Finance

Foreign-owned Banks in CEE/CIS

• Business models of major, highly diversified western banks operating in Central and Eastern Europe, Russia and other countries of the Commonwealth of Independent States are robust and largely depend on traditional lending. Current loan-to-deposit ratios at leading western banks operating in this region are sound and major. Western banks are well placed to increase deposits in line with expected loan growth in the near future.
• Big-name western banks are a dominant force in Central and Eastern Europe. New entrants are unlikely to pose a threat to their defensive strategies in the challenging markets. For example, Sberbank Europe (former Volksbank International) operates 250 branches in Central and Eastern Europe, while the average big-name western bank has some 2000 branches. However, with the latter competing in markets both inside and outside the EU in the region they are exposed to greater regulatory pressure than some local players. On the key Russian market, core franchises of leading foreign banks may be hard put to defend market share.
• Uncoordinated, self-insuring national regulation and soaring regulatory costs are downsides in Central and Eastern Europe, a region where banking integration in practice has gone further than in the rest of Europe. EU regulatory policies need to be formulated with an eye on their potential spillover effects. Otherwise, foreign banks may also face populist demands for a “domestication” of banking in their core markets in the region. Moreover, for most major foreign banks operating in Central and Eastern Europe and the Commonwealth of Independent States, all their local franchises, especially given the weight of the Russian market, are of importance to achieve a solid profit and risk diversification.

Western Banks presence in the region and recent market trends

Compared to the balance sheets of Western Banks (WBs), banking sectors in CEE/CIS 2 are relatively small. Total CEE banking assets amount to EUR 2,068bn in 2011. Top-three European banks such as Deutsche Bank, HSBC and BNP Paribas have balance sheets of roughly the same size. As Russia already represents some 50% of the CEE/CIS market, the CEE banking sector is much smaller in size with banking assets of some EUR 711bn in CE and EUR 231bn in SEE.

As a result, CEE/CIS assets of leading Western banks like Raiffeisen Bank International (RBI) and Erste Bank (Erste), and those of global European banks with a significant regional presence, such as UniCredit, Société Générale (SocGen), Intesa, KBC, Commerzbank (Coba) and Santander, or regional banks like OTP, are also small. The total CEE/CIS assets of the top seven regional WBs (Erste, Intesa, KBC, OTP, RBI, SocGen and UniCredit) amount to EUR 490 bn in 2011 – more or less the equivalent of a single European bank in the top 30–40. The CEE/CIS assets of WBs like UniCredit, SocGen, Intesa or Coba, make up “just” 4 to 20% of their total assets.

Even the balance sheets of major international Russian banks such as Sberbank and VTB are small, with total assets of EUR 260bn and EUR 163 bn respectively (end 2011). With average annual lending growth of 30 per cent, Russia’s banking market has seen the strongest expansion in recent years – it accounted for 20% of CEE/CIS assets ten years ago compared to 50% in 2011. In contrast, CE’s share in CEE/CIS banking assets decreased from 64 to 34% during the same period. As a result, any regional analysis of banking in Eastern Europe has to deal with Russia as the key market for WBs operating in the region.

Western Banks operating in CEE/CIS compared to their European peers

WBs running a traditional universal bank model in the CEE/CIS region differ greatly from the largest European universal/investment banks with little or no CEE/CIS exposure in terms of balance sheet structures and revenues. WBs present in CEE/CIS are in general less active on the capital markets than major European investment/universal banks, SocGen being the exception. As a result, trading income is less important than for the average major European universal/investment bank. Trading accounts for 2 to 8% of the total income at leading WBs with a presence in CEE/CIS (1 to 5% when excluding SocGen), while net interest income (NII) makes up some 60% of total revenue (65% when excluding SocGen). In CEE/CIS subsidiaries of WBs, NII usually represents around 70 to 80% of revenue. On the other hand, European universal/investment banks with little or no CEE/CIS exposure had an average revenue share of 15% from trading and 46% from NII during the last cycle. Among top European investment banks, the figures were 18% and 40 per cent, respectively.

Market and investor pressures and especially regulatory pressures that directly or indirectly affect retail, corporate and investment banking have had a different effect on the capital leverage ratios. In 2008 top European investment/universal banks with little or no CEE/CIS exposure had a higher capital leverage ratio (risk-weighted assets to capital) than WBs with a CEE/CIS presence, namely 16.6 and 14.7 respectively (14.2 when excluding SocGen). However, in 2012 massive adjustments via asset sales took place at European investment/universal banks. Their capital leverage ratio is now 10.2, which is below the 10.8 of WBs present in CEE/CIS (10.9 when excluding SocGen). This trend reflects the intense regulatory strain on international investment/universal banks and global systemically important financial institutions (SIFIs). Moreover, it is easier to deleverage in the capital markets/trading business than in the client-driven lending business. In addition, the current low-interest-rate environment, both globally and in many CEE/CIS markets, limits profit potential in traditional banking for WBs with a CEE/CIS presence. Among WBs present in CEE/CIS, only UniCredit and SocGen – both global SIFIs – now have capital leverage ratios more or less on par with those of major European investment/universal banks.

