•    Upside in CE/SEE banking materializes; EE faced serious headwinds
•    Foreign lenders prove resilience in Russia; Western banks return to more “boutique style” operations
•    NPL ratio increased to ~9 per cent in CEE, down to ~8 per cent in CE/SEE
•    Profitability: RoE in CEE below 5 per cent, in CE/SEE at 9.7 per cent
•    L/D ratio: substantial further improvement throughout the CEE region

“The so-called ‘New Normal’ with stricter capital requirements, a high degree of regulatory involvement and the ongoing ultra-low interest rate environment amidst a still shaky economy in Russia and Ukraine were clearly a burden on profitability in CEE  banking.* But even though 2015 was another difficult year for the banking industry in CEE, notable progress was made in CE/SEE, where profitability approached 10 per cent RoE. The progress in CE/SEE banking reflects improving or at least stabilizing asset quality, while balance sheet growth is also gradually picking up. For the first time, total CE/SEE banking assets even surpassed the EUR 1,000 bn threshold in 2015, reflecting the region’s growth potential. However, the recently introduced and/or discussed regulatory measures in CE/SEE banking, like mandatory FX loan conversions or additional capital requirements, make it more and more difficult to fully utilize the region’s potential and, at the same time, restrain the banking sector’s stimulus for further economic growth. Russia and Ukraine both faced serious economic headwinds in 2015. In Russia, leading Western CEE banks – including RBI – adjusted their business models and focus now more on their core competences in premium niche markets. Investor confidence is again improving, although, given the political tensions in the region, the economic outlook remains dampened. But in spite of all these challenges, CEE remains a growth region for banking and the commitment to CEE continues to pay off.” said Karl Sevelda, CEO of Raiffeisen Bank International AG (RBI).

His assessment is backed by the key findings of the latest edition of the annual CEE Banking Sector Report – a publication by RBI/Raiffeisen RESEARCH with contributions from RBI’s network units in CEE and Raiffeisen Centrobank AG. The report was presented at a press conference in Vienna on 9 June 2016.

The “New Normal“ and 10 per cent thresholds

In the context of the “New Normal”, CEE banking has to master several 10 per cent thresholds. (1) The current environment calls for at least 10 per cent market share in smaller and mid-sized CE/SEE banking markets. (2) Due to the current strategic refocusing, the average country presence of Western CEE lenders is reduced to nine. (3) Achieving at least 10 per cent RoE in CEE banking will likely remain an uphill battle in the years to come. Investors will demand a RoE premium of at least some 1.5 to 2 per cent for lenders with CEE exposure. Within the current setting, this would translate into a cost of equity for Western CEE banks in the range of 11 to 13 per cent compared to some 9 to 10 per cent or even less for Western European lenders. (4) For CEE lenders with EE exposure it will remain a challenge to bring NPL ratios in the subregion below 10 per cent. (5) Another aspect of the “New Normal” in CEE banking is the shift of the subregions’ weightings in terms of total banking assets. The decreasing focus on Russia and other EE markets implies that the share of Russia in exposures of leading Western CEE banks may inch down to or below the 10 per cent level in 2016.

Upside in CE/SEE banking materializes; EE faced serious headwinds

“Growth opportunities do remain in CEE banking. From a short-term perspective, we expect solid growth in CE/SEE markets, with near-term upside in retail. From a long-term perspective loan growth at around 8 to 10 per cent yoy looks feasible. Our CE/SEE outlook is also supported by broader Western banking developments, where deleveraging seems to be largely accomplished. Given the overall margin and profitability pressure, consolidation needs in CE/SEE banking should not be underestimated,” explained Gunter Deuber, Head of CEE Bond and Currency Research at RBI/Raiffeisen RESEARCH and one of the leading authors of the CEE Banking Sector Report.

Overall, EE faced serious headwinds in 2015, reflected in noticeable asset quality deterioration (EE NPL ratio at around 7 to 9 per cent, Ukraine at 20 to 40 per cent) and even more evident in the fall in profitability and a RoE of minus 0.1 per cent (CEE: about 5 per cent; euro area: 6 per cent). According to Deuber, the main reason for the negative profitability was again the large decline in the earnings of the Ukrainian banking sector, due to operative challenges and massive recapitalization needs. Moreover, the EE banking market experienced one of the most decisive clean-ups seen over the last decade and a substantial number of banks left the market in Russia and Ukraine in 2014 and 2015.

Foreign lenders prove resilience in Russia; Western banks return to more “boutique style” operations

Elena Romanova, Senior Expert for CEE Banking at RBI/Raiffeisen RESEARCH and one of the leading authors of the CEE Banking Sector Report, focused in her analysis especially on the Russian market. “Given our rather subdued macro outlook, we expect the Russian banking sector to be caught in a longer period of rebalancing and sluggishness over the next two to three years. However, leading Western banks, such as SocGen, UniCredit, RBI and Citi, have stated their commitment to their Russian businesses and even outperformed the market in 2015. In an upside scenario a RoE of around 12 to13 per cent still looks feasible in the Russian market. Moreover, major Western lenders in Russia may continue to outperform, as they did in 2015 with an average RoE of around 15 to 17 per cent in a barely profitable market. We expect more focussed “niche player strategies” at those banks. It is worth mentioning that such “boutique-type business models” at leading Western banks in Russia would be a return to the status-quo-ante, i.e. the business models that prevailed before the boom years of 2004 to 2013.”

