2015: A transition year

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Please note the risk noti

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cations and explanations at the end of this document

www.raiffeisenresearch.at

CEE Banking Sector Report

June 2015

2015: A transition year

Upside on some CE/SEE markets

Restructuring in HU and RO well advanced

NPL improvements in CE/SEE, downside in EE

2014 RoE in CEE at 6%, not much upside for 2015

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Content

Executive Summary 3

Defi nition of subregions, economic overview 5

Banking trends in CEE

Ownership structures and market concentration 6

Focus on Russia: Harsh market and political trends to impact competitive landscape 8

Financial intermediation, asset-to-GDP ratios 9

Focus: “Deleveraging debate” in CEE banking 11

Loan growth, growth by segments (retail, corporate) 12

Funding, deposit growth and L/D ratios 14

Profi tability (Return on Assets, Return on Equity) 16

Focus: Non-performing loans and NPL ratios 17

CEE banking growth and overall market outlook 19

Country Overviews

Poland 22

Hungary 24

Focus: A big-picture view on Hungarian banking 26

Czech Republic 30 Slovakia 32 Slovenia 34 Croatia 36 Romania 38 Bulgaria 40 Serbia 42

Bosnia and Herzegovina 44

Albania 46

Russia 48

Ukraine 50

Belarus 52

Focus on Ukraine: Key provisions of IMF program 54

Market players in CEE 55

Appendix: Key CEE banking sector data 81

Key abbreviations 82

Risk notifi cations and explanations 84

Disclaimer 86

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Executive Summary

Dear reader of the CEE Banking Sector Report 2015!

The year 2014 marked the 25th_{anniversary of the fall of the Iron Curtain – a}

his-toric event that laid the foundations for a success story in terms of economic de-velopment and political stability on the European continent. Yet, the celebrations were rather moderate, as 2014 turned out to be quite challenging for the EU and Central and Eastern Europe (CEE) – economically and politically.

For one, 2014 was characterized by great uncertainty stemming from the po-litical tensions in the EE region. While the Ukrainian economy and banking sec-tor saw a terrible year, Russia was still able to absorb the negative impacts from the economic nosedive, RUB collapse and Western sanctions. For 2015, we ex-pect a deterioration of key economic indicators with negative impacts gradually feeding into the banking sector performance. Moreover, the medium-term eco-nomic and banking sector outlook for Russia seems less favorable than antici-pated some years ago. Hence, the largest foreign-owned banks may overthink their presence in Russia and consider more cautious business models, while state-owned banks might even increase their market share. Up until 2016, we cur-rently do not see a significant improvement of the economic situation in EE. It will take extensive structural reforms to recover and to return to somewhat sustainable growth patterns. Also, only time will show if the current IMF program for Ukraine will be sufficient to make up for the structural and economic damage caused over the past months of armed conflict and political challenges. Given the significance of EE for the entire CEE region, we dedicated a focus on both Russia (page 8) and Ukraine (page 54) to take a closer look on the current situation and to give a near-term outlook on the development of these two banking sectors.

The second major topic in 2014 in European banking was the Asset Quality Re-view (AQR) and stress testing by the European Central Bank (ECB) and the Euro-pean Banking Authority (EBA). The results were stricter regulations and require-ments for the entire European banking industry and a broad-based balance sheet clean-up. CEE banking markets were also affected, as Western CEE banks had to adapt their business models and overall market presence. On a positive note, this process led to improved NPL ratios in CE/SEE and more risk-averse lending policies. At the same time, stricter capital requirements and increasingly nega-tive effects stemming from the ultra-low interest rates environment resulted in prof-itability pressure in several key CE banking markets. Overall, the appeal of CE/ SEE banking markets, with the exception of Poland, the Czech Republic and pos-sibly Slovakia, suffered compared to the euro area. Hence, our focus on the “De-leveraging debate” (page 11) discusses the current dilemma of Western banks in CEE.

Executive Summary

 CE/SEE: New lending cycle may start; balance sheet clean-up results in improved NPLs, but affects profi tability  EE: Western banks may start to rethink their market presence, returning to “boutique-style” business models  High-growth markets: Poland, the Czech Republic, Slovakia, Hungary and Romania

-5 -4 -3 -2 -1 0 1 2 3 4 2012 2013 2014e 2015f 2016f

CE/SEE EE Euro area

Real GDP (% yoy)

Source: national sources, Eurostat, RBI/Raiffeisen RESEARCH 50 70 90 110 130

Dec 07 Mar 10 Jun 12 Sep 14

CE/SEE EE Euro area

Cross-border claims*

* BIS-reporting Western European banks (Dec 2007 = 100, latest data point Q4 2014) Source: BIS, RBI/Raiffeisen RESEARCH

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Executive Summary

With regards to the growth outlook for the individual CEE banking markets, we continue to consider Poland, the Czech Republic and Slovakia as high-growth markets, characterized by modest levels of financial intermediation and hence a fair chance that lending and asset growth can outpace GDP growth on a sus-tained basis. From a fundamental perspective, the turnaround markets of Hun-gary and Romania may be added to this group of countries. Both banking mar-kets did see an economic and banking sector turnaround in recent years (based on deleveraging, harsh one-off losses and NPL restructuring). However, at this point it is difficult to predict if the restructuring of the past few years has been yet sufficient to start a decent upturn already in 2015. Our country pages (page 22) provide a detailed picture of individual CEE banking sectors. A special section (page 26) covers the long-term trends in Hungarian banking. Following harsh ad-justment in recent years, we may see a return to growth and profitability based on a more constructive stance by Hungarian policymakers.

In retrospective, 2014 was much more challenging than expected. Economic growth in the euro area was disappointing, and the stricter regulations on the banking sector resulted in a “new reality” for the European banking industry as a whole. In addition, the political tensions in the EE subregion worried businesses and investors. In total, three out of 14 CEE banking markets (Hungary, Romania and Ukraine) were loss making in 2014, which is close to the number of loss mak-ing markets (four) seen in the aftermath of the global financial crisis in 2008/09. The Russian banking market experienced a noticeable drop in profitability in 2014 (RoE down from 15% to around 8% in 2014, Q1 2015 RoE at 4.8%). For 2015, we expect cautious and very selective business strategies of larger Western European CEE banks, characterized by capital discipline as well as a stark differentiation between country and business segment strategies. Therefore, overall business strategies in CEE banking are likely to be dominated by balance sheet optimi-zation, cost-cutting, very selective growth and investments strategies focusing on product optimization, modernization and operational efficiency. It is unlikely that we will see new market entries or large-scale expansions of existing branch net-works. Although we still expect 2015 to be a transition year in CEE banking, we see players that are already positioned to profit from the increasing upside and next credit cycle in CE/SEE banking and who are placed to gain market share and to lay the foundations for future growth and profitability. The overview on in-dividual market players (page 55) discusses the business models and strategies of the largest Western and Russian banks operating in the CEE region and offers data for comparison.

We hope you find the CEE Banking Sector Report 2015, with our analysis, data and graphics in it, a reliable and unique reference for your daily work.

