Eastern Europe, that is, a part of the world that has seen a shocking boom in mortgage lending over the last few years.
In fact, even as most mortgage lending was beginning to freeze up in the west, many of the big Eastern European banking players like Allied Irish and Unicredit were reporting ongoing growth in lending to the region.
The European Mortgage Federation tracked this sort of growth even in Q1 of this year:
The practice of mortgage and ordinary personal lending in Eastern Europe is still relatively new, in a historical context. As a result, most analysts - even up until a few weeks ago - didn’t foresee a big problem. Certainly in terms of mortgage lending versus the GDP, figures for eastern Europe are substantially smaller than for any of the more established western markets.
However, there was always one major risk identified - the number of Eastern European mortgages based on floating foreign exchange rates (mainly versus the swiss franc). Here’s the Polish Mortgage Federation looking at possible consequences of the US subprime meltdown on Poland noted in April 2008:
Looking for analogues among products offered on the Polish market, some experts point to another risk factor peculiar to this market, namely foreign currency loans – which expose borrowers not only to interest rate risk, but also to FX risk, caused by the volatility of these parameters, including currency exchange rates.
In the meantime the swiss franc has done this versus the zloty:
Emerging Markets startegist Bartosz Pawlowski from TD Securities now sees the foreign-exchange mortgage factor as a big problem.
He writes:
Explosion of CHF-denominated credits that began after the EU entry (May-04) was one of the reasons behind robust investments growth. Poland and Hungary have been particularly active in this field (e.g. the stock of foreign-currency denominated mortgages in Poland is PLN88bn vs PLN58bn in local currency and the proportion in Hungary is even higher). Average CHF/PLN and CHF/HUF exchange rates since May-04 until Jul-08 (after which credit activity dried up) were 2.48 and 160, respectively.
He goes on to alert that Hungarian banks were actually accepting bids for JPY-denominated mortgages this year. JPYHUF now looks like this:
Pawlowski goes on:
There is always an option to convert foreing-currency mortgages into local currencies, but by doing so one would face a substantial increase in debt burden. However, we think that if CHF crosses approached 2.80-3.00 and 200-220, respectively, proportion of non-performing loans in the banks’ portfolios would increase substantially.
He also cautions about the exposure of the corporate sector.
Anecdotal evidence suggests that a lot of companies have been taking advantage of the appreciating trend of the currency in the recent quarters to sell call options with knock-out barriers, hoping that the trend will continue and their exposure will be “turned off” by markets. However, once the trend reversed, these companies could be facing massive payouts that could lead to liquidity problems (indeed, there was already one example of a company being forced to pay a lot of money back to a bank). Given that majority of such options are accounted for as “hedging instruments” it is impossible to calculate the full impact of recent appreciation but it is yet another factor that clouds the short-term outlook for CEE assets.
So what’s the solution? Pawlowski is of the opinion that interest rate hikes are not a viable solution under current circumstances and that CEE countries should seek assistance from both the ECB and the IMF to restore confidence. Calls for early entry into the Euro Zone have certainly been making the rounds. Pawlowski agrees:
We also reiterate that Poland, Hungary and Romania would be much better off if they committed to entering the Eurozone as soon as possible.
Meanwhile, BNP Paribas’s chief forex strategist Hans Redeker has this warning on Eastern Europe:
“This crisis is starting to look like the Black Wednesady in 1992. Unless we see an extension of central bank swaps in dollars and euros to Eastern Europe within days to stop this uncontrolled process of deleveraging, this could get out of control and do serious damage to Western Europe. We could see the euro fall to parity against the dollar by next year,” he said.