CEE/CIS banks are to a certain extent used to current NPL levels. 

NPLs in CEE stood at 8 to 12% ten years ago, and had peaked well above that level. In contrast, for major European banks their current NPL level is new territory as NPLs have ranged from 2 to 4% in the 1995–2007 period. Moreover, aggregate asset quality at CEE/CIS banks stabilized somewhat in 2011 and the first half of 2012, driven by the Russian, Polish, Czech and Slovak markets. Well diversified WBs benefited from the sketched asset quality trends, as opposed to those with a focus on markets like Hungary, Slovenia and several SEE countries, where NPLs continued to rise in 2012 and reached 15 to 30% in some cases.

Relative strengths and weaknesses of leading WBs in CEE/CIS

At WBs present in CEE/CIS, country-specific downsides are at least partly offset by more resilient markets, diversified networks, presence in Russia and Poland and/or increased capitalisation. The profiles below show the respective weaknesses and strengths of WBs with at least 1000 branches and operations in at least five countries.

ERSTE:

• Operating in 7 CEE/CIS markets with 2,100 branches (below WB average), strong focus on selected CEE markets, very strong market position in selected CEE markets
• NPLs at 8.9% (2011), expected to peak at around 9.5% in 2012/2013; third quarter of 2012: first reduction in NPL volumes since 2007 due to NPL sales
• Risk provisioning at 63% of NPLs; high credit risk concentration in Hungary and Romania (loss-making operations in Hungary throughout 2011 and the first half of 2012, in Romania since the second quarter of 2011); sound Austrian home market, but CEE/CIS operations, except for Czech Republic, too small to compensate for negative effects in Hungary and Romania; profits in CEE driven by Czech Republic and to a lesser extent Slovakia (NPLs: CZ: 5.5 per cent; SK: 7.5 per cent; ROM: 27.5% and HU: 25.3 per cent)
• Relatively weak capitalisation (2011 Tier 1 capital ratio: 10 per cent; 2011 core Tier 1 capital ratio: 7.8 per cent, slight improvements expected in 2012, to 11% and 8.5 per cent, respectively)
• Not present in Poland, Russia (largest, attractive CEE markets), possible divestment in Ukraine

INTESA:

• Represented in 10 CEE/CIS markets with 1,400 outlets (below WB average)
• NPLs at 11% in 2011, which may increase to around 12% in 2012
• Solid position on domestic market, strong capitalisation (2011 Tier 1 capital ratio: 11 per cent; 2011 core Tier 1 capital ratio: 10.1 per cent), no further improvements required/expected in 2012
• Management committed to maintain/grow selected CEE/CIS exposure despite limited scale compared (6-7% of group exposure) to UniCredit, RBI and Erste

OTP:

• Represented in 9 CEE markets with 1,400 outlets (below WB average)
• Challenging conditions in home market; domestic Hungarian operations accounted for 68% of 2011 profit, share of largest foreign contributor, Russia, was 25 per cent
• Relatively high NPLs in Russia and Bulgaria (14.8% and 18 per cent, respectively) compared with peers – in the case of Russia this is driven by a strong focus on consumer lending
• High overall NPLs, at around 24% (2012), but solid NPL coverage of around 73 per cent
• High capitalisation (2011 Tier 1 capital ratio: 13.3 per cent; 2011 core Tier 1 capital ratio: 11.9 per cent; uptick in core Tier 1 ratio to 13% expected in 2012); high capitalisation required due to perceived risk profile as a bank with a CEE home country
• Management looking to compensate for weak Hungarian lending by accelerating growth in high-margin consumer/POS lending in Russia (where OTP currently has a return-on-equity of 30 per cent) and Ukraine; however, competitive environment in Russia in consumer/POS lending can create significant challenges for OTP

RAIFFEISEN BANK INTERNATIONAL:

• Represented in 15 CEE/CIS markets with 3,200 branches (above WB bank average)
• Strong presence in Russia (third-largest foreign-owned bank), Russian profit contribution usually on par with other CEE sub-regions (i.e. CE and SEE)
• NPLs at 9.3% (2011), expected to peak above 10% in 2012/2013; very low NPLs in Austria and some CEE markets (e.g. SK: 5.2 per cent; RU: 5.8 per cent; CZ: 6.6 per cent); double-digit NPLs in Hungary (27.7 per cent), Ukraine (37.5 per cent) and several SEE markets
• Still solid risk provisioning at 66–67% of NPLs, but coverage ratio decreased from around 75% some 2-3 years ago; limited need for deleveraging, but some capital-intensive assets have been disposed of and Slovenian business has been restructured
• Overall lending volumes outside Austria more or less flat since four years and year to-date loan growth mainly driven by Polbank acquisition; adjusted for consolidated negative loan growth in the first half of 2012, which limited profit growth
• Relatively weak capitalisation (2011 Tier 1 capital ratio: 10 per cent; 2011 core Tier 1 capital ratio: 6.4 per cent; improvement expected in 2012 to 11% and 7.1 per cent, respectively); rating agencies consider capital buffer too low in relation to perceived risks, moderate wholesale funding reliance
• Highly diversified CEE franchise (35% of exposure in non-investment grade countries); M&A; in Poland (Polbank acquisition from Greece’s Eurobank) to reduce dependence on Russia

