to weaken even only slightly further from an all-time low of 303.50, the pain could spread. “Above 300 (to the euro) I can already see problems given that over the past years the average exchange rate was about 250,” said analyst Dániel Bebesy at Budapest Fund Management. “So a 25-30% depreciation can put many borrowers in a hard spot.”

Three months ago, Hungary was the only country in the region expected to slide into recession this year. Now the whole region’s growth prospects look much more dismal than before. Romanian central bank data showed the number of individual borrowers with past-due debts older than 30 days rose by around 21% to 443,000 from January 2008.

“The level of non-performing loans is not yet worrying but the trend needs to be monitored,” said Nicolae Cinteza, head of its surveillance department. “Against a background of rising unemployment and national currency depreciation, it is expected that non-performance will increase,” he added.

Erste’s BCR is the biggest player in Romania, followed by Societe Generale’s BRD and Raiffeisen. In Poland, banks with large portfolios of Swiss franc mortgages have seen the zloty’s steep falls over the last four months swell the value of loans on their balance sheets: they are now scrambling to attract more deposits.

Slovak banks -- the biggest are owned by Erste, Intesa and Raiffeisen -- said last week they had not seen any dramatic worsening of mortgage portfolios, but the government plans to help cover mortgages for people who lose their jobs because of the crisis. Foreign banks in Serbia have been reluctant to lend since October.

Plumbing engineer László Vadász has already seen the consequence. Since the construction project he was working on folded, the 61-year-old defaulted on his Swiss franc mortgage worth HUF 20 million ($92,360) on a house outside Budapest. He has been declared unfit to work with high blood pressure and his bank is preparing to auction off the house he shares with his wife and disabled son. (Reuters)