Moody’s has placed seven Hungarian banks on review for downgrade in response to a recently approved Hungarian law.
The law gives foreign-currency mortgage borrowers the option to repay the outstanding balance of their mortgages in a lump sum at exchange rates well below the market average – 36% below for the Swiss Franc and 19% below for the euro – triggering haircuts for the banks.
Given that Moody’s estimates that around 70% of mortgages in Hungary are foreign-denominated, this raises concerns about the negative impact on banks’ balance sheets.
Bartosz Pawlowski, head of CEEMEA strategy for BNP Paribas, suggests two reasons for the government’s questionable move. The first is that the government is venting some of its anger at the country’s financial sector.
“The government is unsatisfied with the way that the banks have been selling these mortgages, and at any rate it blames the banks for the economic shambles that the country has found itself in,” says Pawlowski.
The second reason is more economically driven. The vast amount of foreign-held debt in Hungary is proving to be a significant constraint on the growth of the country.
“Foreign debt has choked Hungary,” explains Pawlowski, “This needs to be solved if the country is to grow in the future – and by the future I mean for years.”
While the policy may have a plausible economic goal, its efficacy in achieving that goal is questionable. Since the announcement, Hungary’s currency has weakened, with the US dollar being up around 0.5% against the forint.
Furthermore, Moody’s projects that only around 30% of mortgage holders are projected to take advantage of the new legislation – the Hungarian government has weakened its currency while simultaneously failing to make a significant dent in its foreign-held debt.
The reluctance to make the swap is rooted in a number of different concerns, namely the difficulty of mobilising sufficient cash to make the payments and the comparatively low interest rate that foreign-denominated loans enjoy compared to loans in the forint.
“I’m not convinced this is the right way of doing this,” says Pawlowski. “The proof is in the pudding, and so far we have only seen the currency weaken.”
Bond sales are at a level similar to their 2008 peak, where foreign-held bonds dropped from around $21.5bn to around $10bn. Pawlowski emphasises the fear of a large bond sell out, and the possibility of an ensuing interest rate hike.
The approval of the law has had a notable effect on the cost of securing Hungarian bonds, with the cost of five-year credit default swaps rising to 571 basis points – this is a significant step up from the cost for other countries in the region. Slovakian 5-year CDSs, for example, are trading at 266bp.
“The government has certainly created a buzz,” says Pawlowski. “This could have a significant effect on the cost of funding for Hungary.”
Pawlowski emphasises that the government needs to focus on economic reforms to try to encourage appreciation of the forint
The Hungarian financial sector is already in a precarious state; policy decisions since 2010, including the introduction of a punitive banking tax, have had a significant effect on the sector.
Around 80% of Hungary’s banking sector is foreign owned, putting them in the demographic most affected by the crisis. Velhon Partners today released a study showing that foreign-owned banks in emerging markets have taken the biggest growth hit from the crisis, with a 2010 growth of 2.5% versus 14% in 2008.
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