Equity
Will Hungary's largest bank OTP buy MKB Bank?
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Is OTP out to buy MKB? - OTP denies rumour
Instead of holding on to it for two to three years the Hungarian state would sell MKB Bank already in early 2016, said Ádám Balog, then Deputy Governor of the National Bank of Hungary (MNB) in August. He has since left the central bank and is now MKB’s Chief Executive Officer. MKB was acquired by the state last September and it has been under direct resolution by the MNB since December.
According to Portfolio’s knowledge, there were several scenarios as to what could happen to MKB, but all of these have been dropped by the cabinet by today:
- There were market rumours that Növekedési és Hitel Bank (NHB, Growth and Credit Bank), an interest of central bank Governor György Matolcsy’s cousin, would be happy to buy MKB. The deal would have been similar to the Széchenyi-Raiffeisen transaction in early 2014, as MKB’s total assets are 47 time larger than the balance sheet total of the small NHB. The deal would have probably been “sold" to public by citing the dynamic growth targets of such an ambitious local bank.
- The government and the MNB have been constantly keeping on agenda MKB’s potential merger with Budapest Bank that was taken into state ownership this year and is in a much better shape than NHB. The issue, however, was taken off the agenda, primarily due to the incompatibility of the two organisations and their IT systems.
- When the state acquired the bank, Economy Minister Mihály Varga and MNB Deputy Governor Balog had repeatedly said they would go public with MKB on the Budapest Stock Exchange (BSE). One particular plan, the purchase of the BSE by the central bank would have helped realise this scenario. MKB, however, was allegedly to be listed not separately, but as part of Hungary’s largest bank.
One of the reasons for this - besides the technical aspects of power and the following synergy potentials - could be that OTP showed serious interest in MKB already back in 2013 and 2014. At that time, uncertainties over MKB’s nearly HUF 500 billion worth of non-performing loans and the central bank’s disapproval made the transaction fall through. By the end of this year, however, the central bank’s resolution asset manager will get rid of MKB’s bad loans, hence OTP could be taking over a “good bank" in 2016. By realising potential synergies the cleaned MKB may be more profitable for Hungary’s largest bank than for other potential buyers. Although no other bank had bigger losses in the crisis than MKB - its balance showed HUF -578 billion (IFRS) between 2010 and 2014, the loss-making period will most likely be over as of next year, thanks to the ongoing resolution.
MKB Bank is still burdened by an extremely low quality loan portfolio and revenue level. In more detail:
- Since September 2011, MKB keeps register of its special-need corporate customers in its Special Credit Unit (SCU). In September 2011, MKB set up a new organisation unit within the framework of strategic restructuring in order to separate the customers requiring normal and special treatment. The Special Credit Unit (SCU) concentrates specifically on borrowers requiring special treatment. The activities of the new unit include all market and risk functions related to the customers managed, from debtor rating through daily relationship and services to complaint handling. SCU contributes to the Bank’s business goals by minimising losses and elaborating and implementing adequate special credit management procedures. In practice, this probably means mostly defaulted or close-to-defaulting corporate project loans. At the end of June, the book value of loans here amounted to HUF 365 bn, which made up 35% of MKB’s total receivable. This is likely the portfolio which is to be bought by the central bank’s asset manager by the end of 2015, provided it cannot be sold to market players.
- According to weekly HVG, MKB wanted to get rid of EUR 400 m worth (HUF 120 bn) project loons (on book value) over the last few months but it failed to do so, as market players were willing to pay less than half book value. Should MKB try to sell the same portfolio at market value to the resolution asset manager, it would probably need to swallow losses of HUF 60-80 bn compared to BV. We mean this portfolio only, i.e. one third of the SCU. Theoretically, the parties could sell well below market value and the loss would be swallowed by the central bank, but it would definitely raise brows in the EU, so in practice it most likely wouldn’t work.
- We do not know the ins and outs of the whole SCU therefore the million dollar question is how large losses the bank could still incur on selling the divestible loans at market value. Assuming that the bank sells its HUF 365 bn worth of SCU loans at 50% book value MKB would wipe out its equity which totalled HUF 181 bn at the end of June. It is unclear whether the MNB will be able or willing to opt for a less transparent solution over this, which would make the transaction acceptable also from a political aspect. This may be achieved by having a great deal of the losses realised (or even minimised) by the resolution asset manager rather than by MKB itself, possibly over a period of several years.
