Most analysts maintain that Poland stands to ride the financial storm better than any other country in emerging Europe. The country in some ways seen as the quasi China of Europe. Yet indicators suggesting the opposite are mounting up.
First, this out of Moody’s late on Thursday (our emphasis):
London, 18 June 2009 — Moody’s Investors Service has today downgraded the ratings of five Polish banks. The affected entities are Powszechna Kasa Osczednosci Bank Polski (PKO BP), Bank Polska Kasa Opieki SA (Pekao), Bank Zachodni WBK, Bank Gospodarki Zywnosciowej (BGZ) and Bank Handlowy w Warszawie (Bank Handlowy).
Today’s downgrades concludes the reviews on the five out of the eight banks initiated on the 19th of May and reflect Moody’s view that the deterioration in the Polish operating environment is putting pressure on the banks’ standalone creditworthiness, as measured by their bank financial strength ratings (BFSRs). The reviews on the remaining entities are expected to be concluded in the next month. With the Polish economy having entered a downturn the likelihood of an increased number of corporate defaults is rising and therefore the losses in bank’s corporate loan portfolios are expected to grow. In the meantime rising unemployment and the decline in house prices are expected to result in increased losses also in the mortgage and consumer portfolios.
These potential losses and substantial provisioning needs are expected to weaken the profitability and, thus, capital positions of most Polish banks over the next two years. The declining profitability trends were already evidenced in the Q1 financials of most of the rated Polish banks. Also a marked deterioration in asset quality indicators became apparent for the past 6 months, prompting some banks to declare losses on a quarterly basis. We note, however, that funding position remains relatively comfortable with customer deposits funding close to 100% of loan books. However, the availability and fierce competition for this form of funding will significantly constrain the growth prospects of most of the banks. All these factors indicate that the system as a whole, as well as individual banks, lost its growth momentum and is retrenching, leading Moody’s adjust its rating assessment accordingly.
They continue:
Thus, the anchor used for measuring the influence of the probability of systemic support on banks’ ratings is now Polish government bond rating of A2 (stable outlook) plus one notch of uplift, resulting in an A1 input. Although the refined approach allows two notches of uplift on the government bond rating, given the recent rapid growth in bank lending, expansion in foreign currency lending (particularly in residential mortgages) and potential for large losses on FX derivatives due to the zloty volatility Moody’s considers that one notch uplift is more appropriate, reflecting its view that the probability of systemic banking losses are medium to high.
The downgrades implemented being:
- Moody’s downgraded the BFSR of PKO BP to C- (mapping to the BCA of Baa2) with negative outlook from C.
- Moody’s downgraded the BFSR of Pekao to C- (mapping to the BCA of Baa1) with stable outlook from C.
- Moody’s downgraded the BFSR of Bank Zachodni WBK to D+ (mapping to the BCA of Baa3) with negative outlook from C-.
- Moody’s downgraded the BFSR of BHW to D+ (mapping to the BCA of Baa3) with negative outlook from C-.
- The local and foreign currency deposit ratings of BGZ were downgraded to A3 with stable outlook from A2, due to the reassessment of the systemic support input.
Then there was the employment and wage data released on Thursday, which proved much worse than expected. As Danske Bank writes on Friday:Polish employment dropped 1.7% y/y in April, down from -1.4% y/y in March. Wage growth was much weaker than expectations.
Meanwhile, the analysts project:
Taking yesterday’s negative surprise on Polish labour data into account, we could be in for another negative surprise today when we get numbers for Polish industrial production in April.Worsening wages and unemployment growth are bad enough. Worse than expected industrial production, though, is possibly worse. You see analysts have always viewed Poland as stronger than its respective neighbours on the argument that its dependence on exports is not as big as, say, Hungary’s. The old China “decoupled” story, you might say. Growth, the reasoning goes, is based on a solid manufacturing and production base, growing foreign direct investment flows, a booming property sector, and rampant growing consumer appetite for, err, everything. On this basis, IPOs and foreign listings on the Warsaw Stock Exchange mushroomed over the last couple of years. See the China parallel?What these analysts may have failed to account for, however, is to what degree Poland’s growth was dependent on debt and the rapid expansion of lending and loan distribution to a largely credit-history free population. As well as real-estate.
The debt binge was not only sizeable but concentrated in a small part of the population. FDI on the other hand flew both heavily into commercial and residential real-estate development, both of which are now vulnerable to price collapse.
On the retail side, gigantic shopping malls sprang up across the country (Warsaw alone, population 1.7m, has five mega shopping centres, to compare London population 7.5m has four). What’s more, as real-estate specialists Cushman & Wakefield report, retail space is only set to grow further in 2009 as projects already in the pipeline are completed.
But while demand and rental rates were previously rising, they are now expected to stabilise in 2009. If the country experiences any more currency shocks, this could get worse. As CW write:
The falling exchange rate of the PLN against the euro translates into rising lease costs — a result of leases in shopping and entertainment centres usually being made in euro and settled in the Polish zloty according to the exchange rate as on the VAT invoice date.
But it was office space that was seen as the biggest golden ticket in the boom years, based on the notion the country would emerge as the financial hub of emerging Europe. Vulnerabilities and exposure to a financial crisis were not foreseen. Note the following story from the Warsaw Voice from June 8th:
The global economic crisis has the banking sector readjusting its leasing priorities
Take-up of office space by banking-sector tenants fell dramatically across Europe in the first three months in comparison with Q4 2008, according to a recent report by Cushman & Wakefield. The most affected locations on the continent included Moscow, London and Warsaw, where take-up decreased by 97 percent, 94 percent and 87 percent q/q, respectively. meanwhile, in Brussels, Budapest, Milan, Amsterdam, Barcelona, Glasgow and Edinburgh no office space was taken up by banks in the first quarter. Paris, Frankfurt and Madrid, however, saw increases in take-up by banks. Cushman & Wakefield, meanwhile, write:
The total value of transactions recorded in 2008 amounted to EUR 1.79 bn and was lower by over 40% compared to the previous year. The leading market segment was the office property sector, which accounted for over 62% of the value of all the transactions.
So that’s quite a dependence on office space.
The other point to consider is cultural. As yet there has not been an economic crisis in a post-communist European country where citizens are as extended in debt as they are now. Default rates in these circumstances have never been tested before, and just how partial Poles are to write offs, especially considering their relatively short credit history, is the big unknown that all banks might be vulnerable to.
Moody’s already establishes default rates are rising quickly. What’s worse, the increase comes as fresh credit lines are being pulled almost completely.
The one reassurance the ratings agency does offer is that at least deposits fund 100 per cent of Polish loan books. But could this in itself be a danger? The practice of mattress banking and dollar stockpiling was a relative norm under the communist era. A severe economic shock, which fuels growth in the grey economy could see that trend reemerge with disastrous consequences for bank deposits.
Related links:
The big Le-borrow-ski – FT Alphaville
Emerging Europe outlook: still bleak – FT Alphaville
CEE’s stand against SPECTRE-lators – FT Alphaville
Another Eastern European meltdown? - FT Alphaville