Equity 8 September 2017, 4:52pm

ANALYST VIEW - Morgan Stanley ups target price for Hungary's OTP

Portfolio

Morgan Stanley has raised its target price for Hungary’s OTP Bank to HUF 11,165 from HUF 10,143 previously. MS remains bullish on Hungarian consumption and housing demand with outsized opportunities for home loans, especially in the regions. The rating remained ‘Overweight’.

OTP remains an earnings recovery story into 2018e, Morgan Stanley said in a research note published on 6 September.

“The negative impact of lower rates on our revenue forecasts is offset at the bottom line by loan growth and lower provisions," MS analysts said, forecasting 38% growth in adjusted EPS this year, 7% in 2018e and 6% in 2019e.

Key projections:

Good macro, solid coverage and NPL workout. The analysts noted that net provision reversals in Hungary and benign asset quality trends at the other subsidiaries drive earnings momentum.
OTP to benefit from improving opportunities for bank mortgage lending in Hungary, which MS forecast to grow at 14% CAGR over the next three year. “This loan growth provides an offset at NII from the pressure of lower rates, particularly on the bond portfolio."
Ukraine is expected to slowly grind higher in FY17: Ukraine posted a significant YoY reduction in risk costs in 2016, driven by underlying macro recovery and recent FX loan restructuring. MS analysts expect a slow grinding recovery.

Mortgage lending to boom

Morgan Stanley’s analysis of affordability trends and conversations with market participants drives the analysts’ assumption that 50% of mortgage disbursements in 2017 will be in smaller towns and villages (vs 25% in Budapest and 25% in the county seats).

“Therefore, whilst in the 2014-2016 period OTP's market share in new mortgages has been stable at around 25%, due to an acceleration in loan growth in rural Hungary we see OTP capturing 34% of new mortgage lending this year

; with OTP maintaining this level of market share through to 2019, with a 20% CAGR in mortgages between 16-19e. For OTP group this lifts our volumes +3% in each year 2017-19e from our previous forecasts."

Watch the threat of 'consumer friendly' mortgages

Earlier this year the National Bank of Hungary announced a proposal to introduce a quality approval process for retail mortgages. In order to attain the "Consumer Friendly" stamp mortgages must meet a number of criteria, including a spread capped at <350bps; new mortgage loans at OTP on average have a spreads of 400bps.

Whilst this is not a mandatory move for banks, Morgan Stanley estimates the impact could amount to 2.0%-3.5% of earnings in Hungary for 2018-19e, worth 8bps-10bps of group ROTE.

We do not expect in our base case that OTP moves to offer the majority of its new disbursements under this endorsement. However, even at 350bps spread, we still calculate that Hungarian retail mortgages generate 30% return on allocated capital.

The analysts believe that this policy would be especially negative for mortgage lending in rural areas, where spreads are typically higher to reflect underlying credit risk of lending in rural Hungary where wages tend to be lower, unemployment higher and property market more illiquid versus urban Hungary.

Other scenarios

Besides the base case scenario, they also drew up bearish and bullish scenarios. In the former, the TP for OTP was set to HUF 6,626. In that case, the analysts said, the cost of risk improvement fails to offset pressure on OTP’s net interest income. “Pan-region macro recovery delivers slowly, though credit demand remains weak in Hungary and Bulgaria in particular. Cost of risk fails to offset pressure from low rates on slower macro. ROTE 15.9%."

In the bull case, the analysts expect swift economic recovery and credit demand to pick up. “Stronger cyclical recovery in core markets, with credit demand picking up in Hungary and Bulgaria in particular. We assume Russian CoR normalises at a faster rate, with limited disruption to Ukrainian business. ROTE 23.9%." The TP in this case is HUF 17,204.

Risks to the target price

Hungary: no improvement in credit demand would limit NIM expansion and hence revenue growth.
Russia: a harsher asset quality cycle and more severe funding cost pressure could limit OTP Russia's return to profitability.
Ukraine: Morgan Stanley’s base case assumes significant deterioration in asset quality this year, with a positive return unlikely before 2018.
M&A: management has said its preferred use of excess capital would be to strengthen those businesses where it is are subscale. This poses a risk to dividend.