SOCIÉTÉ GÉNÉRALE:

• Represented in 14 CEE/CIS markets with 2,700 outlets (above WB average)
• Greater deleveraging needs than some CEE peers at group level, relatively high reliance on (short-term) wholesale funding at group level
• International retail business underperformed for some time, due in part to one-off charges at the Russian operation (including goodwill impairment on Rosbank), strong earnings capability in Czech Republic; NPLs at 6.5% (2011), expected to pass 7% in 2012, relatively cautious approach to foreign-currency denominated loans in CEE as compared to Austrian and Italian peers
• Strong capitalisation (2011 Tier 1 capital ratio: 11 per cent; 2011 core Tier 1 capital ratio: 9.3 per cent; further improvement expected in 2012 to 12% and 10.5 per cent, respectively)
• Largest foreign player in Russia, combined loan book (Rosbank, Rusfinance, Deltacredit) 1.5 times larger than that of UniCredit, restructuring of the Russian operations on-going, some progress recently (net profit in the third quarter of 2012 after several quarters of net losses); ambitions to grow corporate lending in Russia, targeting synergies between Rosbank and SocGen’s global corporate and investment banking; SocGen to sell Belrosbank (from Rosbank) to Alfa Bank Belarus as Rosbank will focus on Russian market going forward

UNICREDIT:

• Represented in 16 CEE/CIS markets with about 2,800 branches (above WB average)
• Need for deleveraging less urgent, but Italian business has undergone substantial restructuring; NPLs at 12.9% (2011), which may increase to around 14 to 15% in 2012/2013 as conditions on the home market deteriorate, NPLs at 10.1% at UniCredit Bank Austria with NPL coverage of 52 per cent; certain reliance on wholesale funding at UniCredit Bank Austria
• CEE business performing relatively well; substantial improvement in capitalisation (2011 Tier 1 capital ratio: 9 per cent; 2011 core Tier 1 capital ratio: 8.4 per cent; improvement expected in 2012 to 11% and 10.3 per cent, respectively); diversified CEE/CIS franchise (30% of exposure attributable to non investment grade countries)
• Second-largest foreign bank in Russia; significant upside due to large presence in Turkey

Current and future challenges for WBs operating in CEE/CIS

Like their West European peers, some major WBs with a presence in CEE/CIS were hit by sovereign and/or bank rating downgrades in 2011 and/or 2012, which sometimes concerned the entire banking system. Parental downgrades by two to three notches since 2011 also affected the ratings of their CEE/CIS subsidiaries. In some cases CDS spreads of WBs with a CEE/CIS presence are more driven by sovereign risks in their home country rather than individual credit profiles. This can be seen in the “risk shift” between WBs from Austria and Italy in recent years. Some major WBs with a CEE/CIS presence are also suffering from asset quality problems on their home market or sizeable holdings of peripheral Eurozone sovereign debt, leading in some cases to a higher domestic cost of risk than in CEE/CIS markets in 2011/2012. This is especially true for Italian and Greek lenders, Hungary’s OTP and to some extent French banks, among which SocGen is a key regional player.

No indiscriminate deleveraging has taken place at WBs active in CEE/CIS. Like other European banks, major WBs with a CEE/CIS presence are currently focusing on boosting efficiency and reining in costs. Moreover, major Western CEE/CIS lenders are refining their business strategies. However, compared to the significant cuts European banks implemented in Developed Markets, modest deleveraging took place in CEE/CIS. This can be attributed to the behaviour of large WBs with a CEE/CIS presence based in Austria, Italy and France. All of the major banks (Erste, RBI, SocGen, UniCredit and Intesa) increased their CEE/CIS loan books in 2010/2011 on a cumulative basis. As a consequence, in Austria, France and Italy cross-border banking claims on CEE/CIS also remained flat or increased slightly, while banks based in these countries cut back other international activities by 30 to 40 per cent. Overall, cross-border CEE/CIS exposures of European banks are 4 to 5% below their 2008 levels, while European banks reduced global exposures by around 35 per cent. The sketched trends in cross-border banking flows do not exclude substantial selective cuts made by Austrian and Italian banks in, for example, Hungary or Slovenia. However, the fact that WBs did not cut exposures in the CEE/CIS markets has not brought them some of the possible benefits of a stronger RWA ratio, such as a better capitalisation or lower leverage.

