Annual Financial Statements 2011 of Bank Austria

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Management Report of UniCredit Bank Austria AG (allocation: € 489 bn / net of expiring transactions: + € 194 bn on that day). From the middle to the end of 2011, the outstanding volume of open-market operations rose by 64% or € 233 bn. Use of the deposit facility was almost equally intensive. In the euro system, divergence between countries taking and placing funds became more pronounced. Interbank interest rates remained comparatively high. At year-end 2011, the cost of three-month interbank money was 1.36%. The three-month Eonia swap (which limits default risk to compensation payments based on the interest rate swap) was almost 1 percentage point lower, at 0.38%. The secured interest rate was as low as 0.14% (repo). Ultimately, three-month Treasury bills (German Bubills) even traded at a negative yield of 0.9%. Doubts about the power of determination of EU institutions and about the expansionary central bank policy pursued worldwide fuelled the strong rise in prices for precious metals and in the Swiss franc. In the crisis weeks of the third quarter, gold rose to an all-time high of US$ 1,920 per ounce; as institutional investors subsequently realised profits, the price of gold fell to US$ 1,564 per ounce at the end of 2011 (+10% year-on-year, +83% compared with year-end 2008). The Swiss central bank succeeded in stopping the rise of the Swiss franc (1.0085 CHF/EUR on 9 August) by announcing unlimited intervention at a level of below 1.20 CHF/EUR (closing rate at the end of 2011: 1.2133 CHF/EUR, +2.9%). The US dollar more or less followed the interest rate differential, initially showing a weak trend (1.4939 USD/EUR on 4 May 2011). On the basis of expansionary central bank measures taken by the ECB, the US dollar strengthened to 1.2945 at the end of 2011; at that level it was slightly up on a year earlier (+3.3). Recurrent media reports on the crisis led to widespread uncertainty among investors, which further reinforced the shift away from investments in mutual funds and shares. For example, the MSCI index of the BRIC stock markets at the end of 2011 was 20% lower than at year-end 2010, and the MSCI index of CEE stock markets was down by 19%. The ATX index, in which banks have a strong weight, lost 36%. Jumbo mortgage bonds generated a performance of +3.8%, corporate bonds were weaker after two good years (+2.5%, non-financial, BBB). Commodities also showed a disappointing performance (–6.3%, Rogers, euro). In Austria, economic recovery proceeded at a surprisingly quick pace in the first half of 2011. Growth picked up from 2.3% in 2010 as a whole to over 4% in the first half of 2011. It was driven by robust export demand, moderate growth of consumption and highly dynamic investment activity fuelled by a backlog of demand accumulated during the crisis. In summer, however, the loss of confidence caused by the European government debt crisis started to have an impact on economic expectations. Capacity utilisation in the Austrian economy, which almost matched the multi-year average in the spring of 2011, declined as the year progressed. After a strong recovery in which investment in equipment rose by an annual average of 8%, Austrian companies’ propensity to invest fell significantly. However, external uncertainty prevented domestic growth from becoming self-sustaining. Private consumption, on the other hand, increased moderately but steadily throughout the year, rising by less than 1 per cent in real terms although the labour market situation eased visibly. The number of employed persons in Austria was up by 1.8% on the previous year, reaching a new record level of over 3.4 million. Thanks to a mild winter in 2011, employment trends did not yet reflect the economic slowdown. The unemployment rate declined from 4.4% to 4.2% in 2011, though the improvement has recently come to a halt. Factors dampening consumption were the economic slowdown and the rise in inflation, caused by commodity prices, to an average level of 3.3% (2010: 1.9%), which did not ease until the end of 2011. Global demand, and in its wake also Austrian exports, weakened in the course of the year. Production in Austria’s exportoriented industrial sector therefore lost momentum and even entered a mild recessionary phase before the turn of the year. Based on the sharp upturn in 2010 and in the first few months of 2011, however, annual average rates of change were high: both exports and industrial output rose by over 7% in 2011, strongly supporting the Austrian economy. Real GDP grew by 3.3%, making Austria one of the euro area countries which recorded the strongest growth in 2011. Credit demand in Austria remained weak in 2011. Nevertheless, this was the first year after 2009 and 2010 which saw growth (adjusted for CHF exchange rate effects) of just under 1.5%. While demand for residential construction loans was relatively robust, growing by about 4%, the volume of loans to small and mediumsized enterprises (SMEs) stagnated. In the area of consumer loans, repayments once again exceeded new business, leading to a decline of