On behalf of the author team,

Gunter Deuber Elena Romanova

Vienna, June 2015 0 4 8 12 16 20 24 0 25 50 75 04 05 06 07 08 09 (1 ) 10 (4 ) 11 (4 ) 12 (3 ) 13 (1 ) 14 (3 )

CEE RoE (right hand scale) Impact on foreign banks** CEE: RoE & impact on foreign banks*

* RoE and average market share loss-making CEE bank-ing markets in %, loss-makbank-ing in 2014: Hungary, Roma-nia, Ukraine

** Average market share foreign-owned banks on loss-making CEE markets, number of loss-loss-making markets - if any - in brackets on horizontal axis

Source: national central banks, RBI/Raiffeisen RESEARCH

-5 0 5 10 15 20 25

CEE Euro area

Long-term avg.* Max Min 2014 CEE vs. EA profi tability (RoE, %)

* 1999-2014

Source: national central banks, ECB, RBI/Raiffeisen RESEARCH

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0 10 20 30 40 50 60 70 80 90 CZ HU PL SK SI AL BH BG HR RO RS BY RU UA 1996-1998 2006-2008 2016-18f

Subregions and economic overview

Central

Europe

(CE)

Southeastern

Europe (SEE)

Eastern

Europe

(EE)

Key economic indicators

Real GDP (%yoy) GDP (EUR bn) Trade (% of GDP) Public debt (% of GDP) Unemployment (%) 2000-2013 2014-18f Chg. (14-18f vs. 00-13) 2014 2014 2008 2014 2008 2014 Poland 3.6 3.4 -0.2 412 80 47 49 9.8 12.3 Hungary 1.9 2.7 0.8 103 164 73 77 7.8 7.7 Czech Republic 2.6 2.4 -0.2 155 148 29 44 4.1 7.7 Slovakia 3.9 2.9 -1.1 75 170 28 54 9.6 13.2 Slovenia 2.0 2.0 0.0 37 120 22 80 4.4 9.7 CE 3.2 3.0 -0.2 783 115 44 54 8.1 10.7 Croatia 1.8 0.8 -1.0 43 45 36 85 8.5 17.3 Romania 3.6 3.0 -0.6 151 62 13 40 5.6 6.8 Bulgaria 3.5 2.5 -1.0 42 105 14 27 8.1 10.7 Serbia 3.2 1.6 -1.6 33 87 27 69 13.6 22.0

Bosnia and Herzegovina 3.1 2.8 -0.4 14 66 30 45 23.4 27.5

Albania 4.7 3.5 -1.3 10 31 55 72 12.8 18.0 SEE 3.3 2.4 -0.9 298 67 21 49 8.7 12.5 Russia 4.8 0.0 -4.8 1,384 54 7 12 6.3 5.3 Ukraine 3.9 -2.0 -5.9 99 84 20 70 6.4 9.3 Belarus 6.2 1.1 -5.1 57 94 13 34 0.8 0.5 EE 4.8 -0.1 -4.9 1,540 57 8 17 6.1 5.5 Euro area 1.1 1.4 0.3 10,111 38 69 92 7.6 11.6

Source: national sources, Eurostat, RBI/Raiffeisen RESEARCH

CEE: GDP per capita (in % of European Union average)*

* at PPP; 2016-18f: IMF forecasts Source: IMF WEO, RBI/Raiffeisen RESEARCH

Key institutional indicators

Ease of Doing Business Rank* Getting Credit* Enforcing Contracts* Resolving Insolvency* Corruption Per-ception Index** Poland (EU) 32 17 52 32 35 Hungary (EU) 54 17 20 64 47

Czech Republic (EU) 44 23 37 20 53

Slovakia (EU/EA) 37 36 55 31 54 Slovenia (EU/EA) 51 116 122 42 39 CE (avg.)*** ₄₄ ₄₂ ₅₇ ₃₈ ₄₆ Croatia (EU) 65 61 54 56 61 Romania (EU) 48 7 51 46 69 Bulgaria (EU) 38 23 75 38 69 Serbia 91 52 96 48 78

Bosnia and Herzegovina 107 36 95 34 80

Albania 68 36 102 44 110 SEE (avg.)*** 70 36 79 44 78 Russia 62 61 14 65 136 Ukraine 96 17 43 142 142 Belarus 57 104 7 68 119 EE (avg.)*** 72 61 21 92 132

* out of 189 countries, ** out of 175 countries, *** regional aggregates unweighted averages Source: World Bank, Transparency International, RBI/Raiffeisen RESEARCH

Key banking indicators

Bank assets (EUR bn, 2014) Assets-to-GDP (2000) Assets-to-GDP (2014) PL 360 61% 89% HU 102 67% 100% CZ 195 125% 126% SK 63 89% 81% SI 37 71% 100% CE 756 78% 98% HR 53 63% 123% RO 90 29% 61% BG 28 36% 104% RS 27 53% 85% BH 13 36% 92% AL 10.2 52% 98% SEE 222 37% 81% RU 1,136 32% 109% UA 68 23% 86% BY 33 28% 62% EE 1,238 31% 106%

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Banking trends in CEE

In the CE banking sectors, the secular trend of gradually decreasing foreign own-ership ratios continued in 2014. For the first time in over 15 years, the foreign-ownership share dropped slightly below 70% of total assets. This decreasing share reflects a market-based gradual decrease of foreign ownership in Poland, a state-led restructuring of ownership in Hungary as well as state-driven bank bailouts in Slovenia. In SEE, the foreign ownership ratio remained at a high level of around 80%, with a slight upward bias from 2012 to 2014. Minor decreases in the foreign ownership ratio in Croatia and Romania were overcompensated by a fairly strong rise in Bulgaria by some 5 pp, which was the result of the fail-ure of one fast growing local player. Hence, a modest correction in the SEE for-eign ownership ratio could be in the cards for 2015/16.

In the EE countries, foreign ownership ratios are characterized by two very di-vergent trends. In Russia, the market share of 100% foreign-owned banks has been decreasing ever since 2008. The 100% foreign ownership ratio in the Rus-sian banking sector currently stands at 7.6%, the 50% foreign ownership ratio (which includes lenders with foreign participation and partially also Russian off-shore-money) stands at some 14%. Compared to Russia, the market share of for-eign-owned banks in Ukraine was on an uptrend in 2014, increasing from 27% to around 31%. However, this market share increase should not be overrated. It is by and large a reflection of an increasing number of failed and restructured lo-cally-owned banks, while foreign-owned players (among the largest banks) are still in the market. The overall foreign ownership ratio in the EE banking sector remains below 10%, showing that foreign-owned banks in EE are niche players compared to their presence in the CE/SEE region.

Not much has changed with regards to state ownership ratios in nearly all CEE banking sectors, with the possible exception of Hungary. There, state ownership increased from some 6% in 2013 to around 12% in 2014. The overall state own-ership in the CE region remains more stable at around 15%, mainly driven by Po-land, Hungary and Slovenia (as state ownership is insignificant in the Czech and Slovak banking sector). In SEE, state ownership remains insignificant in all bank-ing sectors, with the exception of Serbia where it stands at some 20%. With

re-1,000 1,100 1,200 1,300 1,400 1,500 1,600 140 170 200 230 260 00 02 04 06 08 10 12 14 CE SEE EE (r.h.s.)

CEE: Number of banks operating

20 30 40 50 60 7 9 11 13 15 17 04 06 08 10 12 14 CE SEE EE (r.h.s.)

CEE: Presence of state-owned banks*

* in % of total assets

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 00 02 04 06 08 10 12 14 CE SEE EE

CEE: Average bank size (EUR bn)*

* Total assets divided by number of banks

6 10 14 18 22 50 60 70 80 90 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Central Europe Southeastern Europe

EE (50% foreign-owned Russian banks, r.h.s.) EE (100% foreign-owned Russian banks, r.h.s.) CEE: Presence of foreign-owned banks (% of total assets)

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Banking trends in CEE

gards to potential changes in state ownership, we may see a sale of state assets in Hungary and Serbia going forward.

In the EE region, state ownership in the banking sector remains significant, with an uptrend in recent years mainly driven by Russia, with a 55% share in 2014 and potential for further increases. The Russian Central Bank (CBR) expects the market share of state-owned banks to increase above 60% in the years ahead. Moreover, the de facto influence in the banking sector is even higher (and in-creasing) compared to the official ownership figures (see also our focus section on page 8). The banking sector in Ukraine also experienced an increase in state ownership in 2014, while there was a further modest decrease in the state own-ership ratio – from very high levels – in Belarus.

Given the high fragmentation of the Russian and Ukrainian banking market, the challenges of 2014 resulted – as expected – in an increased number of market exits and overall market consolidation. This trend comes as no surprise and is ex-pected to continue in 2015. In Russia, the number of banks dropped from 923 to 834, which reflects one of the highest reductions in over a decade. However, this high number of market exits did not impact the market concentration, as the exiting banks were quite small. The market share of the Top 5 banks in Russia re-mained more or less flat at around 55%. In all other CEE banking markets there was not much change in terms of the number of banks and market concentra-tion. In Ukraine, the high number of market exits (17 in 2014 and at least 10 to 15 more as of May 2015) may finally result in an improvement of overall mar-ket standards and practices. As a result, the marmar-ket share of the Top 5 banks in-creased to 43% in 2014 (up from the mid-30ies), which still leaves room for fur-ther structural consolidations.