WBs with a significant CEE/CIS presence and deep regional ownership links have bucked the trend towards cross-border deleveraging in Europe, because they still see a substantial growth and earnings potential in a lot of countries in the region. The crucial question going forward will be their ability to fund and grow their business, i.e. to translate financial stability to credit expansion/growth. Moreover, the creditworthiness of some WBs with a CEE/CIS presence has deteriorated due to home country sovereign rating downgrades. It remains to be seen whether this will be reflected in a permanent increase in refinancing costs. According to long-term time series there is a clear link between unsecured bank bond issuance costs and the sovereign creditworthiness and this link holds especially at the lower end of the rating scale. At least in price-sensitive areas of business, like corporate finance, increased refinancing costs could translate into disadvantages for some WBs.

Adverse effects of regulatory pressures on the lending volume of WBs active in CEE/CIS should not be underestimated. Some global Western CEE/CIS banks, for example UniCredit and SocGen, will be affected by the regulatory treatment of global SIFIs. Others, such as RBI and Erste, will be impacted by local SIFI regulation, such as the “Austrian Finish” which also calls for higher capital ratios, as well as market pressure to increase capitalisation. Due to underdeveloped capital markets, the trend towards disintermediation in CEE is likely to be less pronounced than in Western Europe, but the risk of credit supply shortages for SMEs is all the greater. Moreover, lack of long-term refinancing opportunities combined with current regulatory pressures may lead to a shortening of loan maturities in CEE. Here, IFIs will continue to have a role in supporting leading CEE/CIS banks. Banks’ CEE/CIS subsidiaries could also be hit by stricter national banking regulation. All of the above trends could promote disintermediation in CEE, even though corporate lending in the region is still at low levels. The attraction of capital market financing is already growing in CEE – but this only has a bearing on top corporates and not on SME clients. In Western Europe, we expect some policy initiatives to support the SME sector due to its high dependency on bank lending and very negative trends in SME lending in the euro area and especially in its peripheral countries. It remains to be seen to what extent such initiatives can be implemented by the CEE/CIS countries on their own.

Increasing country differentiation at WBs is the “name of the game”. Going forward, WBs in the CEE/CIS region are likely to pursue highly differentiated country strategies, designed to refocus on the “right markets” or “better-quality regions”. They will probably select markets where they will invest and others where they will remain on hold or divest. KBC may sell its operations in Russia (ZAO Absolut Bank), Slovenia (NLB stake) and Serbia. RBI is currently adjusting its presence in Slovenia significantly. Erste will offload its Ukrainian operation to locally-owned PJSC Fidobank in the course of 2013, Coba has already sold its Ukrainian subsidiary (Bank Forum) and SocGen sold Belrosbank (Belarus) to Alfa Bank. For WBs with a presence in CEE/CIS, an ability to grow the deposit base and remain profitable in every country under current funding conditions will be much more important than before the crisis. A footprint in retail banking, a highly regarded brand and an extensive branch network will be key to grow the deposit base. Refocused country strategies are also a likely trend, as the gains from RWA optimisation or optimised data reporting at WBs active in CEE/CIS have largely been exhausted. Such measures partly explain reasonable loan growth at leading WBs despite RWA reduction. Nevertheless, highly differentiated country strategies along national lines, which potentially favour some selective CEE/CIS markets vis-à-vis other markets, sit somewhat oddly with current efforts in Western Europe to achieve increased banking integration which in practice is to some extent already a reality in CEE.

While there are still tendencies towards nationally oriented regulation in CEE, for example regarding refinancing, banking sector integration requires cost-effective supervisory structures for multinational banking groups. Cyclically insensitive and uncoordinated national policies or resolution planning and soaring regulatory costs are the main downsides in the CEE banking sector. Complete separation of the parent WBs from their CEE/CIS subsidiaries is not a realistic option. Moreover, regulatory policies adopted at the European level, like the exercise of the European Banking Authority, need to take account of potential collateral damage to the CEE banking sector. For example, the Single Supervisory Mechanism (SSM) is still far from inclusive for non-EMU members from the CEE. Meanwhile, banks in CEE/CIS with West European parents are being buffeted by reputational problems that provide ammunition for calls to “domesticate” the banking systems. The Western European debate about separating bank activities, namely to separate fairly vaguely defined investment banking activities from deposit taking, may also have an impact on banking in the CEE region. In case of a separation, there can be some downside effects as major WBs with a presence in CEE/CIS markets are more or less traditional universal banks, with all advantages this business model offers in terms of diversification effects and more stable return profiles compared to specialised banks/banking systems. Given the smallness of the CEE banking sectors and limited international attention, WBs with a CEE/CIS presence and local regulators may need allies, such as the EBRD and the IMF, to prevent negative regulatory spill-overs. It need hardly be added that stabilisation of the euro and the euro area will be crucial to the prospects of WBs with a CEE/CIS presence. Only a sustained period of calm and recovery on European financial markets would permit capital increases at affordable cost.

Greek-owned banks in SEE:

Banks with Greek-capital are major regional players in SEE and are in the same league as their Austrian and Italian counterparts in Albania, Bulgaria, Macedonia, Montenegro, Romania and Serbia. Most Greek banks that have a presence in SEE operate in four or five countries via 400 to 600 branches. In all, Greek lenders account for 30 to 35% of total cross-border claims in a small group of SEE countries (but not in Croatia, which is dominated by the Austrian and Italian banks). In some SEE markets, Greek-owned banks’ have market shares of some 20 to 25 per cent. Although the SEE banking markets themselves remain challenging in terms of profitability and asset quality, NPLs of the Greek parent banks in their home market have topped those of some of their foreign operations in 2012: NPLs are in the range of 10 to 20% in SEE markets, compared to some 16–17% in Greece.