OTP or any other buyer is likely to want to buy MKB without this loan portfolio, which means that a significant part of the certain but still unforseeable losses will have to be borne either by the soon-to-be-sold MKB or the resolution asset manager. Either way it will be Hungarian taxpayers that will foot this bill. As the central bank wants to close the resolution process by year-end, it will be most likely a cleaned MKB that will be sold next year.
As a starting point we cannot use the bank’s book value estimated for next year for - in view of the above - it is practically impossible to project BV for early 2016, and it also depends on the size of recapitalisation by the state, should it become necessary. We have a little more to go by when it comes to the assessment of MKB’s long-term profit (once its portfolio is cleaned). Our assumptions/estimates in this respect are the following:
- In 2014, MKB had net interest revenues of HFU 52.7 bn, which could drop to HUF 46 bn this year and to HUF 38 bn in the longer term, mainly over the retail FX loan settlements and the narrowing interest margin.
- This could be partly offset by rising net fee and commission income, which we see growing from last year’s HUF 23.2 bn to HUF 28 bn in 2015 and to HUF 24 bn later on.
- Based on what Deputy-CEO Márk Hetényi told Portfolio in an interview, MKB aims to save HUF 7.5 bn on operating expenses. In our view, at the end of the cost-cutting MKB is to post HUF 47 bn operating expenses (IFRS) on a group level.
- Assuming a 1% loan loss on the greatly diminished “normal" loan portfolio, risk costs could reach HUF 7 bn annually after the portfolio cleaning.
- The bank tax payable by MKB could drop close to HUF 4 bn from HUF 13.6 bn as a result of the radical reduction of the tax base and the cut to the tax rate. At the same time, once we take into consideration the negative consequences stemming from the brokerage scandals (additional contributions to compensation funds), the bank’s actual “regulatory-type" savings could be around HUF 8 bn.
- no more than HUF 2 bn even in the long term;
- and around HUF 10 bn at most even without regulatory burdens
The situation becomes entirely different, though, once we look at MKB as part of OTP Group. As a result of parallel activities and the infrastructure there are serious synergy potentials in MKB’s amalgamation into OTP. Assuming no changes in the clientele, the integration could lead to a 50% reduction to MKB’s operating expenses, which means OTP Group’s new member would be able to rake in cc. HUF 25 bn annual profit. At a 6x P/E ratio, the low end of the range characterising the banks in the region, MKB may be worth HUF 150 bn for OTP, whereas a newly arriving foreign punter is unlikely to be willing to pay more than HUF 30 bn for it.
In other words, buying MKB may be worth the most to OTP, the largest bank by assets in Hungary, because of the synergy potentials. One of the key questions is how large benefits OTP could reap from this and how much it is willing to pay. The case of MKB clearly points out how hugely important the cost-cutting “race" has become in changing the local banking system.
Why would OTP buy MKB anyhow?
OTP boasted not only a high capital adequacy ratio but liquidity reserves of around HUF 2,200 bn at the end of June, which means taking over MKB would not be a problem for it. Another argument in favour of taking this step besides the profits to be made on synergies is that
- OTP has intricate knowledge of what is going on at MKB, given that Tamás Erdei, who had been CEO of MKB, has been on OTP’s Board of Directors since the spring of 2012.
- Compared to the potential buyer OTP, which aims for growth in several corporate lending segments (e.g. agriculture), the share of corporate customers is much higher both in lending and on the depsit side at MKB.
- Whereas OTP is traditionally a retail bank, MKB stands closer to corporations. Depending on market conditions OTP could boost its share in the corporate segment by about 10 percentage points via the transaction.
- MKB’s well over 300,000 retail customers are regarded as affluent, with better-than-average savings capacity.
- The private banking business has 1,430 accounts and managed assets worth HFU 313 bn.
Takeover may give reason for concern
Given that Hungary’s largest bank and another large Hungarian bank would be integrated, the central bank, which is the financial markets supervisor and is currently carrying out the resolution of MKB, would surely have something to say about the deal. MNB is not keen to see market-distorting takeovers in the banking sector in any case.
The Economic Competition Authority (GVH) may also find something to oppose about this transaction, but it is unclear at this point how chances of this deal would be reduced by these two authorities. The likelihood of any serious objection will probably diminish if OTP makes clear its intention to buy and the state does likewise on the seller’s side. So far, the bank has only denied such intention.
MNB’s stance on M&A
“The growth of local large banks via M&A is not healthy. Via their merger these players may exploit the synergies and economies of scale, which implies higher profitability. At the same time, such merger would distort competition, and such strongly concentrated market structures would occur in certain sub-segments which would undermine competition and exacerbate the problem of too-big-to-fail banks," the MNB said in a discussion paper last year.
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