On the Russian market, the increasing de facto and de jure state ownership may partially compensate for the positive effects of a decreasing number of market players (in some cases with non-viable business models). Over the past years, the number of banks in CE stayed quite stable with 200 banks, while SEE contin-ued to see a modest drop. Here, some 20 banks left the region in the past five to six years. However, as the SEE banking market is comparably small (total as-sets at some EUR 200 bn vs. EUR 750 bn in CE banking markets), the currently 170 banks operating in it still suggest more room for consolidation. That said, the overall profitability and margin pressure in CE and SEE (including core mar-kets like Poland, Hungary and Romania) makes further consolidations in both re-gions likely.

The Top 5 concentration in CE remains more or less constant at around 60%, with higher concentrations on the Czech and Slovak markets, but below average mar-ket shares in Hungary and Poland. While the Top 5 concentration in Hungary is further decreasing, it is on the rise in Poland. Although this increasing concentra-tion in Poland (driven by organic growth and M&A) is positive for the market, it also implies that further players may reconsider their presence on this consolidat-ing market. On average, the Top 5 concentration in SEE remains a tad lower than in CE. However, this ratio is largely driven by a fairly low market concentration in Romania, Serbia and Bulgaria, while in other SEE markets the market share of the Top 5 banks is much higher. We expect further consolidation (in terms of mar-ket shares) in SEE to be concentrated in Romania and Serbia – either in terms of organic growth or M&A.

Financial analysts: Gunter Deuber, Elena Romanova, RBI Vienna 0.0 0.3 0.5 0.8 1.0 1.3 1.5 2004 2006 2008 2010 2012 2014 EE Russia

Russia (excl. Sberbank, VTB) Ukraine

EE: Average bank size (EUR bn)*

* Total assets divided by number of banks

35 40 45 50 55 60 05 06 07 08 09 10 11 12 13 14 Market share state-owned banks Market share Top 5 banks RU: Ownership & concentration (%)*

Source: CBR, RBI/Raiffeisen RESEARCH

48 52 56 60 64 68 2009 2010 2011 2012 2013 2014 CE SEE EE

CEE: Avg. market share Top 5 banks*

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Banking trends in CEE

Focus on Russia: Harsh market and political trends to impact competitive landscape

2014 was a challenging year for Russia, as its banking sector had to digest and adjust to multiple changes that also impacted its com-petitive landscape. Several trends in the sector’s composition intensified, and some new tendencies revealed their initiations. Following, we will focus on three main trends:

Sector concentration is set to increase, with the share of state-controlled banks boosting Foreign banks are set to contract on cautious risk taking

Total overall number of banks is expected to progressively diminish

We start from the latter. The banking sector clean-up continued. Both, the CBR-initiated foreclosure of feeble banks as well as the im-pact of deteriorating economic and market conditions, which intensified further crowding-out of inefficient bank-like institutions, led to a notable reduction of the number of banks. In 2014, it contracted by about 10% yoy to 834. We see this development as positive and long needed for the sector improvement, and expect the number of banks to further decline, albeit perhaps at a bit lower speed. Be-sides, along with the decreasing fragmentation of the Russian banking sector, there comes an increasing concentration within the re-maining banking cohort.

We expect state banks’ market share to increase further

Although on balance, the share in total assets of state-controlled banks stayed stable at 55% in 2014, we expect it to grow towards 60% in the course of the next couple of years. The current financial market turmoil, and the expected economic nosedive in 2015/16, should benefit state-controlled banks’ market positions both on funding and lending sides. On the funding side, first, state-controlled banks are still considered “safe havens” and places for the retail savings to wait until the market calms down again. Second, amidst the volatil-ity of interest rates, these banks are able to offer the most attractive deposit pricing to private deposit holders. Also, as the government started to talk about re-thinking the volumes and rules for state guarantees on commercial banks’ deposits, risk-averse households are likely to shift their funds to state-controlled banks, too. On the lending side, these banks are the first choice for the government to distri-bute stabilization loans and other financial support to distressed systemic borrowers. In retail business, the recent state measures to sup-port the mortgage lending (interest rates subsidizing, issuing loans to low-income categories of population, etc.) are also by and large introduced via state-controlled banks. The fact that funding and recapitalization of these banks also benefit from the governmental sup-port, makes it easier for them to maintain and even increase their asset size and market shares. In addition, the role of sizeable regional banks that are controlled by the regional authorities must not be discounted. Even though their relative size is much smaller (below 1% of total banking assets for each), and their individual impact on the Russian economy is much less notable than that of the Top 5 play-ers, these regional players’ role gains increasing importance in supporting the regional economies.

Foreign banks: Contracting lending and presence

It seems that for the first time in over a decade, foreign banks are losing their optimism regarding the development of the Russian bank-ing market. Even though the market still suggests potential for returns, the nature of emerged counterweightbank-ing risks makes it currently difficult and costly to manage the risk-return tradeoff. In addition, Western sanctions crowd out a significant share of corporate custom-ers from foreign banks’ franchises, and respectively, all sorts of related business.

Therefore, foreign banks, which kept their presence in Russia after the 2008/09 crisis, have started to act towards risking in Russia. Whether accompanied by publicly de-clared programs, or just organically implemented on a routine basis, we expect the bal-ance sheet contraction (in EUR-terms) of Russian subsidiaries of the major foreign banks to be notable. Like for all processes linked to political risks, the scope of this expected con-traction is hard to predict precisely. However, if today’s trends in geopolitics stay approx-imately unchanged, without sudden significant worsening or improvement in the short-term perspective, we see a possibility for foreign banks’ share in total banking assets to go down closer to 5%, which are the levels seen back in 2002/03, within the next two to three years. Nevertheless, such a scenario would imply that Western foreign-owned lenders would still have a combined asset base of some EUR 50 bn to 60 bn on the Rus-sian market, while RusRus-sian assets of major foreign-owned banks stood at some EUR 5 bn to 10 bn some ten years ago.

Financial analyst: Elena Romanova, RBI Vienna 2% 4% 6% 8% 10% 12% 0% 10% 20% 30% 40% 50% 60% 02 04 06 08 10 12 14 State-owned banks Foreign-owned banks (r.h.s.)* RU: Market shares (% of total assets)

* 100% foreign ownership ratio Source: CBR, RBI/Raiffeisen RESEARCH

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180% 200% 220% 240% 260% 280% 300% 30% 40% 50% 60% 70% 80% 90% 100% 110% 1999 2001 2003 2005 2007 2009 2011 2013

CEE total assets (% of GDP) Euro area total assets (% of GDP, r.h.s.)* CEE vs. EA: Long-term asset-to-GDP ratio trends

* Excluding MFI-business

Source: national central banks, ECB, RBI/Raiffeisen RESEARCH

Banking trends in CEE

Overall financial intermediation in CEE – as measured by asset-to-GDP ratios – increased from some 89% in 2013 to well above 100% in 2014. Hence, this ra-tio reached an all time high, posting one of the strongest increases (in pp) over the past 15 years. Such a surge is definitely somewhat surprising, given the still ongoing deleveraging in several key CEE economies, the subdued or just mod-estly recovering GDP growth and moderate loan demand in numerous countries of the region.

However, there were stark distorting effects at play that inflated the overall CEE financial intermediation level in 2014. Due to massive currency devaluation ef-fects in the EE region (including the heavyweight Russia), tangible shares of as-sets in FCY as well as negative developments for the denominator (GDP), the in-crease of the 2014 asset-to-GDP ratio in EE was stronger than the “real” asset growth. Moreover, Russian asset growth was also driven by other distorting ef-fects, namely the strong banking sector expansion in the first half and state sup-port to banks and corporates in the second half of 2014 (which supsup-ported strong corporate loan growth). The average asset-to-GDP ratio in CE continues to re-main more or less constant at around 98% – a level that has not changed much since 2008/09. For the SEE region, the year 2014 was again characterized by another drop of the asset-to-GDP ratio, down by 2 pp to 80% in 2014 – about 6 pp below its peak in 2010.

