Tough Road Ahead for Bulgaria's Banks

Views on BG | May 1, 2013, Wednesday // 15:46
Bulgaria: Tough Road Ahead for Bulgaria's Banks A pedestrian passes by an office of UniCredit Bulbank in Sofia. UniCredit Bulbank is the country's largest bank by assets. Photo by BGNES

By Andrew MacDowall

The Banker

The Bulgarian banking sector has not needed government assistance in the wake of the financial crisis, but its slow growth rates and high non-performing loans do not make an inspiring combination.

Bulgaria's banks initially weathered the crisis of the past few years better than many of their European counterparts. But the aftermath, characterised by low growth and high levels of non-performing loans (NPLs), is proving difficult. After several years of double-digit credit growth, lenders face a rather more modest outlook in an emerging market that has been knocked sideways by the crisis in the eurozone.

The banking sector's assets totalled Lv82.4bn (bn) at the end of 2012, or just over 100% of gross domestic product (GDP), according to the Bulgarian National Bank (BNB), the country's central bank. Foreign-owned institutions account for about 70% of assets, a proportion that has declined due to Greek banks' deleveraging. Total system deposits reached Lv57bn in 2012, growing 8.4% year on year.

Banks' overall loan portfolios grew more slowly at 2.3% year on year, with corporate loans rising 4% but consumer lending up just 0.6%. Banks' net income fell 38% in 2012, to Lv63m, as the net interest margin (currently about 3.5% to 4%) declined and provisioning charges rose. As banks maintained a cautious stance towards lending, but continued to draw in deposits at a rate well above GDP growth, the loan-to-deposit ratio fell to 93% in 2012 from 99% in 2011. By the end of February 2013, the last date for which BNB statistics were available, claims on loans to the non-government sector represented 68.1% of GDP, indicating low-to-moderate loan penetration by developed-country standards.

The main reason for banks' caution is clear enough – the global economic crisis, particularly the eurozone's woes and its potential impact on Bulgaria's economy. Credit growth ran in double digits for most of the 2000s, reaching 62.5% in 2007. Bulgaria's currency board arrangement, which has maintained a fixed exchange rate with the German mark (and then the euro) since 1997, curbs the BNB's scope to use interest rates and other traditional monetary tools to cool lending, and the bank's increases in minimum reserve requirements had a limited effect.

Weathering the storm

In 2009, however, Bulgaria hit the buffers, belatedly compared with most of its EU partners, but hard nonetheless. GDP shrank by 5.5% in 2009 and has grown at a meagre rate since. Bulgaria may have achieved 1% GDP growth last year, averting recession, but such growth is hardly impressive for what remains the EU's poorest member. On the one hand, Bulgaria has largely avoided the banking bailouts that have occurred elsewhere; on the other, after years of rapid credit growth, NPLs have soared, and the crash in the property sector has had particular effect.

The NPL ratio in Bulgaria reached 16.62% of gross loans at the end of 2012, according to First Financial Brokerage House (FFBH), using figures drawn from the BNB. They totalled Lv9.6bn, up 14.9% year on year. The ratio of classified loans (for which payment has been delayed for more than 30 days) was 23.75%.

Nonetheless, the consensus in the banking sector is that it has weathered the past few years remarkably well, partly thanks to a stringent regulatory and monetary framework imposed after the 1997 crisis, when the economy teetered on the brink of collapse. Official figures suggest that aggregate capital adequacy ratios stood at 16.66% at the end of 2012, well above the minimum of 12%. The Tier 1 ratio was 15.16%.

"The sector proved to be resilient to the crisis, despite forecasts that it would go bankrupt," says Levon Hampartzoumian, CEO of UniCredit Bulbank, the country's largest bank by assets, and chairman of the Association of Banks in Bulgaria. "This is not a coincidence – after the creative destruction of 1996 to 1997, the system is conservatively regulated and the coverage ratio is much, much better because of it. Most NPLs are covered by collateral and it will just be a matter of time [before they] recover, as the economy does."

Foreign worries

Concerns that foreign mother banks would siphon off liquidity to bolster balance sheets at home proved to be "an urban myth", according to Mr Hampartzoumian. "Bulgaria is too small to provide a serious level of support; the market is equivalent to that of a mid-sized German town."