In view of the adverse home market conditions they face, the continuing presence of Greek lenders’ and only gently declining market shares in SEE (at least up to now) may surprise some observers. Greek-owned banks active in SEE have shrunk their balance sheets by only about 10% since 2008. This has led to a modest fall in their average market share of five percentage points from the peak reached in 2008 to some 20% in 2012. Up to a certain extent, the declining market shares of Greek-owned banks in SEE could be also interpreted as a market-based process of “flight to quality/safety”. The Greek banks’ defensive stance in SEE should also be seen in the light of high L/D ratios: 150 to 200% for all foreign operations in 2010/2011 and even higher in some countries.

The better than expected performance of Greek-owned lenders in the region is due to the fact that they are largely operated as subsidiaries, resulting in a degree of independence from their parent companies – a feature that SEE regulators have lately sought to reinforce. Nevertheless, conditions on both home and SEE host markets are likely to prevent the Greek banks’ earnings situation from normalising before 2013 at the earliest. Those that have not pulled out will most likely attempt to stay on in SEE in order to generate much-needed profits. Moreover, successful mergers between Greek banks themselves (like NBG and EFG) could partially strengthen their market position in some SEE countries. However, recent sales of foreign-owned Greek parent banks also caused a reduction of the Greek presence in the SEE banking sectors that might be reflected in their future market share and cross-border exposure data (e.g. Crédit Agricole separated SEE activities from Emporiki before its sale). M&A; activity involving Greek-owned SEE banks and third parties is unlikely before the overall earnings situation in SEE rights itself, although it cannot entirely be ruled out.

Consolidation and the growing importance of Russian banks in CEE

There are few competitors to challenge the leading regional WBs in CEE. At the top end of the market, major WBs with a significant CEE/CIS presence face little competition in CEE. Poland is a possible exception as there are also many other WBs present. In CE, the top five or six regional WBs have a 30% market share; when Poland and Slovenia are excluded, their share is even 50 per cent. In SEE, the top five WBs also have a 50% market share, the top three (UniCredit, RBI and Erste) have a combined share of 34% and there is no locally owned bank among the top five. Due to large market shares, defensive strategies by WBs could possibly have a major impact on the SEE banking sectors and economies. In CE, there are some local competitors such as OTP or PKO. The latter is among the top five CE banks and, like OTP, may seek opportunities beyond its home market. The current regulatory and market pressures on WBs may also benefit smaller locally owned competitors. However, in most of the CEE countries, domestic banks are too small in terms Banking in Central and Eastern Europe and Turkey.

M&A; activity in the next one to three years cannot be excluded, but no large deals involving major players are expected due to defensive RWA stances. The major WBs’ constantly need to work on their capital adequacy. This may prevent them from seizing growth opportunities, which would make room for other players – notably Russian lenders. Even if this happens, however, it is questionable whether newcomers will make up for the shortage of credit from WBs in CEE.

Russian banks – a dominating force in the home market – are increasing their footprint in CEE and globally. The Russian banking market, dominated by local champions, is currently growing much faster than the rest of CEE and the other CIS countries. Although 962 banks have banking licenses in Russia, the sector remains very concentrated. The 50 largest banks have a combined market share of 70% in lending. If Vnesheconombank (a development bank) is counted, the five largest banks are all state owned. The loan book of the market leader, Sberbank, is 12 times the size of that of the largest privately owned bank, Alfa. In contrast to most other CEE/CIS markets, Russia’s banking sector has recently recorded strong growth. Lending was up 28% in 2011 and almost 15% in the first nine months of 2012, while annual inflation stood at 6 per cent. Unsecured retail lending has been rising rapidly by 40 to 50% per year. Such high growth is unlikely to persist as banks have been pumping up balance sheets beyond the ability to source funding and generate capital. A combination of margin pressure, weaker demand and regulatory tightening has already slowed corporate lending. It remains to be seen whether recently introduced regulatory measures to discourage banks from aggressive (retail) lending will be effective.

Most large Russian banks remain CIS-centred and Sberbank is the only player with international ambitions. Russia’s two largest state-owned banks, Sberbank and VTB, are the biggest lenders in CEE/CIS, with a combined market share of 20 per cent. This equals the combined market share of the five to six leading WBs in the CEE/CIS region. However, both Russian lenders hold the lion’s share of their assets in their home market, while their international footprint is CIS centred. The banks’ strategies outside CIS diverge. Sberbank gained access to the Turkish market and several CEE markets outside of CIS through the acquisitions of Turkey’s Denizbank and Vienna-based Volksbank International (VBI, now Sberbank Europe). While Denizbank has a high-profile franchise in Turkey, former VBI is a small CEE player and it will take time to increase the footprint. Around 97% of Sberbank’s 19,700 branches are located in Russia and 99% in CIS countries. Sberbank Europe has around 250 branches in seven CEE countries.