The relative stability in the CE asset-to-GDP ratio masks stark and fundamen-tally backed intra-regional divergences, while the ratio’s downward trend in SEE is more broad-based. In CE, the financial intermediation trends continue to re-main more positive in Poland, the Czech Republic and Slovakia, while in recent years substantial drops in the asset-to-GDP ratio (by around 30 pp) in Hungary and Slovenia were driven by decisive deleveraging and restructuring (including write-offs). The sustained and more broad-based pressure on the asset-to-GDP ra-tio in SEE, which was seen over the past few years, is well in line with our long-held view that some deleveraging was needed (and in some cases still is) follow-ing the brisk financial sector expansion that took place between the years 2000 and 2008/09. 20% 35% 50% 65% 80% 95% 110% 99 01 03 05 07 09 11 13 CE SEE EE

CEE: Asset-to-GDP ratios

-10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 00 02 04 06 08 10 12 14

CEE* Euro area

CEE vs. EA: Total asset growth (% yoy)

* EUR-based

Financial intermediation levels, asset-to-GDP ratios

-1.4% -1.0% -0.6% -0.2% 0.2% 0.6% 1.0% 1.4% 0% 2% 4% 6% 8% 10% 99 02 05 08 11 14

CEE total assets (% of euro area) Change vs. euro area (pp, r.h.s.) CEE vs. EA: Asset-to-GDP catch-up

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Banking trends in CEE

50 75 100 125 150

Dec 07 Mar 10 Jun 12 Sep 14

CE SEE RU

TR EA

50 60 70 80 90 100 110 120 130 140

Dec 07 Mar 10 Jun 12 Sep 14 Czech Republic Romania

Croatia Poland

-1,000 -750 -500 -250 0 250

CEE* Euro area Change total assets 2011-14 (EUR bn)

* EUR-based

In Hungary, Slovenia and Romania – where the deleveraging process lasted at least half the time of the boom phase – most of the much needed deleveraging has already been achieved or is likely to be achieved in 2015. Interestingly, the strongest deleveraging took place in Romania – the one SEE country with pos-sibly the least deleveraging needs from a fundamental point of view. Going for-ward, we see a chance that the asset-to-GDP ratio in CE continues its modest up-trend. In contrast, we do not see much near-term upside for the asset-to-GDP ra-tio in SEE. Although we see the Romanian banking sector ready for a new lend-ing cycle, improvements in countries like Croatia and Serbia are still to come.

With the recent surge in asset-to-GDP ratios in Russia and Ukraine, both coun-tries are characterized by financial intermediation levels close to or even above thresholds that could be deemed as fundamentally backed and sound. A com-parison of the wealth and financial intermediation levels with CE/SEE peers il-lustrates this quite well. Russia’s GDP per capita level currently remains some 25 pp below the one in CE, while its asset-to-GDP ratio (currently at some 110% of GDP) is about 11 pp above CE levels. A comparison to the still more lever-aged SEE region is even clearer. On the one hand, GDP per capita levels in Rus-sia are some 12 pp above the ones in SEE. On the other hand, RusRus-sia’s asset-to-GDP ratio is now some 36 pp above SEE levels. Although overall financial mar-kets in Russia are fairly sophisticated from a regional perspective, which usually adds to a certain upward bias in the asset-to-GDP ratio, it seems that there is not much fundamental underpenetration left on Russia’s banking sector. Therefore, the times of fairly “easy” catching-up asset growth (with asset growth strongly out-pacing GDP growth) without risks of accumulating too much threats to asset qual-ity seems to be over. Hence and for the time being, Russia’s banking sector can-not be considered as a high-growth market from a fundamental point of view, i.e. unless wealth levels and nominal GDP levels are again increasing very strongly – a scenario that we do not foresee for at least the next one to two years. The in-creasing leverage of the Russian economy during the recent years of weaker eco-nomic expansion implies that the (retail) credit-driven growth model runs out of steam – just like the economy’s strong dependence on oil price growth. This de-velopment adds to our more cautious medium-term economic and banking sector growth outlook. In Ukraine, the fundamental degree of overleverage is extreme. As one of the poorest countries in CEE, Ukraine has one of the highest asset-to-GDP ratios in the region at some 80% to 90%. While in Russia, we might only see a period of “just” a flat asset-to-GDP ratio, in Ukraine a substantial reduction, similar to the one between 2009 and 2012, seems likely for the years ahead. This process will be supported by the massive banking restructuring as well as substantial write-offs (page 54).

The current real “growth” picture in CEE banking seems to be better represented in the overall total asset base of the region. Due to somewhat improving banking dynamics inside the euro area, still ongoing deleveraging in some CEE banking markets, modest currency weakness in several CE/SEE markets as well as strong currency depreciation in EE, the overall CEE banking asset base decreased in 2014 in absolute EUR-terms as well as in relative terms (e.g. in relation to the euro area). Total CEE banking assets dropped from EUR 2.400 bn to around EUR 2.200 bn in 2014. Given slightly increasing banking assets inside the euro area – the first increase in nominal terms since 2011 – overall CEE banking assets dropped from 9.7% of euro area banking assets to 8.6% in 2014 (marking one of the strongest relative drops in recent years). That said, it seems that the (West-ern) European large-scale rebalancing and deleveraging cycle – at least in terms of total banking assets – is gradually drying up, while the CEE banking sector was underperforming compared to broader European banking trends in 2014.

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Banking trends in CEE

Focus: “Deleveraging debate” in CEE banking

Cross-border financing and the (potential) deleveraging of Western banks in CEE continues to be a widely followed topic. Its relevance has even increased once again as new aspects in the so-called “Deleveraging debate” arose. By and large, there was nothing like an aggressive deleveraging of Western banks in CEE up to now, although the region exhibits one of the most impressive penetrations by foreign (cross-border) banks among Western and global emerging market banking sectors. Currently, cross-border claims of Western European banks in the whole CEE region are 5% to 10% below their 2008-levels, while overall international exposures or exposures to Western Europe (by Western European banks) were slashed by around 35% to 40% during the same period of time. Cross-border exposures of Western European banks to the countries of the so-called euro area “periphery” were even cut down by some 70% from 2008 to 2014, reflecting a trend of national re-orientation and substantial (cross-border) deleveraging in overall European banking. The “Banking Union” implementation (including the AQR exercise, stress testing etc.) added to the deleveraging process at Western Euro-pean banks that are in a defensive mode regarding their international operations anyway (e.g. compared to international peers). That said, there is also a general trend of global cross-border banking deleveraging, also driven by regulatory tightening for cross-border exposures as well as a refocusing of business strategies (see also the Global Financial Stability Report 2015, International Banking Af-ter the Crisis: Increasingly Local and Safer?, ChapAf-ter 2, pp. 54-91).

A critical reflection of the success of the “Vienna Initiative” in stabilizing cross-border funding as well as crisis experience within West-ern European banking sectors shows that regulation should clearly focus on the risks stemming from excessive cross-border funding and lending that is not backed by deep ownership links (or in other words, an equity-based cross-border integration). At the same time, cross-border funding to CEE (and especially in the CE and SEE region) had been fairly stable in the recent challenging years. The over-all commitment of leading Western European banks to their large and locover-ally embedded franchises in CEE can be seen by the develop-ment of CEE exposures compared to overall international exposures in Western European banking sectors of systemic importance for the CEE region, i.e. those in Austria, Italy and France. In these three banking sectors, cross-border exposure to CEE developed much more favorably than overall international exposures or the CEE exposures of other Western European banking sectors. The relatively stable cross-border exposures to CEE in general and the CE region in particular are also a reflection of the fact that, up to now, all larger di-vestments of Western European banks in the region involved another Western European bank on the buyer side.

