Balkan honeypot turns to black hole for foreign banks

By Ivana Sekularac and Benet Koleka

BELGRADE/TIRANA, Nov 15 (Reuters) - Bad loans have turned the Balkans from high-yielding paradise to profit-sapping purgatory for international banks, crimping their ability to lend and weighing on the region's economic potential.

In Albania, banks' return on equity was 34 percent in early 2000 and stayed in double digits for most of the decade until the financial crisis tightened its grip. It was minus 2 percent in the third quarter of 2013, after what Seyhan Pencabligil, president of a lobby group for Albania's 16 banks, called an "alarming increase in bad loans".

"This is affecting our profitability so negatively that we are either unable or unwilling to lend more," he said.

Before the crisis, foreign-owned banks typically borrowed from their parents at low interest rates to lend to corporate customers in the Balkans. Capital markets were just beginning to operate, and there was very little equity financing there.

But the 2008 crisis hit the region's corporate sector hard, and foreign banks could no longer borrow from their parents. Everything they earned, mostly by investing in government securities, went to repay debt to the group.

Individually, problems in the Balkan countries are too small to have a material impact on international banks, but taken as a whole, the region's difficulties can make their presence felt.

Raiffeisen Bank International, emerging Europe's second-biggest lender, in September raised its forecast for 2013 bad loan provisions by as much as a fifth, citing struggling borrowers in Albania, Bulgaria and Slovenia.

"Bad loans are my biggest headache," Draginja Djuric, head of Italian lender Intesa Sanpaolo's market-leading business in Serbia, where banks made a return on capital in 2012 of just 1.9 percent before taxes, down from 8.6 percent six years earlier, told an investment forum last month.

"I don't have time to think how we can improve our lending conditions to boost the economy; bad loans take most of my time," she said.

In October bad loans in Serbia increased to 24.5 percent of total lending from 19 percent in January, according to banking association figures.

That gives Serbia one of the worst non-performing-loan (NPL) ratios in Europe, only marginally better than the 28 percent recorded at midyear by the four biggest banks in Greece, the euro zone's most stricken economy.

"It is hard to say, but we don't expect any improvement in the future; our economy is not solvent. The only solution is to attract more foreign direct investment," said Veroljub Dugalic, head of the Serbian banking association.

NO EASY SOLUTIONS

It's a similar story throughout the region. Bad loans make up more than 24 percent of lending in Albania, nearly 15 percent in Bosnia, 17 percent in Montenegro and 14 percent in Croatia, the newest EU member, central bank figures show.

ECB data show NPL rates in Bulgaria at 12.5 percent at end-2012. In Romania, it was 18 percent. Figures from the World Bank show NPLs in the Balkans have been consistently above the EU average over the last decade. On the plus side, Balkan banks tend to have higher capital than the EU average, so they have greater capacity to absorb future loan losses.

"In general, in central and eastern Europe NPLs are becoming the number 1 policy priority," the European Bank for Reconstruction and Development's (EBRD) country and strategy director, Piroska Nagy, told Reuters. The EBRD holds stakes worth around 4.1 billion euros in Balkan banks.

Nagy said low growth rates, the lack of a legal framework to move more aggressively on bad loans and the fact that loans, mostly indexed in euros, were susceptible to exchange rate fluctuations contributed to the high number of bad loans.

"It is not OK to sit on lots of NPLs. It is important to clear balance sheets," Nagy said. "This has to be tackled."

A banker with insight into NPL management in the Balkans said the picture could be much worse, as some loans classified as performing had a chequered past.

"In many instances banks have given out additional credit lines to clients that could not keep up with instalments, just to keep paying for interest on the first credit line," he said.

"This way the first credit line seems to be under control. However, it is not paid out of the cash flow but out of the second credit line."

Among the foreign-owned banks that dominate Balkan banking, NPL treatment and recognition isn't necessarily as rigorous as at their international parents, said a banker with an international consultancy firm who is familiar with Balkan banks.

"It depends on the discipline the parent has, and the level of control they exert," he said. "Some have much more decentralised local operations than others."

"There's always a question mark on the extent to which banks recognise NPLs," the consultant added. "The standard varies quite significantly across different countries."

UNHAPPY PARENTS

If the bad loan problem has been years in the making - regional central bank governors in Belgrade last week partly blamed foreign banks' poor credit risk management in the late 1990s and early 2000s - it could also be years in the mending.

"We think the macroeconomic environment will be extremely unfavourable for the next three or four years, and we unfortunately fear that the zenith of non-performing loans has not been reached yet," said Franz Hahn, a senior economist at the Austrian Institute of Economic Research (WIFO).

Now they are having to find savings to offset the charges.

"Parent banks are not happy. There will be cost-cutting in the banking sector ... in the whole region," said one executive at a big lender who has exposure to the region, adding that the Balkans had become a "black hole" for foreign banks.

Not all foreign parents are equally concerned. "We're not seeing any particular burden there at the moment," said a senior executive whose bank has billions of euros of assets in the Balkans. "The rate of non-performing loan creation has gone down. We're past the worst."

Italian bank UniCredit's Bank Austria unit, the leading lender in central and eastern Europe, has said it is not concerned what an ECB-led review of big banks' balance sheets might turn up.

Ellen Goldstein, the World Bank's director for southeast Europe, is also cautiously optimistic.

"While there may be not a quick win on this (NPLs), we are starting to see some progress. Reduction in public sector arrears and payment of bills owed to the private sector will also help to resolve that situation," she said of Albania.