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back to index backEUROtalk October,  2005

Eastern Europe: What Bankers Know

Why are bankers aggressively staking their claims east of the Danube?

Bankers are economic bell-wethers, often the first to arrive on the scene of a new or revitalised market opportunity. In Europe this year, there have been two very different scenarios in the banking sector. Italy, the birthplace of banking on the Continent, arguably has been the locus of the Old Europe” story, where a mature sector appears to be on the brink of dismantling the remaining barriers to a single market for financial services through a new wave of Continent-wide consolidation.

This kicked off in June, when UniCredito, Italy's largest bank by market value, launched a bold €16 billion takeover of HVB, Germany's second biggest privately held bank. It was the largest of a string of deals that saw bank M&A activity in the first three quarters of this year equal that of the previous three years combined. By September, however, the scandal that had enveloped Italy's Central Bank governor, Antonio Fazio—over allegations of cronyism in blocking Spain's BBVA from bidding for Italian bank BNL and, more particularly, his effort to stop ABN Amro of the Netherlands from taking over Antonveneta—underscored much that is wrong with European banking: highly profitable domestic bank markets being protected—perhaps illegally—by narrow nationalistic interests at the expense of customers.

The fallout from that scandal may ultimately help open up Italy's banking market and boost the broader European consolidation. In the meantime, however, garnering less attention but saying perhaps more about immediate growth opportunities for European banks and their corporate customers, is the New Europe” bank story to the east. When the Romanian government announced in September the shortlists of bidders for controlling shares in Banca Comerciala Romana (BCR), the country's largest commercial bank, and Casa de Economii si Consemnatiuni (CEC), a savings and loan institution that ranks as the country's fourth largest bank, the 14 in the running for the privatisation made up a virtual Who's Who of European banking, and included Deutsche Bank, BNP Paribas, Société Générale, Rabobank and Banca Intesa.

Why the interest? The privatisation of the two Romanian banks is seen as one of the few remaining opportunities to snap up juicy bank assets in the former communist bloc before things really heat up and the cost of entry becomes prohibitive. The enthusiasm also spotlights a turnabout for the region, as the anxiety raised by the Russian financial crisis at the end of the 1990s has given way to growing optimism. And it says a lot about the accommodating business culture in the region relative to more developed neighbours, bank chiefs say.

Fortis, the €61 billion Dutch-Belgian bancassurance group, is among BCR's nine suitors. CFO Gilbert Mittler says: Two years ago, if I had told analysts that our company was considering a quite sizeable investment in Romania, our share price would have been hit. Not any more.” Fortis, which was created during the first wave of pan-European bank consolidation 15 years ago, is probably more alert than most to the risks and rewards of expanding beyond its traditional markets. As Mittler puts it, Consolidation is part of our DNA.” In laying out its growth strategy in June, Fortis management said the priority will be to double the amount of revenue generated outside of the Benelux countries, from 15% currently to 30% by 2009. A key part of the push will be to increase its private and commercial banking presence from 14 to 25 European countries, mostly by expanding in eastern economies.

Some of this will have to come through acquisition. Mittler says that though Fortis is a very cautious acquirer—”we have 55,000 people working [on growing the bank] organically and six people looking at M&A”—he reckons the environment for doing deals in general, and in the former Soviet bloc in particular, has become more friendly. From 2000 to 2004, market acceptance [of bank acquisitions] was very difficult. Selling even small acquisitions to analysts, to investors, to boards of directors, was difficult in relation to the 1990s. This is changing.”

Indeed, in late September, Fortis CEO Jean-Paul Votron surprised the market when he confirmed Belgian press reports that the bank was seeking merger talks with local rival Dexia, citing among the attractions the fact that Dexia is a bidder for BCR.

The central rationale for eastward expansion is plain: mouth-watering growth prospects. According to Herbert Stepic, chief executive of Raiffeisen International (RI)—one of the contenders to acquire CEC in Romania—economic growth in the region (including the eight new EU members, Russia, its other former satellites and the Balkans) is projected to average nearly 12% a year between 2004 and 2007, or more than three times the rate in the 15 western EU countries. Growth in the banking sector is expected to be much higher still: in some countries, between 30% and 40% a year.

The ideal battlefield

RI, a unit of Austria's RZB, was the first international bank to move into the region, with a joint venture in Hungary in the late 1980s, even before communism began to tumble. Stepic says that while showcasing RI's €1 billion initial public offering earlier this year (the biggest in Austria's history), he was able tell prospective investors that he expects the bank to grow about 2.5 times faster than GDP growth in the region. RI has reported a string of record results during its rapid, acquisition-driven expansion since 2000, with compound annual growth in assets of around 40%, and earnings CAGR of nearly 30% a year. For the half-year ended June 30th, pre-tax earnings were up 58% at €274m. RI's share price since the February IPO (at €32.5) was up a whopping 90% by mid-September.