Nevertheless, leading Western CEE banks also had to adjust their exposures in the region. Recent regulatory tightening was a blow to less profitable and funding-consuming (but possibly still moderately profitable) business lines and markets. It also became more challeng-ing for banks to pursue long-term strategies, which may offer less short-term profit, while profits and retained earnchalleng-ings are currently the best means to shore up capital positions and to meet regulatory and/or market demands in terms of capitalization. Moreover, the over-all modest cuts in cross-border exposures towards the whole CEE region are partiover-ally hiding increasingly selective country strategies. In some countries (such as Poland, Slovakia or the Czech Republic), there was definitely no pull-back of Western European banks. How-ever, in the more challenging SEE markets, as well as in Hungary, Slovenia, Ukraine and since 2014 also in Russia, they pursued more conservative business strategies. Due to this de-risking, Western European banks were by and large increasing their gearing towards markets with lower macro-financial risks, lower NPL ratios (i.e. less legacy problems) and better profitability. Moreover, the modest re-duction in cross-border exposures also reflects still limited new lending dynamics, a turn to more local refinancing and finally also selling (to non-bank investors) or write-offs of certain NPL exposures (like in SEE or Ukraine). Western European banks, who are still key pro-viders of liquidity and financing to Russia, turned more conservative in terms of cross-border exposures to the country in 2014, a clear decoupling of overall trends in emerging markets banking. Many drivers for the most recent reduction of cross-border exposures to Rus-sia (higher macro-financial risks, weak developments in the domestic economy and in external trade in comparison to other emerging markets, more conservative business strategies of Western corporate clients in Russia, and Western sanctions) are likely to stay well into

2016. This is why overall cross-border exposures to CEE are likely to see some downward pressure in 2015, mainly driven by decreas-ing exposures to Russia and still limited need for large cross-border financdecreas-ing in most CE/SEE markets as indicated by low L/D ratios. From a strategic perspective, the “Deleveraging debate” in CEE also reflects a

cer-tain dilemma for leading Western European CEE-lenders. On the one hand, they deliv-ered on their regional commitment and were sometimes even criticized by regulators or IFIs for trimming their exposures in certain markets in a modest way (e.g. in the reg-ular “CESEE Deleveraging and Credit Monitor”). On the other hand, their European competitors with a focus on Western and global business improved their capitalization ratios via substantial deleveraging in international business. Capital ratios were raised substantially in the EU and the euro area, and this was partially achieved via substan-tial cross-border deleveraging. Given the modest deleveraging compared to their West-ern European peers, it comes as no surprise that most leading WestWest-ern European CEE banks (still) have lower capitalization ratios than their peers (page 20) with a focus on non-CEE markets (although there are other drivers for this development as well).

Financial analyst: Gunter Deuber, RBI Vienna 60 70 80 90 100 110 120

Dec 09 Feb 11 Apr 12 Jun 13 Aug 14 AT, IT, FR banks CEE European banks CEE AT, IT, FR banks Dev. Markets European banks Dev. Markets Cross-border claims*

* Dec 2009 = 100, latest data point Q4 2014 Source: BIS, RBI/Raiffeisen RESEARCH

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0% 15% 30% 45% 60% 75% 99 01 03 05 07 09 11 13 Hungary Romania CE-3 (PL, CZ, SK) SEE (excl. RO) Loan-to-GDP ratio

Banking trends in CEE

10% 20% 30% 40% 50% 60% 99 01 03 05 07 09 11 13 CE SEE EE

CEE: Loan-to-GDP ratio

-5 -3 0 3 5 -10 -2 6 14 22 30 09 10 11 12 13 14

CE/SEE (total loans) Euro area (total loans, r.h.s.) CE/SEE vs. EA loan growth (% yoy)

Loan growth, growth by segments (retail, corporate)

Major trends in the regional CEE loan-to-GDP ratios are a reflection of the as-set growth picture sketched previously (relative stability in CE, downward trend in SEE, distorted increase in EE with a massive impact on the overall CEE trend). In combination with currency effects, the total CEE loan stock posted a drop in 2014 (down from EUR 1.370 bn to EUR 1.200 bn). In relation to bank loans inside the euro area, the overall CEE loan stock dropped from 11.7% in 2013 to 10.4% in 2014 (driven by currency devaluation effects as well as a slightly increasing loan stock inside the euro area). Once again the drop was mainly driven by the EE region, as the CE/SEE total loan stock remained more or less flat in 2014, at around EUR 550 bn or 4.7% of total loans inside the euro area. Hence, in terms of loan growth there was at least no significant underper-formance of CE/SEE markets compared to the euro area in 2014 (where total loan growth stood at 0.2% after two years of decline).

Nevertheless, in 2014 overall loan growth remained modest in CE and SEE as in-dicated by a CE/SEE loan stock that remained virtually flat in nominal terms. But stark country differentiation prevails. CE banking markets once again strongly outperformed SEE markets. Annual CE loan growth in LCY-terms came in at 5.1% yoy in 2014 and at 1.5% in EUR-terms, while the respective annual “growth rates” in SEE stood at -2% in LCY-terms and -2.9% in EUR-terms yoy. Real loan growth in CE/SEE in LCY-terms, largely driven by the larger CE banking mar-kets, reached some 3% yoy in 2014, which has been the strongest level since 2011 and quite decent given the subdued inflation developments. Therefore, the 2014 loan-to-GDP ratios increased by several percentage points in the CE mar-kets without adjustments needs (like in Hungary or Slovenia). Due to contract-ing loan stocks, the overall SEE loan-to-GDP ratio (mainly driven by Romania, Bulgaria and Croatia, where loan stocks were dropping in both LCY- and EUR-terms) dropped modestly from 50% to 48% in 2014. Now the ratio stands some 5 pp below the peak levels of 53% (reached from 2010 to 2012) reflecting broad based regional deleveraging needs. As already mentioned, the strongest regional adjustment was observed in Romania, mainly driven by regulatory tight-ening related to NPL exposures, which caused write-offs and NPL sales. There could be similar adjustment needs in other SEE markets with similar high loan and NPL stocks, that have not been addressed yet.

100% 110% 120% 130% 140% 150% 10% 20% 30% 40% 50% 60% 1999 2001 2003 2005 2007 2009 2011 2013

CEE total loans (% of GDP) Euro area total loans (% of GDP, r.h.s.)* CEE vs. EA: Long-term loan-to-GDP ratio trends

* Excluding MFI-business

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Banking trends in CEE

0 50 100 150 200 250

Spain Portugal Ireland UK Start credit cycle Peak 2014 Deleveraging Western Europe/EA*

* Loan-to-GDP ratio (%), period from 2000-2014 Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 0 20 40 60 80 100

Hungary Romania Slovenia Start credit cycle Peak 2014 Deleveraging CE/SEE*

* Loan-to-GDP ratio (%), period from 2000-2014 Source: national central banks, RBI/Raiffeisen RESEARCH

Hungary, Slovenia and Romania saw drops in their loan-to-GDP ratios by some 10 pp to 20 pp in recent years. We consider Hungary and Romania ready for a new lending cycle (especially in LCY lending), which cannot be said about some other SEE banking markets. In euro area countries with substantial deleveraging needs, like Spain or Portugal, recent drops in loan-to-GDP ratios were even more extreme (in absolute and relative terms) than in the CE/SEE region. In light of deleveraging experience in selected CEE markets and inside the euro area, we see a fair chance that at least 30% to 50% of a brisk pre-crisis expansion of the loan-to-GDP ratio has to be corrected within a deleveraging phase (either via less credit-driven economic growth and/or loan write-offs).

From a longer-term perspective, the outperformance in the by and large more healthy CE banking sectors compared to SEE markets is even more striking. The cumulative loan growth from 2011 to 2014 stands at 18% in LCY-terms or 8% in EUR-terms. On contrary, in SEE the cumulative loan growth was just some 6% in LCY-terms or 1% in EUR-terms over the same period of time. Putting the cumu-lative LCY loan growth rates in relation to cumucumu-lative nominal GDP growth, the recent SEE deleveraging becomes even more obvious. From 2011 to 2014, no-minal GDP growth in SEE stood at 20% (i.e. well below loan growth), whereas in CE loan growth was at least slightly outpacing cumulative nominal GDP growth at 16%. Since the overall CE aggregate was driven down by a negative perfor-mance in Hungary and Slovenia, the real loan growth in the other CE markets was even higher. The overall loan growth in most CE/SEE banking sectors cur-rently remains geared towards more short-term transactions in corporate and re-tail lending as well as mortgage lending. In many CE/SEE markets – with the possible exception of Poland for overall corporate lending and Hungary for SME lending – corporate lending growth remains below expectations and mostly fo-cused on working capital financing. The focus of many CEE banks on retail lend-ing seems to be explained by still higher margins and better (risk-adjusted) re-turn prospects. However, the recent substantially increased consumer protection on EU and CE/SEE banking markets should also support cautious business strat-egies in retail lending, in order to avoid unpleasant restructuring issues later on.

