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Monday, October 27, 2008

Poland To Consider Interbank Guarantees As The Forex Lending Crisis Deepens

Well, it's been a few weeks now since I posted on this blog, but I have a feeling that this situation may now be about to change. Pressure on Poland's economy is mounting as the clutches of the global credit crunch start to make their grasp and reach felt.

Stocks In Decline

Central European stocks declined for a fourth consecutive fourth day today, with indexes in Vienna and Budapest heading for record monthly drops, on mounting concern that the global financial crisis is going to have a severe impact on economic growth in the region and that the IMF sponsored rescue packages in Hungary and Ukraine won't avoid the worst of the damage. Concern is also mounting that the problem will affect the whole region, and hence the mounting pressure on Poland's rather stronger economy. If Poland falls, god help the rest of them.

Erste Group Bank AG slid to the lowest level in more than five years while Raiffeisen International Bank Holding AG, which operates in Russia and the Ukraine, plunged after mounting financial chaos forced Ukraine to seek help from the IMF.

Poland's WIG20 Index added 2.2 percent today following a 5.9% fall on Friday. The MSCI Barra Core Index (which is a measure of comparative equity values) is down 48% so far this month, and 61.24% over the last three months.

The Polish government has also announced today that Poland is considering guaranteeing interbank transactions, according to Deputy Prime Minister Waldemar Pawlak speaking on Polish public radio this (Monday) morning. Pawlak said that the government is examining the possibility of taking bank shares as collateral for the guarantees. Foreign investors in Polish banks have applied policies that are too strict in Poland, though credit problems have not affected Polish banks, Pawlak said .

According to the draft of a new law which is set to go before cabinet tomorrow (Tuesday) Poland's government will be empowered to guarantee commercial banks loans from the central bank and other lenders on the interbank markets. The government will also be able to lend cash and state securities to banks.

Poland's central bank injected 9.3 billion zlotys ($3.42 billion) of liquidity into the banking sector last week, in the form of 14-day repos. The decision was taken in order to try to ease strains on the Polish money market. The bank said it had accepted all bids worth 9.267 billion zlotys, at an average rate of 6.16 percent, 16 basis points above the main policy rate, with state bonds used as collateral. The minimum rate at which the central bank lent money to banks was 6.15 percent, while the maximum at 6.25 percent.

Poland's deputy prime minister also warned that local bank capital was at risk of capital being transferred to their financially-strapped foreign owners and urged the country's watchdog to stay vigilant.

"There is a risk that the capital will be transferred from Polish institutions to their parents," Waldemar Pawlak, who is also the economy minister and heads the governing coalition's junior party, was quoted as saying by PAP newswire.

The Financial Oversight Commission (KNF) has asked banks domiciled in Poland to report all transactions with their foreign owners daily. In a newspaper interview last week, the head of the KNF, Stanislaw Kluza, said the risk of capital transfers was very low, however, because Polish banks, with $284 billion in total assets, were too small to rescue large players in Europe and the United States. This is evidently true, but some of these bank are now under great pressure to avoid additional exposure in the east, and movement of funds can equally correspond to this strategy.

Foreign financial groups, among them Italy's UniCredit, the Dutch ING Groep, and KBC Group NV, Belgium's biggest bank and insurer by market value (all of whom are struggling with major problems at the present time), control two-thirds of the Polish banking sector after buying stakes in local lenders during the banking sector privatisation of the 1990s.

Polish lenders have been especially hurt in recent weeks by concerns over their ability to obtain foreign currency through interbank markets and worries about the fate of their foreign parents. Executives at some Polish banks have urged the government to consider introducing guarantees after the central bank's moves to boost liquidity on the interbank market, including foreign exchange swaps, failed to boost confidence between lenders. The financial watchdog KNF said on Saturday that Poland should think about measures to boost the Swiss franc positions of Polish banks, along with guarantees of interbank transactions or an eventual "institutionalisation" of the interbank market. But the regulator, the government and central bank insist Polish banks remain solvent and enjoy "over-liquidity."

Many of Poland's banks, like other lenders in the region, have been forced to introduce severe curbs on mortgages in Swiss francs due to pressure on their own liquidity and balance sheets. Such lending had become popular in Poland in recent months due to lower interest rates available from Switzerland and what was once favourable exchange rate.

