Critical gateway

IFR Emerging Europe and Turkey Special Report 2014
10 min read

Vienna has been seen in the east as a portal to Western prosperity since the time of Genghis Khan and today remains a gateway to the CEE states.

To see the digital version of this report, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

Thanks to the Vienna Initiative, set up to stem outflows of capital by Western European lenders out of the region, the Austrian capital has built on its foundations of influence in recent years.

Perhaps even the Mongol warriors knew. When the armies of Ogedei, third son of Genghis Khan, reached Vienna in 1241, they were there for a reason. The Austrian capital, powerful even then, was also viewed as the entry-way to Western Europe. Destroy it, and nothing remained between Ogedei’s men and the cities of Paris, Milan and Venice.

In the end, they were saved by the Khan’s death, and the overnight disappearance of his armies from the plains of Europe. But nearly nine centuries on, Vienna remains a continental clasp, drawing together the disparate economies of Western and Eastern Europe.

Vienna-based lenders, led by Erste Group Bank and Raiffeisen Bank International, remain the financial powerhouses of Central and Eastern Europe. According to the Bank for International Settlements, the combined exposure of Austrian financial institutions to the CEE region at the end of 2013 was €210bn, more than any other sovereign nation.

A January 2014 report issued by the National Bank of Austria described the exposure of domestic lenders to the region as “fairly large, but broadly diversified, with more than 50% [of outstanding loans] in countries rated investment grade”.

The relationship is based on trade as well as finance: the flow of Austria-made goods to the largest seven CEE states in 2013 outweighed combined Austrian exports to Switzerland, Italy and the US.

“Austria is definitely still the gateway to Central and Eastern Europe,” said Michael Buhl, co-chief executive officer of Vienna’s flagship stock exchange, the Wiener Boerse (WB).

Austrian corporates and banks piled into the region during the boom times of the 1990s and 2000s and remained as the clouds gathered over Europe. The Vienna Initiative, formed in 2009 by Austrian lenders and a collection of multilaterals and development banks, averted a potentially catastrophic outflow of capital by Western European lenders desperate to shore up capital in core markets.

A rare example of public and private sector interests working for the common good (though the latter sometimes had to be dragged kicking and screaming to the table by taxpayer-funded multilaterals), the Initiative proved that Austrian investors “weren’t just fair-weather friends, and that our financial institutions were and will remain responsible and committed long-term investors in the region,” said Gernot Mittendorfer, chief financial officer at Erste Group Bank.

“The eastern expansion of the EU and a focus on infrastructure have made Vienna one of the leading business locations on the Continent. Vienna is still the gateway to CEE and the place to be when doing business in the region,” said Gianni Franco Papa, head of CEE division at UniCredit.

The same is true of Erste’s big Austrian rival, Raiffeisen. “There are no signs of a retreat [by] dedicated Western banks from CEE markets,” said a Raiffeisen spokesperson. In fact, the exposure of Austrian lenders to the eastern half of Europe has, since the advent of the Vienna Initiative, remained “more or less flat”, she said, despite the vicissitudes of two crises and a deep eurozone recession.

Loyalty

That’s not to say Austria’s lenders have stood still over the past five years, or failed to rejig their strategies to accommodate a changing world. Both have stuck it out in struggling CEE markets held back by the still sluggish eurozone, but they are prepared to respond decisively if political or institutional issues threaten their interests or foreign investment.

In April 2013, Erste Group sold its Ukrainian division for US$83m, booking a US$200m loss on the sale. Mittendorfer said Ukraine was the only country where “we couldn’t get a clear sense of the direction their development was taking them, or where they were heading in the foreseeable future”. Given Russia’s annexation of Crimea and the troubles in eastern Ukraine, that move looks remarkably far-sighted.

Then there’s Hungary, which has become a trying jurisdiction for foreign investors. Prime Minister Viktor Orban has made plain his preference to champion local firms, including in the financial space. This creates a quandary for Austrian lenders, highly exposed to an economy that has, despite Orban’s nationalistic feather-ruffling, performed admirably in recent years.