about 3% in total volume. Demand for corporate loans was slightly stronger: annual growth rose from 2% to 2.5%, mainly driven by developments in the second half of the year. Interest rates on deposits and loans in Austria rose in parallel with the increase in money market rates in 2011. While margins had narrowed towards the end of 2010, this development did not continue in 2011; the mark-up on money market rates was therefore lower, in annual average terms for 2011, than in the previous year, especially for SME and housing loans. The same applies to deposit rates although interest rates in customer business rose much more strongly than money market rates towards the end of 2011. With the economic recovery in 2011, and as there were no major insolvencies during the year, insolvency liabilities fell sharply, by 41%, and the number of insolvencies also declined by 8%. While the number of insolvencies of private households increased again, the related liabilities were lower than in the previous year. In 2011, consumption probably continued to rise more strongly than incomes. The savings ratio declined significantly, from 8.4% to 7.6%. This means that monetary capital formation of private households was as weak as in 2010. While bank deposits accounted for about one half of additions to financial assets, the total volume of deposits held by private households stagnated after the summer although deposit rates, unlike money market rates, increased slightly. Thanks to long-term contracts the life insurance sector recorded steady inflows of funds. The strong demand for bonds seen in the first six months of 2011 did not continue in the second half of the year. The net change in total volume of investment certificates was negative in 2011, after two years which saw net inflows. Central and Eastern Europe (CEE) did not completely escape the two major external influences, namely the economic slowdown in the second half of 2011 and the impact of the government debt crisis. Divergence among the regions and countries was pronounced, however. All countries were impacted by the slowdown in the European industrial sector in the latter half of 2011, but this development affected in particular the Central European countries, which are highly integrated in the production network. While exports of these countries rose strongly in the first few months, weaker growth in the second half of 2011 failed to be offset by trends in domestic demand in view of the fiscal consolidation efforts made in all of these countries. In Hungary, special local factors dampened economic growth as in the previous year (real GDP 2011: +1.6%). Bank Austria – Annual Financial Statements 2011 186
Management Report of UniCredit Bank Austria AG Exporters of commodities and basic materials in CEE also recorded weaker growth but world market prices for such goods remained high compared with the previous year. Expansion in Russia (real GDP +4.2), Ukraine (+4.0%) and Kazakhstan (+6.8%), and also in Romania (+2.6%), was additionally driven by real domestic demand, but this was accompanied by inflation rates of about 8%, far above the average level, and by currency depreciation. Among the large markets with a high degree of economic autonomy, Turkey was one of the countries which achieved the highest real growth rates, at close to 8%, despite economic-policy measures acting as a brake. Booming domestic demand (investment and consumption) in Turkey resulted in a large current account deficit (of over 10% of GDP). The turnaround in the Baltic countries, with strong GDP growth of between 5% and 7%, was based on tough restructuring measures of previous years. As oil prices remained high, Kazakhstan was able to continue its ambitious investment in infrastructure (GDP +7% in real terms). In 2011 as a whole, economic growth of the CEE region (Bank Austria perimeter, without Poland) probably reached about 4.5%, two and a half times the rate achieved in Western Europe. Collateral damage of the European debt crisis was limited in 2011. In contrast to 2008, financial markets did not focus their attention on the CEE region. The main reasons for this were the generally low levels of government debt in CEE, which averages 41% – calculated without the statistical outliers: Hungary (79%) at the upper end, and Russia (8%), Kazakhstan (13%), Bulgaria (17%) and Estonia (7%) at the lower end; the fact that measures to reduce annual public deficits, which rose during the crisis years, were initiated in time; and current account surpluses recorded by most CEE countries (with the exception of Turkey). The IMF’s presence in five countries was another reason for the region’s resilience. Nevertheless, in the third and fourth quarters of 2011, the region was affected by the risk aversion of international providers of capital. Countries with a wide external funding gap were hit hardest by the withdrawal of short-term portfolio investments (while direct investment remained more or less stable). At the same time, risk premiums – measured, for example, by CDS or interest rate spreads – rose. Highly exposed countries like Hungary and Croatia as well as Ukraine were faced with a