Millennium BIGW.WA and PKO BP PKOB.WA, two of Poland's top home loan lenders, have gone so far as to announce that they were going to tighten rules for new mortgages due to the rising cost of money and fears that global financial nervousness may lead to much slower economic growth in Poland. Millennium Chief Executive Boguslaw Kott said last week that the group - which is Poland's third-biggest mortgage lender would ask for a 35 percent downpayment for popular Swiss francs-denominated home loans, a move which is likely to put a sharp brake on the growth of its mortgage portfolio.

PKO, Poland's largest mortgage lender, also confirmed it would ask new clients to put up 20 percent of the value of property when borrowing in francs. Millennium, which is controlled by Portugal's Millennium bcp, will now also require customers to cover 20 percent of investment when borrowing in Polish zlotys. Both banks had previously been offering mortgages equal to the entire value of the new home (100 LtV). Basically, what the hell these people thought they were doing by continuing to lend at 100% LtV after we have seen all that has happened in the US, and that is now happening in the UK and Spain is totally beyond "my ken", it really is.

Chief Executive Boguslaw Kott described the move as a precautionary one, and said it did not reflect any liquidity problems, adding that it was now more difficult to get Swiss francs on the interbank market. Marek Juras, head of research at BZ WBK brokerage is quoted as saying: "At times like these it is more important for banks to take care of their liquidity than drive their sales even higher." He estimated that for some lenders this would translate into a drop in new mortgages by between one-third and one-half.

The two market leaders join other smaller lenders, which in recent days moved to raise the bar for mortgage lending in foreign currencies as banks become more conservative and try to lure more cash on deposits by offering even higher yields. Mortgage adviser Expander said Getin's DomBank and Santander and GE Money had tightened their lending requirements. Many banks have also boosted margins on their mortgages in the past two weeks.

The Polish mortgage market has expanded rapidly since 2003, driven by economic growth and soaring wages, with annual growth exceeding 40 percent in the first half of this year. Large numbers of central and Eastern European housebuyers hold loans in foreign currencies, especially Swiss francs.

Most major Austrian banks, including UniCredit's Bank Austria, Erste Group Bank and cooperative Raiffeisen have now completely stopped lending to Polish domestic retail customers in foreign currencies.

After a meeting with economic advisers President Kaczynski advised Poles to keep faith in the zloty as the currency suffered further setbacks on the markets on Friday. Kaczynski recommended that loans should be taken in zlotys, not foreign currencies in order to avoid losing money on currency exchange.

"The depreciation of the zloty, which has its good sides for exports, boosts
mortgage loan installments for those who took them especially in the Swiss
franc. This may, however, be a lesson to us all to take loans in the Polish
currency. Considering low inflation, this gives the best results," Polish
President Lech Kaczynski told a press conference last Friday.

Seventy percent of the Polish banking sector is owned by foreign banks leading to concern that the impact of the general crisis in the banking sector will be felt in Poland. On Tuesday, Polish business Daily, Gazeta Prawna wrote, "The global financial crisis may cause large shifts in the Polish banking sector, AIG Bank Polska will soon be sold and there has been speculation that Fortis, Dominet, Citi Handlowy and even Bank Pekao may change hands."

Sell off speculation has surrounded the Italian owned Pekao bank over the last two weeks. It was subject to a 20 percent share price decrease in October prompting concerns that owner UniCredit may have been considering selling of all its Central and Eastern European assets. This has since failed to materialize but shows the current lack of faith surrounding the Polish banking sector.

Slawomir Skrzypek, president of The National Bank of Poland stated it had no intention of stepping in to help the zloty as it continues to weaken on the foreign currency market in a statement to reporters on Friday.

The sale of apartments in Poland has dropped by 70 percent in comparison to the same time last year, showing that the credit crunch is beginning to bite in Poland. The tightening of lending policies by banks has caused demand to fall and though prices are decreasing by 10 to 20 percent in some areas, buyers are looking for smaller flats, or withdrawing from the transaction altogether. The financial crisis has also influenced the situation of those clients who wanted to buy apartments without needing to get a mortgage, the number of which is declining due to losses on the stock market, says Gazeta Prawna.

