Yesterday, the Ukraine received a USD16.5bn loan from the IMF and the IMF at the same time said that it would agree with the Hungarian government on a rescue package in the coming days. Under normally circumstances this would be good news for CEE assets. However, it seems like the markets are totally giving up on CEE. This morning the Hungarian stock markets have dropped more than 10% despite the promise of an IMF package.
……it is worrying that the CEE markets continue to sell-off despite IMFâ€™s clear commitment to support the regionâ€™s markets and economies. One might in fact see the lack of positive response to IMFâ€™s rescue packages for Hungary and the Ukraine as an indication that these packages are in fact making the markets even more nervous that something â€œis seriously wrong in CEEâ€.
Lars Christensen, Chief Analyst Danske Bank, CEE: Markets fail to respond to IMF packages, 27 October 2008
Central European stocks declined for a fourth consecutive day on Monday, with indexes in Vienna and Budapest heading for record monthly drops, as concern mounts that the global financial crisis is going to have a severe impact on economic growth across the entire region and amidst worries that the IMF sponsored rescue packages in Hungary and Ukraine simply won’t be sufficient to avoid the worst of the damage. Concern is also mounting that there will be a process of “contagion” which will affect the whole region, and hence what we are now seeing is mounting pressure on financial systems across the CEE including, surprisingly perhaps, the Polish one. I say surprisingly, since Poland’s economy is normally thought to be rather stronger than most in the CEE and especially than those of countries like Latvia, Lituania, Estonia, Bulgaria, Romania, Hungary, Ukraine, Belarus and Serbia, all of whom are currently in negotiations of some kind or another with the IMF. Thus, we might be forgiven for thinking quietly to ourselves “if Poland falls, then god help the rest of them.”
Stocks Slide, Lead By Banks
Banks with heavy involvement in Central and Eastern Europe took another pounding on Monday, with Austria’s Erste Group Bank AG sliding to its lowest level in more than five years while Raiffeisen International Bank Holding AG, which operates in Russia and the Ukraine, plunged after mounting financial chaos forced Ukraine and Hungary to accept a loan and conditions from the IMF.
Against the general trend Poland’s WIG20 Index added 2.2 percent on the day, but this did follow a 5.9% fall on Friday. The MSCI Barra Core Poland Index (which is a measure of comparative equity values) is down 48% so far this month, and 61.24% over the last three months.
The Polish government also announced on Monday that Poland is considering guaranteeing interbank transactions – according to Deputy Prime Minister Waldemar Pawlak speaking on Polish public radio. Pawlak said that the government is examining the possibility of taking bank shares as collateral in exchange for any guarantees offered. According to Pawlak external investors in Polish banks have been applying policies that are “too strict” in the Polish context, since the credit problems encountered elsewhere have not affected Polish banks in the same fashion. This is a classic example of what we economists call “contagion”.
According to the draft of the new law which is set to go before the Polish cabinet on Tuesday, Poland’s government will be empowered to guarantee commercial banks loans from the central bank and other lenders on the interbank markets. The government will also be able to lend cash and state securities to banks. Poland’s central bank has already injected 9.3 billion zlotys ($3.42 billion) of liquidity into the banking sector (last week), in the form of 14-day repos. The latest decision seems to have been taken in order to try to ease strains on the Polish money market, and in particular the availability of forex loans.
Poland’s deputy prime minister also issued a warning that local bank capital was at risk of capital being transferred to financially-strapped foreign banks who own the local banks and urged the country’s financial watchdog to stay vigilant in the face of this. Here we see the reverse side of the coin of having non-national banks in such a dominant position. Previously this was thought to be a great advantage, since the parent banks were thought to be ready willing and able to fund domestic lending almost ad-infinitum. Now we see that this is not at all the case, and that their behaviour moves in a pro-cyclical direction, exaggerating the boom in the good times, and sharpening the downturn in the bad ones.
“There is a risk that the capital will be transferred from Polish institutions to their parents,” Waldemar Pawlak, who is also the economy minister and heads the governing coalition’s junior party, was quoted as saying by PAP newswire.
As a consequence of this governmental concern the Financial Oversight Commission (KNF) has asked banks domiciled in Poland to report all transactions with their foreign owners on a daily basis. KNF head, Stanislaw Kluza, said in a newspaper interview last week that the he considered the risk of capital transfers to be very low, however, because the European banks Polish outlets, with only $284 billion in total assets, were much too small to rescue large players in Europe and the United States. This is evidently true, but some of these foreign banks are now under great pressure to avoid additional exposure in the East, and a rapid withdrawal (or ceasing up in the flow) of funds could equally correspond to just this kind of damage limitation strategy.
Foreign financial groups, among them Italy’s UniCredit, the Dutch ING Groep, and KBC Group NV, Belgium’s biggest bank and insurer by market value (all of whom are struggling with major problems at the present time), control two-thirds of the Polish banking sector after buying stakes in local lenders during the banking sector privatisation of the 1990s.