Sberbank’s limited presence in CEE will not be easily scaled up. By way of comparison, leading WBs are operating via 10,000 branches in CEE. Moreover, Sberbank’s management stated that the lender will be pausing for breath after recent acquisitions, which was also reflected in the declared non-interest in buying additional CEE exposure from Austrian HypoAlpe Adria. It will first focus on integrating existing assets. Though, there is good reason to suppose that it is serious about the consolidation strategy as capital adequacy has declined as a result of acquisitions and strong organic growth.

Despite its international ambitions in investment banking VTB is unlikely to pursue major acquisitions in CEE in corporate or retail banking for some time to come. The bank needs to tackle its low capital adequacy, which stems from two large acquisitions in Russia (Bank of Moscow and Transcreditbank) and large losses in equity trading.

Looking at other larger locally-owned players, there are few candidates for expansion into CEE. Gazprombank has used most of its recent capital increase to grow its loan portfolio. Russian Agricultural Bank has a semi-development bank mandate with a focus on agro-industry, which makes CEE expansion an unlikely scenario. The same applies to Vnesheconombank. Nomos will have its hands full with its merger with Otkrytiye. Besides the need to rebuild its capital adequacy, Promsvyazbank has no track record of growing by acquisition, even on its home market. Alfa, the biggest Russian privately-owned bank, is a “dark horse”, since its shareholders will cash in on one large investment soon and may start looking for capital allocation opportunities. However, it is not clear at this stage whether any of this money will be invested in the bank, and if so, whether it will be used for acquisitions in Western Europe or CEE. Other Russian banks, outside the top ten, are too small to have an impact in CEE.

Central and Eastern Europe (CEE) is a fast growth region for the insurance sector. With low penetration and in many cases low barriers to entry, it is an attractive market to local, regional and international players.

The most developed markets are those in Central Europe, although there remains huge disparity across the region, with insurance premium per capita as high as €800 in Slovenia and as little as €10 in Albania. This diversity means that there are continued and varied opportunities for growth in the region.

Like most markets and sectors, the insurance market in CEE will not emerge unscathed from the current financial crisis. International players may face financing constraints which affect their growth plans in non-core markets and the drop in the region’s stock markets has negatively affected unit-linked sales. It is likely that the mid to long term outlook for the market remains positive with the overall trends being increasing awareness of products; gradual increase in wealth; and reduction in state social security benefits.

The regulatory environment is seeing increasing unification, integration and liberalisation, boosted in some countries by integration into the EU. While it still lags behind much of Europe, governments are working to modernise the legal framework and build regulatory capacity. In 2006, Poland and the Czech Republic established multi sector financial regulators, and Croatia has recently merged all its non-banking financial regulators into one.

Some of the most notable markets in the region include:

• Poland (the largest country and the largest and most profitable insurance market in the region) is dominated by state-owned PZU, although its market share has declined over the last few years as competition from international firms has increased dramatically;
• The Czech Republic has seen consistent growth for the last 5 years, with a strong regulatory framework and economy and low penetration rates. With numerous small players in the market, this is one of the most likely countries for consolidation in current economic conditions; and
• Romania is comparatively underdeveloped and therefore has potential to grow dramatically. Several European insurance giants have entered the market in recent years via a wave of M&A; activity in 2007-2008.

Liberalisation of the CEE markets has seen a spate of merger activity in the sector since 2005 (25 deals completed in 2008), leading to increased concentration in the market and companies growing in size. This is driven by the need to gain economies of scale and compete effectively. International players see acquisition as an entry strategy for these markets, tempted by low insurance penetration rates. As a result, international companies hold leading positions in many CEE markets.

Current M&A; trends show that deals are no longer driven by the State, but by entrepreneurs or companies seeking strategic partners or exits for their businesses. In this context, it is much more aligned to M&A; in Western Europe and other developed markets. Despite market conditions, this region will remain of interest to the insurance industry, due to the long term prospects for growth and consolidation.

A new generation of consumers has appeared on the scene and digitalization has made great inroads. These two trends will necessitate change in the business and operating model.

A new study by Roland Berger Strategy Consultants, “Next Generation Insurance in Central Europe”, reveals current industry trends and identifies growth opportunities for insurers in the coming five to ten years. The study examines the market situation for insurers in Poland, the Czech Republic, Slovakia, Hungary and Croatia, and is based on a fresh, in-field survey of more than 1,800 households.

Emerging technologies are to reshape the motor insurance in CEE: The currently available technology enables provision of usage-based insurance (UBI) for individuals. “These products are based entirely on the individual usage and risk profile of the clients,” says Frigyes Schannen, Partner and Head of Insurance Services for the CEE region at Roland Berger Strategy Consultants. Vehicle insurance is particularly suitable for UBI. With the help of cutting-edge technology, the clients’ driving behaviour can be monitored and the insurance premium adjusted accordingly. “The less you use your car and the more safely you drive, the less you pay. Many Western European insurers fear the negative margin impact of such innovations.

