CEE MONEY-Hungary could risk forint selloff with fx loan conversion

Mon Jul 21, 2014 6:45am EDT

Related Topics

* PM Orban wants to get rid of toxic forex mortgages

* Bill in Nov-Dec to allow conversion in 2015

* Timing could be risky due to end of Fed stimulus

* Conversion in one go could cut cbank reserves too much

By Krisztina Than

BUDAPEST, July 21 (Reuters) - Hungary could risk a selloff in its currency by converting its huge stock of Swiss franc and euro mortgages into forints as the timing looks tricky: the planned conversion will take place after the Fed ends its stimulus programme.

The Fed's bond-buying programme has boosted capital flows into emerging markets and Hungary, which has the highest debt in central Europe, has enjoyed the benefits of a flood of cheap money which drove its bond yields to near historic lows.

However, as the health of the U.S. economy improves, the Federal Reserve is preparing to close the taps on cheap funds in October, before probably starting to raise interest rates next year.

This could be a game changer in global markets towards the end of 2014 - exactly at the time when Budapest wants to pass legislation to convert some 11 billion euros' worth of forex mortgages into forints to ease the burden on households.

Hundreds of thousands of Hungarian households took out Swiss franc or euro-denominated loans before the 2008 financial crisis but were caught out when those currencies shot up against the forint after the crisis, pushing loan repayment costs sharply higher.

Economy Minister Mihaly Varga said on Monday that the loans would be converted in 2015 but the legal framework should be set out by December. The government has not indicated whether the loans would be converted at below market exchange rates as a previous repayment scheme had been, but the head of the ruling Fidesz party's parliamentary group has called for that to be the case.

If conducted in one go and below market rates, the conversion will mean further losses for Hungary's mostly foreign-owned banks, which also face a review of their books by the European Central Bank that might force some to raise capital.

The results of the ECB's asset quality review will be published in the second half of October.

"The (loan) conversion in one go could be risky, especially if in the meantime international sentiment were to become less favourable," said Eszter Gargyan, an economist at Citigroup.

"If the central bank's foreign currency reserves drop sharply or the conversion goes through the market, that could boost (forint market) volatility to such an extent that the central bank would have to hike interest rates."

This is the last thing the National Bank of Hungary probably wants, after cutting its interest rate to a record low of 2.3 percent in 23 consecutive steps to help the economic recovery.

Gargyan said the bank was more likely to support a phased and gradual conversion of mortgages to curb market risks and the impact on its forex reserves, although the head of the ruling party's parliamentary group has called for a full-scale conversion already in December.

The conversion will come on the heels of measures that will force banks to refund borrowers for interest rate and fee increases on loans, which Hungary's top court ruled were unfair.

These refunds could cost 2-3 billion euros to the banks alone around October or November, and any potential exchange rate losses on the conversion could come on top of that.

Banks operating in Hungary include Austria's Erste and Raiffeisen and Italy's Intesa and UniCredit, as well as Hungarian lender OTP.

CENTRAL BANK URGES CAUTION

The last time banks in Hungary had to book exchange rate losses on a repayment scheme on forex mortgages, which allowed borrowers to repay their loans well below market exchange rates, the forint plunged to record lows of 324 versus the euro in January 2012.

At that time, Hungary's main interest rate was at 7 percent, although the slide in the currency was aggravated by the euro zone debt crisis, which was taking its toll on markets.

In that scheme, banks booked a loss of 1.2 billion euros, some of which they could deduct from their taxes. In comparison, the financial blow they will face this time for loan conversions and refunds for overcharging could be more than two times that at least.

During the previous repayment scheme, the central bank sold euros to commercial banks via weekly tenders from its reserves, which dampened the market impact.

It will have to do something similar now, just on a bigger scale, analysts said.

The Swiss franc and euro mortgages are booked as forex assets on banks' balance sheets, funded by external debt or local deposits and hedged on the cross currency swap markets.

To be able to close these positions, banks will need foreign currency. If they buy that in the spot market the forint will fall, so the central bank will have to step in again.

At the moment, it has about 36 billion euros of reserves, which comfortably cover Hungary's short-term external debt. Two central bankers have said the bank could help the conversion to some extent, by providing a certain amount of euros from its foreign currency reserves for banks, but not in a full conversion in one go.

The bank's deputy Adam Balog has warned that any solution should be cautious to avoid causing turbulence in markets.

The question is how fast Prime Minister Viktor Orban and his ruling Fidesz party will want to complete the conversion, and to what extent Hungary's large foreign currency-denominated debt will be a constraint on policies.

"We believe that the authorities still favour a gradual depreciation of the forint, since a more rapid one threatens the reduction of the public-debt-to-GDP ratio," UniCredit said. (Editing by Susan Fenton)

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