Polish lenders have been especially hurt in recent weeks by concerns over their ability to obtain foreign currency through interbank markets and worries about the fate of their foreign parents. Executives at some Polish banks have urged the government to consider introducing guarantees after the central bank’s moves to boost liquidity on the interbank market, including foreign exchange swaps, failed to boost confidence between lenders. The financial watchdog KNF said on Saturday that Poland should think about measures to boost the Swiss franc positions of Polish banks, along with guarantees of interbank transactions or an eventual “institutionalisation” of the interbank market. But the regulator, the government and central bank insist Polish banks remain solvent and enjoy “over-liquidity.”
Many of Poland’s banks, like other lenders in the region, have been forced to introduce severe curbs on mortgages in Swiss francs due to pressure on their own liquidity and balance sheets. Such lending had become popular in Poland in recent months due to lower interest rates available from Switzerland and what was once favourable exchange rate.
Millennium BIGW.WA and PKO BP PKOB.WA, two of Poland’s top home loan lenders, have gone so far as to announce that they were going to tighten rules for new mortgages due to the rising cost of money and fears that global financial nervousness may lead to much slower economic growth in Poland. Millennium Chief Executive Boguslaw Kott said last week that the group – which is Poland’s third-biggest mortgage lender would ask for a 35 percent downpayment for popular Swiss francs-denominated home loans, a move which is likely to put a sharp brake on the growth of its mortgage portfolio.
PKO, Poland’s largest mortgage lender, also confirmed it would ask new clients to put up 20 percent of the value of property when borrowing in francs. Millennium, which is controlled by Portugal’s Millennium bcp, will now also require customers to cover 20 percent of investment when borrowing in Polish zlotys. Both banks had previously been offering mortgages equal to the entire value of the new home (100 LtV). Basically, what the hell these people thought they were doing by continuing to lend at 100% LtV after we have seen all that has happened in the US, and that is now happening in the UK and Spain is totally beyond “my ken”, it really is.
Chief Executive Boguslaw Kott described the move as a precautionary one, and said it did not reflect any liquidity problems, adding that it was now more difficult to get Swiss francs on the interbank market. Marek Juras, head of research at BZ WBK brokerage is quoted as saying: “At times like these it is more important for banks to take care of their liquidity than drive their sales even higher.” He estimated that for some lenders this would translate into a drop in new mortgages by between one-third and one-half.
The two market leaders join other smaller lenders, which in recent days moved to raise the bar for mortgage lending in foreign currencies as banks become more conservative and try to lure more cash on deposits by offering even higher yields. Mortgage adviser Expander said Getin’s DomBank and Santander and GE Money had tightened their lending requirements. Many banks have also boosted margins on their mortgages in the past two weeks.
The Polish mortgage market has expanded rapidly since 2003, driven by economic growth and soaring wages, with annual growth exceeding 40 percent in the first half of this year. Large numbers of central and Eastern European housebuyers hold loans in foreign currencies, especially Swiss francs.
Most major Austrian banks, including UniCredit’s Bank Austria, Erste Group Bank and cooperative Raiffeisen have now completely stopped lending to Polish domestic retail customers in foreign currencies.
After a meeting with economic advisers President Kaczynski advised Poles to keep faith in the zloty as the currency suffered further setbacks on the markets on Friday. Kaczynski recommended that loans should be taken in zlotys, not foreign currencies in order to avoid losing money on currency exchange.
“The depreciation of the zloty, which has its good sides for exports, boost mortgage loan installments for those who took them especially in the Swiss franc. This may, however, be a lesson to us all to take loans in the Polish currency. Considering low inflation, this gives the best results,” Polish President Lech Kaczynski told a press conference last Friday.
Seventy percent of the Polish banking sector is owned by foreign banks leading to concern that the impact of the general crisis in the banking sector will be felt in Poland. On Tuesday, Polish business Daily, Gazeta Prawna wrote, “The global financial crisis may cause large shifts in the Polish banking sector, AIG Bank Polska will soon be sold and there has been speculation that Fortis, Dominet, Citi Handlowy and even Bank Pekao may change hands.”
Sell off speculation has surrounded the Italian owned Pekao bank over the last two weeks. It was subject to a 20 percent share price decrease in October prompting concerns that owner UniCredit may have been considering selling of all its Central and Eastern European assets. This has since failed to materialize but shows the current lack of faith surrounding the Polish banking sector.
Slawomir Skrzypek, president of The National Bank of Poland stated it had no intention of stepping in to help the zloty as it continues to weaken on the foreign currency market in a statement to reporters on Friday.
The sale of apartments in Poland has dropped by 70 percent in comparison to the same time last year, showing that the credit crunch is beginning to bite in Poland. The tightening of lending policies by banks has caused demand to fall and though prices are decreasing by 10 to 20 percent in some areas, buyers are looking for smaller flats, or withdrawing from the transaction altogether. The financial crisis has also influenced the situation of those clients who wanted to buy apartments without needing to get a mortgage, the number of which is declining due to losses on the stock market, says Gazeta Prawna.