It’s a “tricky country” to work in, said a senior banker at a leading CEE-focused lender. “If their government tells you that foreign investors are not welcome, and that local banks are favoured [over you], that suggests we will not be looking for aggressive growth there.”

Mittendorfer said that other than the Ukrainian sale, it remains a staunch believer in the region’s prospects. “Our commitment to the region hasn’t changed dramatically in the last couple of years,” he said. “Our strategy is to be the leading retail bank in the eastern part of the EU. The only place where the bank remains under-represented is Poland; that’s a market on the bank’s future agenda.

“It’s the only major economy that is missing in our jigsaw. Poland is difficult as the banking market has different valuations, and at the moment there are no viable acquisitions options. But we are not in a hurry. We are long-term investors and we have long-term interests in the region.”

UniCredit, Italian by name but another financial player with a decided CEE identity, remains “a committed long-term investor in Central and Eastern Europe”, said the bank’s regional chief Franco Papa. “Regional economic growth is set to outperform [the eurozone] and banking sector profitability is clearly above that of major Western European countries. We focus especially on expansion markets such as the Czech Republic, Russia and Turkey.”

RBI, for its part, is “as committed as ever to the region”, said its spokesperson. Yet the lender is more committed to some markets than others, it seems, having identified six key “focus markets” that will drive the bank’s revenues and profits going forward – Russia, Poland, Slovakia, Romania, Austria, and the Czech Republic. In other markets, including a slew of re-energised economies ranging from the Baltics to the Balkans via Central Europe, RBI intends “either to hold exposure constant or in some cases to reduce our exposure”.

Even within Austria, then, with its punctilious loyalty to nations east of Vienna and west of Moscow, there is no one-size-fits-all strategy, as evidenced by Erste Bank’s Ukrainian exit and Hungarian concerns; and by RBI’s determination to squeeze every drop of profit out of a half-dozen strategic markets.

The sun is coming out…

It’s hard to argue with this approach – no lender, after all, can be strong everywhere – nor to doubt that, after a few very dreary years, there are a few more smiles on faces across Central and Eastern Europe. Assuming the eurozone recovery continues to pick up pace, the next few years should be a choice time for the region. Growth has picked up faster in CEE than in the eurozone, and WB’s Buhl is not alone in pointing to the lower level of regional indebtedness, where the average debt-to-GDP ratio stood at 55% at end-2013, against 93% for the eurozone.

“We are coming out of the crisis, and the sun may well be coming out for CEE,” he said.

Higher regional economic output across the eastern half of Europe should in turn and in time benefit Austrian corporates and financial institutions.

“In the long term, [CEE] will be the region with the best growth prospects in Europe,” said Austria’s central bank in its January 2014 outlook, noting that operations across the eastern half of Europe would generate “higher profits” for Austrian lenders than purely domestic operations.

….but keep a brolly handy

Vienna cannot crack open the champagne quite yet. Loan volumes have yet to catch up with the region’s revival. Total profit generated by Austrian lenders across the region in the first half of 2013 was €1.4bn, flat to the previous year, according to NBA data. Moreover, the bulk of earnings were sourced in just two markets, Russia and the Czech Republic, and were, the report said, “attributable to decreased provisioning rather than improved operating profits”.

Yet Austria’s best banks remain bullish on the region’s prospects, and with good reason. Romania’s resurgent economy is at a turning point: growth in the Balkans’ leading banking market will, both EBG and RBI believe, return sooner than later. Poland’s economy is humming along, as is the Czech Republic’s, both on the back of higher German GDP. The only thing bankers are waiting for is for economic expansion to translate more fully into asset growth in the banking system.

“We see countries growing, demanding loans, and others deleveraging,” said Mittendorfer. “The current rate of loan demand is flat but this will change as deleveraging comes to an end – and in many CEE nations, the net demand for loans has now turned positive.”