S&P: Mainly Positive Rating Actions Taken On Three Hungarian Banks Amid Diminishing Economic And Industry Risks
The rating actions follow our review of economic and industry risks for Hungarian banks. We have observed several positive developments since our last review of the banking industry in July 2015. Among these are regulatory changes, including the completed conversion of households' housing and consumer loans in foreign currency to Hungarian forint, as well as the establishment of a new asset management company to deal with problem commercial real estate loans. As a result, households now have comparatively lower debt burdens and debt service, and domestic real estate prices have started recovering. Most importantly, this conversion has eliminated the most prominent credit risk for domestic banks. Although households' demand for new loans is still weak, we think their appetite for credit will rise gradually. Following several years of deleveraging, Hungarian banks' overall funding metrics have improved visibly, and their reliance on the external bank debt decreased. Yet, we think that the competitive landscape is now tougher because credit demand has picked up only in the past few months and banks are increasingly investing in lower-yield domestic government debt, in line with the government's "self-funding" scheme.
Based on the above, we consider that economic risks for Hungary's banks have lessened and have revised our assessment of economic risk for Hungarian banks to '7' from '8' under our Banking Industry Country Risk Assessment (BICRA) methodology. We now view the trend for economic risks in Hungary as stable.
At the same time, we have maintained our assessment of industry risk at '7' and continue to regard the trend in this risk as stable. We therefore classify Hungary in our BICRA group '7', versus '8' previously. Combined, these changes mean that we have raised the anchor--the starting point for constructing our bank ratings--to 'bb' from 'bb-'.
OTP BANK and OTP MORTGAGEThe upgrade of OTP Bank largely mirrors our revised view of the domestic banking system, while also taking into account the bank's strengthened overall risk profile. The latter mainly follows the positive domestic developments described above but also incorporates the OTP group's increased loss coverage across markets where it's active, including Ukraine and Russia. Also, operations in these countries are returning to profitability, and their share of loans within the group has decreased. They consequently represent less of a drag on the group's risk position. Concurrently, we revised our assessment of OTP Bank's liquidity to strong from adequate. The bank has a sizable amount of liquid assets that cover its short-term funding needs more than adequately. More than half of its deposits in Hungary fall under the coverage-of-savings deposits guarantee, therefore making the bank resilient to reasonable stress in the next 12 months. The bank has a high amount of unencumbered assets that can be repurchased with the National Bank of Hungary and its counterparties. Its exceptionally good liquidity metrics are also attributable to its deleveraging in the recent past. We expect its liquidity metrics will gradually weaken but remain well above peers' when credit growth potentially accelerates in Hungary starting from 2017. We do not foresee the bank more actively funding lending growth with short-term wholesale issuance.
Our assessment of capital and earnings remains unchanged, already taking into account the continued gradual recovery of operational performance in 2016-2017. We consequently expect our forecast risk-adjusted capital (RAC) ratio for OTP Bank will improve to more than 8% in next 18 months but still remain below our threshold for a stronger capital assessment.
We equalize the ratings on OTP Mortgage with those on parent OTP Bank because we continue to regard it as a fully integrated subsidiary that is integral to the group's strategy.
The stable outlook on OTP Bank and OTP Mortgage is based on our anticipation that the group's business and financial profiles will remain commensurate with the current ratings over the next 12 months, all else remaining equal.
The likelihood of a positive rating action on OTP Bank over the next 12 months is limited because it would hinge on a similar rating action on Hungary and strengthening in our stand-alone credit profile (SACP) assessment for the bank, both of which we view as remote at present. In addition, we typically do not rate a bank higher than its country of domicile. To consider an upward revision of the SACP, we would expect to see the bank's RAC ratio above 10% on a sustained manner, along with better assessments of other bank-specific factors.
A negative rating action on OTP Bank, on the other hand, could stem from a similar rating action on the sovereign or deterioration in our SACP assessment for the bank. A weakened SACP could stem from a deterioration of the RAC ratio to below 7%, owing to rapid loan growth to the detriment of capitalization, or internal capital generation weakening because of a surge in risk costs. These are not our base-case scenarios however.
TAKAREKBANKThe ratings on Takarekbank factor in our view that the bank compares poorly, in terms of profitability and earnings generation, with other peers operating in countries with similar economic and industry risk and rated at 'BB+' or lower. They also take into account our upward revision of the group credit profile to 'bb+' from 'bb', reflecting our view of Hungary's reduced economic risks. The bank has reported negative capital sustainability levels, as measured under our methodology, and an overall low earnings buffer. Historical returns on equity have also been generally modest. Consequently, we apply a one-notch negative adjustment to the rating to reflect our view that the bank is and will likely continue to be a relatively poor performer in its peer group. In addition, Takarekbank only recently enacted a radical transformation. Therefore, it remains to be seen if the bank's recent overhaul of its business model and enterprise risk management will prove efficient.
We also think that Takarekbank will benefit less than other larger domestic peers from Hungary's recent regulatory initiatives to address foreign currency-denominated mortgages and large commercial real estate project finance loans, because it had lower exposure to these problematic asset classes.
The stable outlook on Takarekbank balances the improving domestic economic environment and the bank's tighter integration into Hungary's group of savings bank cooperatives with limited business prospects because the demand for credit remains subdued. Moreover, as a niche bank with weaker earnings capacity than the sector average, Takarekbank will in our view benefit less than private banks from improved domestic economic growth. The bank' now operates more closely aligned with the savings cooperatives' group strategy, with harmonized marketing, product, and Information Technology systems. We think that this could create stronger risk management, better efficiency, and wider business opportunities over the next 12 to 18 months, which we already factor into our ratings on Takarekbank. Therefore, we expect these factors will help the bank maintain financial and business profiles that we regard as commensurate with the current ratings over the next year.
We could take a positive rating action on the bank if we concluded that conditions in the domestic economy and the purchasing power of households had further improved, while credit demand picked up, leading to better earnings for the group. This would also necessitate a stronger commercial strategy with higher earnings margins and better efficiency, with improved earnings buffers and capital sustainability.
Conversely, we could take a negative rating action on the group if its profitability and earnings buffer remain below peers leading us to weaken our assessment of its business position and if the group's projected RAC ratio deteriorated below 3% at the same time. We would also consider a negative rating action if, contrary to our base-case expectations, we observed significant weakening in Takarekbank's links with the integrated savings cooperatives, which would trigger a change in our view of its core subsidiary status.
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