Deleveraging by Greek banks has been relatively smooth, despite fears of contagion. Their market share has fallen from 33% before the crisis to 18% now, according to FFBH. A possible merger between National Bank of Greece-owned United Bulgarian Bank, which owns 7.7% of banking assets, and the Bulgarian subsidiary of Eurobank, with 6.8%, could be scuppered by European regulators, but this is not expected to cause disruption either way.

"Banks did not suffer from financial losses and had negligible investments in securities other than government bonds," says Tsvetoslav Tsachev, head of the research department at Elana, a Bulgarian investment bank and asset manager. "The liquidity drain from parent banks created only a brief problem and interbank interest rates are very low. Only a small number of banks needed to raise capital. The BNB is doing its job on maintaining financial stability."

Mr Tsachev points out that the return on equity of the banking sector has fallen sharply, but is still positive at 6% in the past three years, compared with 16% before the crisis.

Tightening credit conditions

But Bulgaria's leading banks and the BNB are not without their critics. One is Lubomir Christoff, a Bulgarian economist and member of the Bank Stakeholder Group at the European Banking Authority.

"In 2006 and 2007 they were ringing people up in the middle of the night to offer them credit. Then the bubble popped and the way that Bulgarian banks were able to resist losses was by increasing interest rates on performing variable-rate loans to offset NPLs, up to 450 basis points above the BNB rate. Banks were permitted to offer low initial teaser rates, but can increase them as much as they want. They are effectively stealing from their customers," says Mr Christoff.

Mr Christoff acknowledges the BNB's work to ensure banks have adequate capital buffers, but says that the regulator is too close to commercial lenders and has prioritised their interests over those of ordinary borrowers. "There needs to be a better balance of rights between borrowers and banks," he adds.

Mr Hampartzoumian disputes that depiction and asserts that rates are lower than they were in 2008. He points out that "we have no intrinsic interest in killing our clients". Tereza Trifonova, an investment analyst at FFBH, says the cost of credit has gone up, but this is because rates offered by banks depend on their own costs of funds and calculations of risks.

Concentration risks

Arguably more serious are claims made in the Bulgarian financial weekly Capital that the BNB has been turning a blind eye to some local banks' concentration risk in companies linked to their owners, and may be underestimating NPLs and overestimating coverage due to inflated collateral figures given by banks. Nikolay Stoyanov, editor at Capital, says that systemic risks are considerably higher than official figures suggest. His reports have focused on Corporate Commercial Bank (CCB), a local lender that has gained market share in recent years and currently ranks sixth, with 6.8% of total assets.

The BNB, which declined repeated requests for an interview, issued a strongly worded statement rebutting these claims.

CCB also defended itself in a statement, saying that "the supervision inspections [of CCB] have confirmed that all exposures are in strict compliance with the local regulations, which are among the most restrictive and conservative within the European banking section. The bank's loan exposures are over-secured – as at year-end 2012 the aggregate value of total collateral was over 200% of total loan portfolio."

Mr Tsachev says it is possible to extrapolate from a 12% reported decline in interest income and an 11% increase in gross loans since mid-2008 that official figures of bad and renegotiated loans are correct. While other analysts agreed that the NPL ratio in the Bulgarian banking sector overall may be higher than reported and that regulation tends to favour bank owners over consumer protection, few took the view that the threat to the system was serious.

Slow growth

But nor is there a great deal of enthusiasm about the immediate outlook. Bulgaria's economy is expected to grow by just 1.5% this year, according to the International Monetary Fund (IMF), and the country's average monthly salary is a little over €400. As Ms Trifonova points out, Bulgaria's shrinking population and the fact that many Bulgarians already own property also limit scope for lending growth.

Further uncertainty has been caused by this year's street protests, which toppled the government of Boyko Borisov. Elections are due in May 2013, and while the result is difficult to call at the time of writing, a coalition seems almost certain. Whether it can implement the structural reforms and trimming down of the public sector that the IMF and business leaders seek remains to be seen.

But while acknowledging political risks and the need for reform, Mr Hampartzoumian is cautiously upbeat. He expects asset and loan growth of 5% to 6% this year, and anticipates that interest rate margins will narrow gradually while remaining healthy – a view shared by Ms Trifonova.

"We expect demand for loans to rise as the economy improves, but we need a predictable environment. That said, we prefer these more sustainable growth rates," says Mr Hampartzoumian.

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