In general, Western CEE banks are no longer focussing on strongly expanding their CEE market shares, but rather trying to position themselves in certain profitable (niche) segments (e.g. retail). They continue to evaluate their general business models within the quite heterogeneously developing CEE markets and to place emphasis on optimizing costs, reducing risks and targeting premium clientele. Hence, it is currently more likely that we see a Western CEE bank rescaling a country presence (e.g. in terms of branches) or exiting a business segment or market than embarking on large scale M&A activity in the region. Nevertheless, certain smaller and opportunistic M&A deals (e.g. portfolio buying in targeted business segments) do remain an option for Western CEE banks. The number of selective M&A deals may even increase somewhat as the uphill profitability battle increases the need to gain market share in selected business segments.

NPL ratio: increased to ~9 per cent in CEE, down to ~8 per cent in CE/SEE

Asset quality, which is measured in the non-performing loans (NPL) ratio, was characterized by stark divergences across the CEE markets. In CE the broad-based trend for asset quality improvements continued in 2015 and pushed the NPL ratio down to 7.3 per cent (2014: 8.5 per cent). Excluding Hungary with a NPL ratio of still close to 10 per cent, the CE NPL ratio would be even lower at 6.4 per cent (2014: 6.8 per cent). To a limited extent, the SEE markets have also seen some improvement in asset quality with a NPL ratio down from 19 to 15 per cent in 2015. Romania posted the strongest improvement following a sector clean-up and decreased its NPL ratio from 20 to 13 per cent.

Contrary to the improving or at least stabilizing asset quality in CE/SEE, all three EE markets have shown a noticeable deterioration over the last 12 to 18 months. Depending on the measurement approach, the EE NPL ratio is up from some 4 to 6 per cent in 2013 to around 7 to 9 per cent in 2015. In Russia, the NPL ratio went up from 4.5 per cent in 2013 to above 7 per cent in 2015 (some 6.5 per cent in corporate lending and 9 to 10 per cent in retail). For 2016, the analysts of Raiffeisen RESEARCH expect modest additional downsides for NPL ratios in the EE banking sector, mainly stemming from Russia and to a smaller extent Belarus.

According to Deuber and Romanova, the key challenge for 2016 will be to stay below the 10 per cent NPL ratio threshold in CEE. The CE/SEE NPL ratio seems to remain on a downward path, possibly inching below 8 per cent. Since the EE NPL ratio may inch close to or above the 10 per cent threshold, the NPL ratio for the CEE region is expected to be slightly below 10 per cent.

Profitability: RoE in CE/SEE at 9.7 per cent, in CEE below 5 per cent

In 2015, profitability in CEE banking was once again a mixed bag. The overall CEE RoE came in below 5 per cent (2014: 6.9 per cent), compared to a RoE at around 6 per cent in the euro area. There was a substantial and broad-based setback for profitability in all EE banking markets, including Russia. In 2015, the EE RoE stood at minus 0.1%. At the same time, notable progress was made in CE/SEE, with 9.7 per cent RoE.

In contrast to 2014 with three negative banking markets in CE/SEE (Hungary, Slovenia and Romania), only Croatia was loss-making in 2015.

L/D ratio: substantial further improvement throughout the CEE region

Following the trend of recent years, nearly all CEE banking sector markets were characterized by very solid deposit collection in 2015 – in most cases outpacing loan growth substantially. Therefore, the overall L/D ratio in CEE banking has substantially further improved in 2015, reaching a multi-year low. Currently, the L/D ratios in CE and SEE are at 92 per cent and 86 per cent respectively – levels not seen since 2005/06. When factoring in the EE L/D ratio at 88 per cent, the overall CEE L/D ratio stands slightly below 90 per cent. In Russia, both key market segments (LCY lending, FCY lending) were characterized by L/D ratios below 100 per cent, which is a reflection of the current situation of over-liquidity and lack of (qualified) loan demand. For larger universal bank models, it is currently feasible to operate in all CEE banking markets with L/D ratios well below 100 per cent.

The CEE Banking Sector Report is available at http://www.rbinternational.com/ceebankingsectorreport2016

* The Banking Sector Report defines Central and Eastern Europe (CEE) as consisting of the subregions Central Europe (CE) – the Czech Republic, Hungary, Poland, Slovakia and Slovenia; Southeastern Europe (SEE) – Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Romania and Serbia; and Eastern Europe (EE) – Belarus, Russia and Ukraine.