Polish banks are to crack down on credit lending for housing loans after Polandâ€™s financial regulator asked them to get tougher on lending practices. Millennium bank is one of the first high street banks to react and will now expect customers to cover 35% of the loan if they borrow in a foreign currency or 20% if borrowing in Polish zloty. The move is thought to be a precautionary one and not an indication of any liquidity problems, according to CEO Boguslaw Kott who told a news conference on Tuesday, â€œThe decision practically blocks an increase of our mortgage portfolio.â€ He also told reporters that Swiss francs are harder to come by on the interbank market. Millennium Bank has been a dominant force in the Polish housing lending market with 80% of its mortgages being in Swiss Francs. This reflects a trend across Central and Eastern Europe where many house buyers have loans in either Swiss or other foreign currencies.
PKO BP, another major Polish mortgage lender, has joined Millennium in reducing credit offered to 80% of the value of the property. Fears that the Polish housing market could suffer a similar fate to that in the Baltics, or Ireland, or the UK (with all the consequences for the bank balance sheets) are as yet premature, but the move does indicate a heightened degree of nervousness and uncertainty on the part of some of the biggest hitters in the Polish lending market.
“We are extending between 35 and 60 million zlotys worth of mortgages each day, the vast majority of those in Swiss francs.” Mariusz Grendowicz Head of BRE Bank BREP.WA is quoted as saying “To fund our growth in mortgages, we were the only bank to the best of my knowledge that was not using swaps, which were the cheapest alternative, but actually taking out a three- to four-year loan in Swiss francs to fund the book,”
The impact of the seize up in Swiss Franc housing loans is hard to guage at this point, although all the indications are that it will be serious. Foreign currency lending has not been such an important phenomenon in Poland as it has been in other CEE countries, but its weight has been growing in the last 18 months or so (see chart below).
One of the reasons for the recent uptick in Swiss Franc lending has been the monetary tightening cycle initiated by the central bank (see chart below), which made the cheaper interest rates available in CHF more attractive even though there was an evident currency risk involved.
If we look at the next chart the year on year rate of increase in the forex loans (the Polish central bank don’t distinguish in their data between CHF and Euro, but all the anecdotal evidence cited above points to a significant role for the CHF, and especially given the role of Austrian banks were this type of lending has been commonplace.
The big problem is really that the CHF is a “carry trade” currency, and carry currencies have a strong tendency to shoot up in value as risk sentiment retreats, quite simply because people all try to liquidate their positions at the same time. Hence carry currencies have a kind of “pro-cyclical” role, adding to the boom during the good times, and making the bad times even worse. Which would be one very good reason why if you really do want an fx mortgage, using a currency other than a carry one would be a good idea. Obviously those who have euro denominated mortgages – while not being immune from the present problems (see the Baltics) – are less exposed, since the movements in the relative value of the euro tend to be in the opposite direction to those of the CHF and the Japanese yen.
Where Does All This Leave Us?
Well obviously Polish GDP growth is now set to slow quite dramatically. At this point just how dramatically is hard to see. Credit Suisse Group recently cut its forecast for Polish economic growth next year, predicting that the global financial crisis will hurt consumption and investment.
Credit Suisse said Poland’s gross domestic product will rise by less than 4 percent in 2009, compared with the 4.4 percent rate it had previously forecast. The Credit Suisse revision, coming as it did amid rising risk aversion in the emerging markets context, pushed the zloty to a two-year low against the euro when it was released, which gives us some indication of just how nervous people have become. I think, basically, even Credit Suisse are being over optimistic at this point, although I think we need to see some more detailed real economy data before we can start putting serious numbers on just how over-optimistic they may be.
Poland’s “private consumption and investment should fall further than we had anticipated due to our expectations of an increasingly restrictive credit environment in 2009,” Jacqueline Madu, an emerging-markets research analyst at Credit Suisse in London, wrote in the note.
One of the first areas where we should expect this current crunch to be felt is in construction activity itself. There is no doubt that Poland has been “enjoying” the fruits of a construction boom since the second half of 2006. It seems to have come in two “waves” if we look at the chart below, with the first wave being much stronger than the second one.
If we actually look at the level of the seasonally adjusted index, then the steep increases in the levels of construction output become apparent. We should also notice how since about April 2008 the level has more-or-less stopped rising, and this seems to suggest that the construction expansion had been slowing even before the latest credit shock. So I think we should all be ready for this easing up in the expansion to be followed by a sharp slowdown in the weeks and months to come.
Also, if we move beyond construction and look at the chart for year on year industrial activity (see below), then it is clear that the expansion in Polish industrial output has been fading for some months now – not a good sign, not good at all, since it means that there is little underlying stability to resist the knock. The thing is running out of energy.
This becomes even clearer when we look at the seasonally adjusted index, since it is pretty evident that industrial output went into decline at the end of last year, killed-off in part by the high zloty, and in part by excess internal wage and cost push inflation.
So all in all, we should now be advising people in Poland to fasten their seat belts, since the ride may get bumpy. It is not clear at this point whether things will actually go so far as to need an IMF intervention in Poland, but with contagion spreading rapidly across the region, and Italian and Austrian banks visibly wobbling, it is a possibility which is not at all excluded.