Stepic says that during the first decade of the bank's expansion, he always chose green field” operations. Why did we do this? First, skeletons in the cupboard: I was deadly shy of taking over any risks that I didn't know about. Second, I was frightened of taking over people with the old communist way of thinking.” But starting in Bosnia in 2000, Stepic has done six acquisitions in quick succession, the latest being Bank Aval in Ukraine earlier this year.

Until 2000, there were only five international banks operating on any scale in the region, including us,” Stepic says. Now the number of interested banks is increasing drastically, and you can see that with BCR and CEC. There is huge interest in central Europe, and no wonder—it is the ideal battlefield.”

The additional competition has meant that the average cost of bank assets is soaring. When RI bought the nearly bankrupt Banca Agricola (now Raiffeisen Romania) in 2001, it paid, reportedly, 1.5 times book value. When its IPO prospectus forced it to declare its interest in acquiring Bank Aval in Ukraine this year, competitors were attracted and pushed up the price above three times book value. The auction competition for BCR and CEC is expected to see values of four times book.

Chasing the assets

Yet, even the largest and most experienced banks in the region are still chasing these assets. RI's Austrian compatriot, Erste Bank, is on the shortlists for both BCR and CEC. While RI has followed a universal bank” model, covering all kinds of corporate and individual customer business, Erste has focused on retail business. CFO Reinhard Ortner says that even with the hot growth in the sector overall, the retail end offers the biggest opportunities. Case in point: bank deposits and loans average around 70% of GDP in western Europe, but only around 25% in eastern countries.

It's a similar story to what we saw in the southern European countries—Spain, Portugal, Greece—when they joined the EU,” Ortner says. The savings and lending rates converge. So that is good from the growth story point of view. But on top of that the demand for asset management is growing even faster.”

Though Erste was already the second largest bank in the region at the end of last year, Ortner says that a strategy of acquisition growth makes sense. For one thing, he says, retail banking is like any other retail business and you'll see what you've seen in developed economies, as with Tesco, Metro and Carrefour in food: two or three large players dominating each market.” So, Erste will only go into a new market when it can see a realistic opportunity to reach a 10% market share quickly, Ortner says, and that is unlikely to be achieved in a heated market without an acquisition. I'd rather pay now, modernise quickly and not try to go for perfection but try to capture growth opportunities as you ride along in this process. That has proved very justifiable over the last five years.” Erste only began venturing beyond its Austrian home market in 1997, and now two-thirds of its pre-tax profit of €1 billion comes from the region.

Of course, it's not just banks that have been bulking up the region. Other early movers include telecoms, building materials and energy. It is an appealing investment opportunity for those industries for the same reasons as for the banks, as Stefano Colombo, CFO of Telekom Austria, explains. The opportunities come in that point in the economic cycle where you can invest in state-of-the-art technologies and you get people with modern mentalities,” he says. We can do business with a much lighter investment structure, and acquire clients at much less cost than is thinkable in developed economies.”

Despite the phenomenal growth rates that the likes of Erste Bank and RI have seen in the last few years, the risks were high and those risks are now changing.

It doesn't sound like a very ‘CFO analysis,' but one of the biggest challenges going into the region is to have an instinctive understanding of the cultural nuances,” says Ortner. We are very much aware of the differences between Bohemia and Moravia [in the Czech Republic], that Czech clocks tick differently to Slovak clocks, that there is a difference between western and eastern Slovakia.” As growth accelerates, it means managing a process whereby incomes are rising—good for overall business—but so are staff and other costs.

Stepic gives this advice to client CEOs and CFOs: The risks now are not much greater than what you would get in developed economies, but they are different. The risks are in not giving enough emphasis to the human aspect of your operation... Simple things, organisational things,” he says.

However, the risks for Erste and RI have changed too. Over the last several years, they have been able to capture, respectively, the number-two and number-four positions in the region, building highly profitable asset bases of €33 billion and €29 billion. Now the game is changing: the pond is growing and the bigger fish are moving in.

As Stepic himself points out, the main reason that UniCredito bought HVB was that it was buying at a relatively attractive price the second largest bank in one of the world's largest industrial economies. The core idea is an Italian bank is conquering the German market.” It was only incidental, he says, that in so doing it also created easily the largest foreign bank in the CEE region, with nearly €65 billion in assets. That's got to worry the smaller fry in Europe's larger banking pool.

Source: magazine - GAI

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