Polish banks are to crack down on credit lending for housing loans after Poland’s financial regulator asked them to get tougher on lending practices. Millennium bank is one of the first high street banks to react and will now expect customers to cover 35% of the loan if they borrow in a foreign currency or 20% if borrowing in Polish zloty. The move is thought to be a precautionary one and not an indication of any liquidity problems, according to CEO Boguslaw Kott who told a news conference on Tuesday, “The decision practically blocks an increase of our mortgage portfolio.” He also told reporters that Swiss francs are harder to come by on the interbank market. Millennium Bank has been a dominant force in the Polish housing lending market with 80% of its mortgages being in Swiss Francs. This reflects a trend across Central and Eastern Europe where many house buyers have loans in either Swiss or other foreign currencies.

PKO BP, another major Polish mortgage lender, has joined Millennium in giving credits up to 80% of the value of the real estate. Fears that the Polish housing market could suffer similar repercussions to that of some western banks are as yet premature although the move does indicate a degree of uncertainty on behalf of the lending sector’s big hitters.

"We are extending between 35 and 60 million zlotys worth of mortgages each day, the vast majority of those in Swiss francs." Mariusz Grendowicz Head of BRE Bank BREP.WA "To fund our growth in mortgages, we were the only bank to the best of my knowledge that was using not swaps, which were the cheapest alternative, but actually taking a three- to four-year loan in Swiss francs to fund the book,"

The impact of the seize up in Swiss Franc housing loans is hard to guage at this point, although all the indications are that it will be serious. Foreign currency lending has not been such an important phenomenon in Poland as it has been in other CEE countries, but its weight has been growing in the last 18 months or so (see chart below).

The role of forex lending is clearly more important in housing loans than in general lending (see chart below).

One of the reasons for the recent uptick in Swiss Franc lending has been the monetary tightening cycle initiated by the central bank (see chart below), which made the cheaper interest rates available in CHF more attractive even though there was an evident currency risk involved.

If we look at the next chart the year on year rate of increase in the forex loans (the Polish central bank don't distinguish in their data between CHF and Euro, but all the anecdotal evidence cited above points to a significant role for the CHF, and especially given the role of Austrian banks were this type of lending has been commonplace.

The big problem is really that the CHF is a "carry trade" currency, and carry currencies have a strong tendency to shoot up in value as risk sentiment retreats, quite simply because people all try to liquidate their positions at the same time. Hence carry currencies have a kind of "pro-cyclical" role, adding to the boom during the good times, and making the bad times even worse. Which would be one very good reason why if you really do want an fx mortgage, using a currency other than a carry one would be a good idea. Obviously those who have euro denominated mortgages - while not being immune from the present problems (see the Baltics) - are less exposed, since the movements in the relative value of the euro tend to be in the opposite direction to those of the CHF and the Japanese yen.

Where Does All This Leave Us?

Well obviously Polish GDP growth is now set to slow quite dramatically. At this point just how dramatically is hard to see. Credit Suisse Group recently cut its forecast for Polish economic growth next year, predicting that the global financial crisis will hurt consumption and investment.

Credit Suisse said Poland's gross domestic product will rise by less than 4 percent in 2009, compared with the 4.4 percent rate it had previously forecast, according to a note to clients last week. The revision, amid rising aversion to risk in emerging markets, pushed the zloty to a two-year low against the euro. I think, basically, even Credit Suisse are being over optimistic at this point, although I think we need to see some real economy data before putting numbers on just how over-optimistic they may be.

Poland's `` private consumption and investment should fall further than we had anticipated due to our expectations of an increasingly restrictive credit environment in 2009,'' Jacqueline Madu, an emerging-markets research analyst at Credit Suisse in London, wrote in the note.

One of the first areas where we should expect this crunch to be felt is in construction activity itself. There is no doubt that Poland has been "enjoying" the fruits of a construction boom since the second half of 2006. It seems to have come in two "waves" if we look at the chart below, with the first wave being much stronger than the second one.

If we actually look at the level of the seasonally adjusted index, then the steep increases in the levels of construction output become apparent. We should also notice how since about April the level has stopped rising, and this seems to suggest that the expansion in the industry had been slowing even before the latest credit shock. Be ready for this to be followed by a sharp slowdown in the months to come.

If we look at the chart for year on year industrial activity, then it is clear that the expansion in output has been fading for months now - not a good sign, not good at all, since it means that there is little underlying stability to resist the knock. The thing is running out of energy.

This becomes evn clearer when we look at the seasonally adjusted index, since it is pretty clear to see that industrial output went into decline at the end of last year, killed off in part by a high zloty, and in part by excess internal wage and cost push inflation.