stronger increase. Overall, however, spreads were lagging well behind those for peripheral countries of the euro area and also behind the SovX index for Western Europe (including AAA-rated countries). In a challenging environment the CEE banking sector continued to expand, driven by nominal economic growth, monetary expansion and the growing market penetration with banking products. New lending business in the CEE market declined recently. Nevertheless, outstanding volume rose by 9% to a total of € 1.5 trn. Growth was disproportionately strong in Turkey (over 30%) and Russia (over 20%), followed by Ukraine and Kazakhstan with over 10%. In most Central and South-East European countries, lending volume rose by about 5%. The expansion of lending business was driven by corporate banking. In the second half of the year, priority was given to attracting deposits as liquidity in CEE tightened as a result of lower inflows of external financing. Asset quality stabilised in most countries in 2011. Impaired loans as a proportion of gross lending volume (impaired loans ratio) have not increased in average terms for the region since the end of 2010; they reached an estimated 14% at the end of 2011. The gradual improvement in asset quality (with the exception of Kazakhstan) was even more visibly reflected in a decline in the cost of risk. The long-term outlook for the CEE region is now, after the fundamental reappraisal of banking business in 2011, perceived differently. In most CEE countries, especially in the large economies, the upturn of the banking sector remains assured, even if it may be more moderate than in the past. But there are some countries with a promising economic environment where the restructuring of the banking sector is not yet complete, or where there is strong dependence on external capital inflows. In Kazakhstan NPL ratios (non-performing loans as a percentage of gross lending volume) will remain disproportionately high for some time, which is partly due to local legislation. Ukraine is suffering from a large external funding gap, and the domestic circular flow of money is only slowly gaining momentum, not least on account of political uncertainty. When, in 2011, international banks reevaluated risks and were confronted with the new regulatory requirements and more difficult funding conditions, they also adjusted their plans for exposed countries to the new scenarios, a process which involved impairment losses on goodwill. In Hungary, a number of amendments to the Constitution and to the legal framework in 2011 were not entirely acceptable to the EU and the IMF, the country’s most important lender. The levy on banks introduced in 2010 was compounded by efforts to ease the solvency problems of private households through administrative procedures, placing a larger burden on banks which acted as lenders. The Home Protection Act passed in May 2011 among other things gave mortgage debtors the option of rescheduling their debt at fixed exchanges rates. In September the government went even further with the option of early repayment of loans denominated in euro or foreign currency at a fixed mandatory conversion rate. The rules imply a loss of at least 25% on CHFdenominated loans and 15% on the rescheduling of eurodenominated loans – the total volume of foreign currency loans is about € 18 bn. In December 2011, the government and the Hungarian Banking Association reached agreement on easing the burden on banks, permitting the latter to offset 30% of the losses thereby incurred against the levy on banks in 2012. The unpredictable regulatory intervention in 2011 (and in the early part of 2012) nevertheless led to a sell-off by international investors. Hungary’s country rating was moreover downgraded to speculative investment on 24 November 2011, which made the rollover of its debt much more expensive, and the country was faced with a downward spiral of currency depreciation. From the end of 2010 to the end of 2011, risk premiums doubled to 551 basis points (10year CDS spreads) and a benchmark spread of 7.8 percentage points for 10-year government bonds (which reflects both a risk premium and the generally higher level of interest rates). Based on a comparison of year-end data, the Hungarian forint depreciated by 11.7% against the euro and by 14.2% against the Swiss franc. Hungary’s economic policy-makers responded by taking countermeasures at the expense of domestic growth. While real economic growth in 2011 was an estimated 1.5%, we assume that 2012 will see stagnation. The deleveraging process in the banking sector also contributed to this development. Lending volume stagnated in 2011 (+0.4% in euro terms). The proportion of nonperforming loans (NPL ratio) rose to 14.5%, and several banks reported losses. Given the close links between the real economy and the banking sector in Hungary and neighbouring Austria, Standard & Poor’s used the Hungarian crisis of confidence as an important argument for downgrading the rating assigned to the Republic of Austria shortly after the turn of the year. Bank Austria – Annual Financial Statements 2011 187
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