“We see a number of opportunities for insurers to create an ecosystem around the vehicle, going beyond mere insurance and providing high value added services such as appointment booking with authorized repair shops or accident prevention through tips on safe driving,” says Schannen. The Central and Eastern European market shows great potential here. According to the survey carried out by Roland Berger, up to 15 million drivers would potentially be interested in switching to usage-based insurance products. International insurance companies must not ignore this market segment, but revise their current approach and pursue this opportunity.

Internet generation brings revolution in sales:  Generation Y and Z refer to everyone under 35 and 20 years old, respectively. They represent huge potential for many industries but also bring a generational break into the offering as they stand for very different values, lifestyle and behaviour. By 2025, Generation Y and Z will make up around 60 percent of potential clients for insurers. Yet this market potential will not be easy to access as these individuals are very self-sufficient, digital native and app savvy, and are also more price sensitive than Generation X and older.

This has inevitable consequences for the sale and marketing of insurance. “The future success of an insurer will depend on its ability to understand the behaviour and psychology of these new generations and to adapt its offering accordingly,” says Ákos Újlaki, co-author of the study. “To win these age groups, insurers need to develop solid skills in e-commerce, build modular product portfolios and master the art of online cross- and up-selling. However, even the new generations will require brick-and-mortar touchpoints such as tied agents.

Growing pressure on margins: The increasing dominance of online sales channels is forcing insurers to improve transparency over pricing and communication. Young customers mainly use social media forums and comparison websites to find out about insurance products. Insurance companies need to transform their websites into more user friendly places where products are well explained and can be purchased right away. In the future, customers will be able to review, compare and then purchase insurance in a matter of minutes via apps.

Digitalization, through its impact on client behaviour, represents a major challenge for insurance companies. As one of the main impacts, younger customers are more price focused. Their ability to quickly compare premiums online is leading to inevitable price competition. Insurance as a service is becoming more and more standardized and affordable. This has a negative impact on insurers’ margins, as it became increasingly difficult to differentiate between providers.

Croatia

• Private equity activity since 1997, but undeveloped market
• Annual amounts very volatile EUR 25 mln – EUR 100 MN per year
• Selected strategies: – Development capital: consumer & retail (Kozmo, Promotehna, Aqua, all by Nexus), food production (Hlad, Quaestus) – Start-ups with high growth potential: alternative mobile operator (Tele2, Quaestus), alternative telecom (Metronet, Quaestus), new technology (Five minutes, RSG Capital) – Natural resources: cement production (Calucem, Mid Europa, exited to Argos Capital) – Strong real estate component: Bluesun Hotels & Resorts (Marfin Investment Group)

What makes Croatian PE unique? Croatian LP/GP model

• One of two CEE countries who has succeeded to mobilize local savings into private equity: local LPs are the most important source of funds (pension funds, insurance companies, large corporates) since 2003
• Pension funds are allowed to invest in private equity funds since 2007 and all pension funds are investing in local private equity funds
• Croatian Government sponsored initiative to jumpstart private equity market resulted in 10x increase of available investment amounts for the industry: five new funds with total commitment of EUR 274 million recently formed:
  1. Alternative Private Equity – EUR 82 million
  2. Quaestus Private Equity II – EUR 72 million (second fund)
  3. Nexus Private Equity – EUR 52 million (second fund)
  4. Prosperus Invest – EUR 47 million
  5. Honestas Private Equity – EUR 21 million

What makes Croatian PE unique? Outlook and lessons learned

• Outlook: impressive success of the Government sponsored private equity initiative has potential to increase significance of private equity activity in Croatia as well as prospects of EU Accession. Risks are on the macro-side as economy is slower to return to growth levels and has other macro-risks.
• Croatian success story in successfully mobilizing domestic savings into Private Equity funds could be replicated to other markets
• Most SEE markets are example of market failure with regards to private equity and venture capital: there is an excess of demand for equity capital, expressed and unexpressed, and lack of supply of risk capital
• Almost every developed country has developed a public support program to develop private equity industry
• Combining public and private funds to support development of Private Equity industry may be the key to solve market failure!

Albania

• Private equity activity since 2000
• Several players: Albanian – American Enterprise Fund, Bedminster Capital Management (SEEF II), Marfin Investment Group, NCH Capital Advisors
• Selected strategies: – Strong real estate component: hospitals (Bedminster, MIG), airport – Niche technology: biometrics (AAEF)
• Outlook: opportunistic deals as part of the regional strategy, grim potential for lower-mid market or venture

Bosnia and Herzegovina

• Private equity activity strong before the crisis, now more difficult market
• Annual amounts very volatile EUR 50 MN to zero
• Selected strategies: – Buy & build: banks (POTEZA: Postbank, Nova Banka); cable & broadband (7LP CAPITAL PARTNERS: Cable BIH (now sold to MID EUROPA), diaries (SALFORD) – Real estate component (POTEZA, HORIZONTE)
• Outlook: opportunistic deals as part of the regional strategy, grim potential for lower-mid market or venture