Interestingly, SEE banking markets are not clearly underperforming their CE peers in mortgage lending. In some countries, there is also government support for mortgage lending. Moreover, customers are currently attracted by the fairly low nominal interest rates and are refinancing existing mortgage loans. In some CE/SEE markets strong

retail/mort-gage lending has led to an increasing regulatory alertness. In some cases, like Slovakia, recommendations aim-ing at more prudent retail/mortgage lending standards were issued. From a through-the-cycle perspective and given the positive experience on the Polish banking sector, such recom-mendations should be welcomed. This holds especially true as the mortgage loan penetration in CE and Croatia is not very low anymore and stead-ily increasing. Here mortgage loan-to-GDP ratios are currently hovering at around 20% of the GDP. At first sight such levels seem low compared to the average euro area mortgage

loan-to-0% 10% 20% 30% 40% 50% Po la nd Hun gar y Cz ec h Re p. Sl ov ak ia Sl ov en ia Ro mani a Bulg ar ia Cr oat ia Rus si a Av er ag e Low * Hi gh* *

CEE Euro area

2002 2008 2014

Mortgage loans (% of GDP)

* Larger EA countries with lowest mortgage loan-to-GDP ratios in 2002 (AT, FR, BE, IT) ** Larger EA countries with highest mortgage loan-to-GDP ratios in 2014 (NL, ES, FR, DE) Source: ECB, national sources, RBI/Raiffeisen RESEARCH

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Banking trends in CEE

-25% 0% 25% 50% 75% 00 02 04 06 08 10 12 14 EE loan growth (% yoy, LCY) EE loan growth (% yoy, EUR-based) EE: Loan growth LCY- vs. EUR-terms

GDP ratio at some 38% (some countries like Spain, France or the Netherlands even have a mortgage loan-to-GDP ratio of up to 40% to 60%). In this context, it is also worth mentioning that a decade ago and before the most recent sustained financial cycle (with some excesses inside the euro area) mortgage loan-to-GDP ratios in some euro area countries, like Austria, Belgium and France, had been as low as 16% to 20% (which are current mortgage loan penetration ratios in several CE/SEE economies).

In Russia, overall loan growth, like the asset growth, looks inflated for 201 4. The Russian banking sector actually posted a higher loan growth rate in 2014 yoy, although the overall economy was moving into a different direction. Even when corrected for FX effects, the overall 2014 loan growth came in at fairly high levels of 12% to 15% yoy. This development is the result of a complex mix of var-ious factors, while the overall market trends in Russia are definitely opposite to the picture in most other CEE banking markets. Corporate loans showed a strik-ing increase, acceleratstrik-ing in the second half of 2014. Robust corporate lendstrik-ing growth was mainly driven by the idea to draw on all existing and still available credit lines to secure an adequate cushion for (external) debt repayments (as in-dicated by the fact that corporate deposits also increased in times of strong loan growth). State-support also played an important role here. Strong corporate loan growth, driving the overall market growth, was even over-compensating for a continuous decline in retail loan growth with an above average decline in activ-ity in longer-term transactions, including mortgage loans. As a result, the share of corporate loans in total loans increased to around 77% at Russian banks – lev-els seen from 2005 to 2010, i.e. before the strong retail lending boom. A some-what similar trend was visible in Ukraine, where the corporate loan stock in total loans also increased in 2014, to a level of 80%. Therefore, the looming restruc-turing in corporate exposures and related-party lending at Ukrainian lenders, as requested by the IMF, will affect large parts of the local banking sector (page 54).

Financial analyst: Gunter Deuber, RBI Vienna

The past years’ trend in core funding dynamics in CEE, and its relation to the lending base, saw a continuation in 2014 as well. The aggregated loan-to-de-posit (L/D) ratio across the CEE banking markets remained stable at some 97% (i.e. notably below its peak at 114% in 2008). Two general tendencies contrib-uted to that in 2014. First, the CEE L/D ratio, well below its peak levels, is a clear indication that the times of very strong loan growth across CEE markets are over. Second, the increasing reliance on local funding is also a reflection of the global trend to decrease cross-border banking flows and penetration that is driven by market and regulatory forces (see also the focus on page 11 about cross-border financing in CEE banking markets.) Thus, the predominantly conservative lend-ing behavior of CE/SEE banks was golend-ing in parallel with still sanguine deposit dynamics within the banks.

2014 was another good year for deposit funding growth in the entire CEE area, notwithstanding some countries’ headwinds, that left the respective banking sys-tems in a tougher funding situation (e.g. Bulgaria, Russia and Ukraine). That said,

Funding, deposit growth and L/D ratios

-5% 5% 15% 25% 35% 00 02 04 06 08 10 12 14 CE loan growth (% yoy, LCY) CE loan growth (% yoy, EUR-based) CE: Loan growth LCY- vs. EUR-terms

-10% 0% 10% 20% 30% 40% 50% 00 02 04 06 08 10 12 14 SEE loan growth (% yoy, LCY) SEE loan growth (% yoy, EUR-based) SEE: Loan growth LCY- vs. EUR-terms

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Banking trends in CEE

80% 90% 100% 110% 120% 00 02 04 06 08 10 12 14

CEE Euro area

CEE vs. EA: Loan-to-deposit ratio

0 10 20 30 40 50 60 70 2010 2014 2010 2014 2010 2014 CE SEE EE

CEE: FCY loans (% of total)

Source: national sources, Raiffeisen RESEARCH

75% 85% 95% 105% 115% 125% 05 06 07 08 09 10 11 12 13 14 CE SEE EE

CEE: Loan-to-deposit ratio

it is possible that the CEE region’s low L/D ratio may witness something like a turning point in the lending cycle. Given the rebalancing of the L/D ratio in most of the countries, and especially in those countries with the strongest macro-perfor-mance, we see sufficient room to finance a new, but more cautious, lending cy-cle going forward. In particular in those CE markets without secular deleverag-ing needs (i.e. the Czech Republic, Poland and Slovakia) the trend of loan and deposit growth continued in 2014 at more or less similar levels, with a slightly stronger deposit growth in comparison to loan growth. Poland, for example, en-joyed deposit growth rates close to 10% yoy, the Czech Republic at 3% yoy and Slovakia at 4% yoy, all in LCY-terms. Banking markets with secular deleverag-ing needs (i.e. SEE as well as Hungary and Slovenia) continued to show a signif-icantly stronger growth in deposits than in loans. In SEE, the leaders in deposit growth were Bosnia and Herzegovina, Romania and Serbia, each posting a 8% yoy customer fund’s growth. Like in previous years, the weakest core funding dy-namics were in Hungary with 2% yoy (LCY-denominated) and Croatia with zero growth. Bulgaria, which managed to recover after the mid-year banking sector turmoil, posted a modest 2% yoy deposit growth (LCY-terms).

Across the CEE countries, the dynamics in EUR-terms were more diverse, as de-termined by the multidirectional trends in the local exchange rates, and in partic-ular in Russia and Ukraine. As a result, the total deposit stock in the overall CEE area was significantly down by 10% (yoy, in EUR-terms) in 2014. This includes a decline of 40% in Ukraine and of 18% in Russia as well as a 4% decline in Hungary, which resulted from a HUF depreciation against the EUR of about 4%.