Macedonia, FRY

• Venture capital market established in 1998 (SEAF Macedonia)
• Small market looked by few regional players, no dedicated country focused fund in the investment stage
• Selected strategies: – Buy & build: diaries (SALFORD, Mlekara Bitola, as part of regional consolidation strategy) – Natural resources: extraction & production of snow-white marble (ETHAMBA CAPITAL, Mermeren), zinc mines (BANCROFT) – Venture & risk capital development: internet service provider (On.Net), supermarket chain (Tinex), fast-moving consumer goods (Mako Market) – all by SEAF Macedonia
• Outlook: very difficult to develop private equity & venture capital market, opportunistic growth capital / buyout deal possible, not necessarily every year

Serbia

• Private Equity activity since 2000
• Annual amounts very volatile from EUR 100 million (equity only) to zero
• Several regional funds doing deals and locally based: Bedminster Capital Management (SEEF II), Salford
• Serbia as a hub for regional buy-and-build play: – MID EUROPA in cable business – SBB / Total TV – largest buyout in Serbia to-date (EUR 175 million transaction value) – SALFORD in diary business (IMLEK) – POTEZA – animal feed / fertilizers sector (PROTEINKA; SUPERPROTEINKA)
• Restructurings – SALFORD in consumer & retail (KNJAZ MILOS, BAMBI)
• However, no new dedicated funds / several players left Serbia
• Outlook: large market and solid growth prospects make Serbia an attractive destination for opportunistic buyout transactions. Lower mid-market and venture industry prospects are still considered too risky for commercial investments.

Montenegro

• Small market looked by few regional players, no dedicated country focused funds
• Very few known transactions
• Private equity with strong asset / real component – more in real estate category
• Selected strategy: – Industrial production: integrated steel production (ETHAMBA CAPITAL: Niksic steel)
• Outlook: very difficult to develop private equity & venture capital market, opportunistic growth capital / buyout deal possible, not necessarily every year

Slovenia

• Private Equity activity since 1995
• Annual amounts very volatile from EUR 10 million to EUR 75 million
• Small and closed market – many local funds (not always publicly known and operating as closed-end investment funds) and local investors
• Many local funds hard-hit by crisis (example Potenza)
• Equity financing available also for early-stage companies
• Selected deals: Telepath (cable broadband, Mid Europe), Donitz Tenet (manufacturing, Mohair Staler), Topmast (manufacturing; DBG Eastern Europe); Attach (electronics, iEurope); Tab Solutions (biometric solutions, RSG Capital)
• Outlook: success story of developing private equity and venture capital investments from early stage to expansion / buyout stage with combination of local GP/LP model and foreign funds. Strong entrepreneurial culture and promising recovery of the market post-crisis.

Bulgaria:

In Bulgaria there are several risk funds with experience that are familiar with economic and political environment in the country. However, the market risk capital for small and medium businesses in the country is at an early stage of development and has strong growth potential.

Despite the weaknesses of the Bulgarian market for acquiring venture capital, there are numerous opportunities before him. Venture capital is a unique means of raising funds for small and emerging companies and may become an effective instrument for the promotion and development.

Venture capital is an alternative form of investment and compared to other investments, offers more opportunities – no guarantees required; a fund manager is involved in the management of the financed company; up-to-date know-how and modern business practices are introduced; there is no need for stating successful financial history of the company and so on. Unique in nature, venture capital is not a subject to competition from other funding instruments. They can only complement it without excluding each other.

Romania:

The Romanian private equity market is in an incipient development stage. The statistical accounts of EVCA Ukraine (€43m) and Romania (€27m) showed lower levels of investment value in 2012 compared to 2011, with decreases of 32% and 60% respectively, due to less capital being invested in venture and growth deals. While the number of companies receiving private equity investments in the CEE region in 2012 compared to 2011 was driven almost entirely by a higher number of companies receiving venture financing, in Romania the trend is decreasing (-6). Romania has the opportunity to improve these statistics. The European Investment Fund (EIU) allocated through the JEREMIE enterprise 10 million Euros for the Catalyst Romanian investment fund. Managed by a local team belonging to 3TS Capital partners and with a target-capital of 30 million Euros, Catalyst will finance, through investments of 200,000-2 million Euros, the local medium and small companies whose activities are connected to technology, internet, media, communication and services. Catalyst will provide the business expertise and the necessary financing in order to support the growth and development of medium and small companies whose activities are related to innovation. The JEREMIE Romania enterprise led to the creation of several other financial tools for the medium and small companies which are currently active: Portfolio warranty (available through Raiffeisen Bank, BCR and Unicredit Tiriac Bank) which already enabled the grant of over 2,000 credits of over 180 million Euros with significantly diminished warranty requirements for medium and small companies. The new lending tool with grant-aided interest through which the medium and small companies could access loans for investments and working capital of 120 million Euros, benefiting from a significantly low interest compared to the market level and diminished warranty requirements.