In SEE, the regional L/D ratio has reached the lowest level since 2006, with around 90% in 2014. A similar pattern also revealed in Hungary and Slove-nia, where the L/D ratios reached their lowest levels over the past decade. In our view, this has come as a clear reflection of a need for deleveraging and restructuring on the asset side (i.e. low loan growth, managing high stock of NPLs), while deposit growth remained at solid levels. In the EE region, the de-posit growth and L/D ratio posted decreases in 2014. The L/D ratios in Russia have been gradually rising since the 2008/09 downward adjustment, while we view the recent L/D ratio increase in Ukraine as a crisis-induced phenomenon (the country’s L/D ratio was on a downtrend before 2014).

0% 20% 40% 60% 80% 100% 120% 140% 160% Po la nd Hun gar y C zec h R ep . Sl ov ak ia Sl ov en ia * Ro mani a Bulg ar ia Cr oat ia Se rb ia Bo sn ia a .H . Al ba ni a Rus si a Uk ra in e* Bel ar us* CE SEE EE 2005 2008 2014

CEE: Loan-to-deposit ratios at the country level (%)

* Scale capped at 160%; Slovenia, Ukraine and Belarus in 2008 with values above 160%; Sl: 166%, UA: 205%, BY: 171%

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0 1 2 3 4 5 00 02 04 06 08 10 12 14 Number of countries with negative RoE CEE: Loss-making banking markets*

* out of 14 CEE banking sectors covered in this report (loss-making 2014: HU, RO, UA)

Banking trends in CEE

-5 0 5 10 15 20 25 00 02 04 06 08 10 12 14 CE SEE EE CE (excl. Hungary) CEE: Return on Equity (%)

-2 -1 0 1 2 3 4 5 00 02 04 06 08 10 12 14 CE SEE EE

CEE: Return on Assets (%)

Pro

fi

tability (Return on Assets, Return on Equity)

Profitability in CEE banking was a mixed bag in 2014. The overall CEE banking RoE has reached its lowest level at some 6.9% since the year 2000. This disap-pointing performance can be attributed to several factors. First, in 2014, three markets in the region, namely Hungary, Romania and Ukraine, turned negative, which is a significant worsening compared to 2013, when only Slovenia made a loss and marks one of the worst years in CEE banking. Only in 2010/11 the sit-uation in the region was worse, with four loss-making banking markets. Although the losses were partially related to one-off effects, the RoE readings in the three affected markets were deep in the red (HU: -11%; RO: -12.5%; UA: -30%). The losses in the Hungarian and Romanian banking sector had a substantial impact on leading Western CEE banks given the still high foreign ownership in both banking sectors. The average foreign ownership ratio on loss-making CEE bank-ing markets reached 61% in 2014 (compared to 57% back in 2011).

Second, in 2014, the overall profitability pressure was notable also in profita-ble CE markets like Poland, the Czech Republic and Slovakia and resulted in a further round of profit compression from already low levels by historical regional standards. The regional CE RoE dropped from 10.3% to 9.2%; excluding Hun-gary, the regional RoE decreased from12% to 11.7%. Due to the relative matur-ing of the CE markets, the risk premium in the region went down, supportmatur-ing the respective downwards pressure on profitability. Nevertheless, we want to em-phasize that the CE countries currently have the greatest potential for banking business in CEE. In SEE, the negative performance of the Romanian market (RoE: -11.6%) was overwhelming. In the other SEE markets, the average RoE has re-mained at meagre 3% and thus at a disappointing level ever since 2009.

Finally, the lower RoE margins in the CEE area reflect the new European regu-latory requirements that are pushing banks towards larger capital buffers. The lower ratio of return to equity in the CEE region, per se, was determined by the increase in denominator value (E: Equity), while Western European banks were acting towards being in accord with the new European capital requirements, and also domestic regulators were increasingly solidifying banking sectors’ capitali-zation in their countries.

-5 -3 0 3 5 8 10 13 15 18 20 23 25 2000 2002 2004 2006 2008 2010 2012 2014

CEE Euro area

CEE vs. EA: Return on Equity (%)

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Banking trends in CEE

0 5 10 15 20 04 05 06 07 08 09 10 11 12 13 14 CE SEE EE CEE: NPL ratios* * % of total loans

Source: national sources, RBI/Raiffeisen RESEARCH

0 1 2 3 4 5 6 7 8 9 10 BY SK RU** CZ PL

CEE: Markets with NPLs <10%*

* year-end 2014; ** RU: Latest data as of April 2015 Source: national sources, RBI/Raiffeisen RESEARCH

0 5 10 15 20 25 30 35 40 HU RO SI BH BG HR RS AL UA* CEE: Markets with NPLs > 10%*

* UA: based on IFRS estimates, official ratio much lower; year-end 2014

0 2 4 6 8 10 0 15 30 45 60 75 90 105 120 135 00 02 04 06 08 10 12 14 CEE NPLs (total EUR bn) CEE NPLs (% of total loans, r.h.s.) Overall CEE NPLs

Focus: Non-performing loans and NPL ratios

Regarding NPL ratios, 2014 was finally a turnaround year in the CE and SEE banking sectors and brought dropping ratios after years of increases. In CE, the positive regional NPL ratio trend got support from solid and/or improving asset quality and new lending activity in markets like Poland, the Czech Republic and Slovakia, while asset quality was finally also improving in hard-hit Hungary (NPL ratio down from 14% to 13.3%) and Slovenia (down from 22% to 16%). The overall NPL ratio in the CE region improved from 9.1% to 8.5%, the regional NPL ratio excluding Hungary dropped from 7.1% to 6.8% in 2014. Hence, on a regional level (whole CE aggregate) the NPL ratio dropped by 0.6 pp in 2014 following five consecutive years of a cumulative increase by 5.2 pp. It is likely that an even larger drop in the regional CE NPL ratio would have been pos-sible, however, the ECB’s AQR led to more cautious assessments of the asset quality in the affected banking sectors (directly or indirectly part of the SSM).

The regional SEE NPL ratio dropped by some 5 pp from 19.5% in 2013 to 14.8% in 2014. This turnaround follows an overall increase of 16 pp between 2008 and 2013. This NPL drop mainly stems from a substantial balance sheet clean-up in Romania (with increased provisioning, write-offs and asset sales) as well as stabilizing or slightly im-proving NPL ratios in some other SEE markets (like Albania, Bulgaria and Bosnia and Herzegovina), partially supported by a mild lending recovery. In Croatia and Serbia, the NPL ratios continued to inch higher throughout 2014 and in both markets we expect the asset quality either deteriorating further or stabilizing only very gradually in 2015. In the SEE region, 30% of the NPL ratio increases of the years 2008 to 2013 were re-versed in 2014 – three times as much as in the CE region. The boldness of the NPL ra-tio turnaround in SEE was reflected in a negative profitability performance of the over-all SEE banking sector, largely driven by Romania, where the banking sector was once again loss-making in 2014. In 2014 and also in 2015, Romania saw a larger number of NPL sales transactions, that may finally pave the way for more transactions to follow in Romania and possibly other markets (e.g. also part of strategic restructuring or possi-ble divestment and M&A transactions). As a first candidate for potential NPL sales trans-actions we see Hungary. Like Romania, Hungary is a large banking market (by regional standards) and hence decent sized NPL transactions are possible. In addition, the EU ju-risdiction in Hungary and an economic turnaround, driven by domestic demand, seem to be supportive factors (like in Romania). In the other SEE markets with high NPL levels, namely Albania, Bulgaria, Croatia and Serbia, we doubt to see NPL sales transactions, as at least one or several previously mentioned criteria are not fulfilled. Here we expect banks to continue with internal work-out procedures for the time being.

The combined CE/SEE NPL ratio dropped from 12% to around 10% in 2014. In con-trast, NPL ratios inched up in all EE countries and we expect this trend to continue in 2015. The NPL ratio in Russia increased from some 4.2% in January 2014 to 5% in De-cember 2014. However, 2014 was still characterized by modest asset quality deterio-ration, also supported by strong loan (which led to a downward bias in the NPL ratio). For 2015, we expect a stronger deterioration of asset quality due to the looming reces-sion of the Russian economy. The first months of 2015 already brought a strong rise of the NPL ratio from 5% to 6% (April), with 7.1% of NPLs in retail and 5.6% in corporate lending. Currently, we expect the Russian NPL ratio to reach 8% to 10% of total loans (depending on loan growth dynamics) in 2015, while the overall restructured loans are expected at 20% to 30%. In Ukraine, we see IFRS-based NPL ratios once again at around 40%, while the recent adverse conditions may add 10 pp to 15 pp to this al-ready high NPL stock. The looming structural banking sector clean-up (as requested by the IMF support package) may also add to NPL formation in 2015. This may finally pave the way for a more sustained NPL resolution in 2016 and beyond. In total, the diverging NPL ratio trends in the three CEE subregions were still somewhat offsetting each other in 2014, resulting in a fairly stable overall CEE NPL ratio of 8.5%. How-ever, in 2015 the developments in EE could overshadow positive NPL developments in other CEE markets, a scenario that may lead to an increase of the total CEE NPL ratio to above 9% until year-end 2015.

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Banking trends in CEE

-15% -10% -5% 0% 5% 10% 15% 20% HU SI** SK PL CZ 2013 2014

CE: Return on Equity (RoE, %)*

* countries sorted by 2014 RoE

** scale capped at -15%; Slovenia RoE 2013: -31.6% Source: national sources, RBI/Raiffeisen RESEARCH

-15% -10% -5% 0% 5% 10% 15% RO RS HR BH BG AL 2013 2014

SEE: Return on Equity (RoE, %)*

* countries sorted by 2014 RoE

-10% -5% 0% 5% 10% 15% 20% UA** RU BY 2013 2014

EE: Return on Equity (RoE, %)*

* countries sorted by 2014 RoE;

** scale capped at -10%; Ukraine RoE 2014: -30% Source: national sources, RBI/Raiffeisen RESEARCH

As a result, given the profitability pressure in key CE/SEE markets, the regional RoE dropped to below 6%, which is hardly above the current RoE inside the euro area and in Western European banking. In the CE/SEE region, the 2014 RoE marks a new 15-year low (previous lows were at around 9% in 2009/10), while the RoE of about 5% in Western European banking represents a recovery. Hence, the overall appeal of CE/SEE banking markets vs. euro area peers suffered a lot in 2014, with the exception of Poland, Slovakia and the Czech Republic.

Also and important for the CEE banking in general, this time around EE markets could not offer any meaningful compensation for the profitability pressure in CE/ SEE banking. In fact, in 2014 there was a significant positive profitability gap between the CE RoE and the RoE in the EE banking sectors. In the second half of 2014, the Russian banking sector RoE dropped to 7.9%, which is still well above the 4.9% crisis-driven slide recorded in 2009. But given the further pressure on profitability, the expectations for 2015 are still on the downside (Q1 2015 RoE at 4.8%). The overall RoE in the EE banking markets stood at around 7% in 2014, i.e. hardly above the average RoE on the CE/SEE banking markets, which bear a notably lower risk profile at the same time.

Depending on the strength of the turnaround in larger CE/ SEE markets, in 2015 the profitability of the CEE banking sector could fall below the one in Western Eu-ropean banking. This would be a first ever since the year 2000, when the CEE region was still characterized by the aftermaths of the Russian crisis of 1998/99. Similar to the situation in Western Europe and given the current profitability in the region, Western banks could barely recoup their equity costs in CEE. The fact that the current profitability in the CEE region is only slightly above the levels in Western European banking will add to pressure on market players in the region and may result in further consolidation and strategic re-orientation. Respectively, given the near-term profitability expectations (put in risk-adjusted return perspec-tive or in relation to funding costs), it will be difficult to sustain large and capital-consuming franchises in some SEE markets, Russia or Ukraine.

In 2014, the aggregated RoA in CEE developed similarly to the RoE in the re-gion. The RoA stood at fairly disappointing 0.8%, which is the same low level like back in 2009. In the SEE and EE banking sectors, the 2014 RoA readings were just at some 40% of their pre-crisis values, with the 2014 RoE at just around 50% of long-term pre-crisis values. The positive exception is once again the CE region, where the core profitability in terms of RoA remains at 64% of its long-term pre-crisis average and hence above the RoE (56% of its long-long-term pre-cri-sis average), which reflects the higher capitalization levels in the region. Exclud-ing Hungary, the CE RoA is even better at 87% of its pre-crisis average vs. RoE of 75%. All in all, the profitability outlook for CEE banking remains challenging. Profitability pressure is likely to stay in the few lucrative CE markets. In Slovakia there is some upside to profitability due to the reduction of the fairly high banking tax. In other larger markets, like Hungary or Romania, it is difficult to predict to what extent a turnaround in profitability can be achieved in 2015. In Romania, the plan to join the SSM is likely to result in further tough stress testing and pos-sible adverse effects on the local banking market. Moreover, potential settlement to CHF exposures could lead to negative effects in Poland, Croatia and partially also in Romania. Furthermore, we expect profitability pressure to stay on the Rus-sian market. Here the main factors will be the ability of the CBR to cut rates sub-stantially without damaging the RUB stability, the pace of asset quality deteriora-tion as well as the ability of Russian banks to cut costs and restructure their fran-chises. The previous credit growth cycle supported fairly expansionary and ag-gressive strategies, while cost inflation was a long-standing issue.

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Banking trends in CEE

According to our current assessment, the prospects for CEE banking in 2015 and 2016 are likely to be shaped by a complex mix of supportive factors, but also headwinds (related to legacy issues and new challenges).

On a positive note, CEE banks are likely to profit from the adjustments and pos-itive trends seen in major CE/SEE banking markets in recent years and in 2014 in particular (e.g. deleveraging, improved L/D ratios, petering out of asset qual-ity deterioration, increased tackling of NPL stocks). The increasing economic mo-mentum in Western Europe and CE/SEE markets adds to the uplift in CE/SEE banking. This holds especially true as in CE/SEE markets economic growth is in-creasingly generated by domestic drivers. Such a situation should translate into growing demand for new lending and investment financing as well as longer-term transactions. Therefore, corporate lending and also SME lending may de-velop in a more favorable way going forward. Up to now, positive dynamics in these two segments were limited to Poland and Hungary. Over the recent one to three years, loan growth in CE/SEE markets was largely driven by short-term transactions (like consumer financing or working capital financing), refinancing

CEE banking growth and overall market outlook

Poland Russia Czech Republic Romania 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 25 50 75 100 125 150 175 Av era ge an nu al lo an gro w th ra te 2015-2019 f (% yoy in L C Y-te rms)

Change in total loan volume year-end 2014-2019f (EUR bn)

CEE: Long-term banking growth outlook: Larger markets

Hungary Slovenia Bulgaria Croatia Serbia Bosnia and Herzegovina Albania Slovakia 0% 2% 4% 6% 8% 10% 12% 14% - 5 10 15 20 25

Change in total loan volume year-end 2014-2019f (EUR bn)

Ave rag e annual loan g row th rate 2 01 5-20 19 f (% yoy in L C Y-te rms)

CEE: Long-term banking growth outlook: Smaller markets*

* Ukraine and Belarus not shown due to expected decline in loan stock in EUR-terms Source: national central banks, Raiffeisen RESEARCH

Banking growth outlook (EUR- vs. LCY-terms) Current loan stock Loan stock growth* Avg. growth 2015-19f Avg. growth 2015-19f

EUR bn EUR bn % yoy,

EUR % yoy, LCY PL 210 143 11.2% 8.8% HU 43 16 8.0% 6.8% CZ 95 53 9.3% 6.6% SK** 40 21 8.1% 8.1% SI** 23 11 4.0% 4.0% RO 48 44 14.2% 12.4% BG** 28 6 3.8% 3.8% HR 37 0.3 0.2% 0.1% RS 15 5 6.1% 7.6% BH** 9 2 4.4% 4.4% AL 4 2 8.9% 8.8% RU 598 114 5% 9.3% UA 51 -11 -2.5% 19.3% BY 23 -6 -5.3% 15.0% Regions CE 411 233 8.4% 8.2% SEE 141 60 8.8% 8.1% EE 672 98 4.2% 10.3% CEE 1,224 411 5.8% 9.5%

* From 2015-2019f in nominal EUR-terms

** In SK, SI, BG and BH loan growth rates in LCY and EUR are matching due to EA membership or Currency Board arrangements