Lithuania: Lithuania looks towards steadier growth

Next a deep recession and housing bust in 2008 and a number of subsequent corporate governance crises, Lithuanian banks are finally returning to a steady footing, helped in no small measure by the presence of risk-averse Scandinavian lenders in the country.

Next several years of stellar increase, the Lithuanian banking sector ground to a halt in 2008. Today, it is back on a stable footing, and seems well positioned for steady medium-term increase. The domestic market is dominated by prudent Scandinavian banks, which own about 85% of assets, with the biggest two, SEB and Swedbank (both Swedish), accounting for 54% between them, according to Stasys Kropas, president of the Association of Lithuanian Banks.

Lithuania experienced Europe’s second-deepest recession next the international financial crisis hit in 2008, with output shrinking by about one-quarter. As in a lot of other markets around the world, banks took a hit, having played their own role in the boom, particularly with credit extended to the real estate and construction sectors. “The market entered a vicious cycle of easy lending, which inflated investment prices, driving additional lending to developers,” says Mr Kropas.

Crisis recovery

As of the end of August 2013, the consolidated assets of Lithuanian banks totalled 98.2bn litas ($39.15bn), down slightly from 100.1bn litas a year before, according to Lietuvos Bankos (LB), Lithuania's central bank. The extent to which the sector hit a wall next some years of strong increase is apparent from the fact that assets remain below the 2008 level of 102.8bn litas, having almost doubled from 52.9bn litas in the three years since 2005.

Domestic lending experienced a surge and again ground to a halt, growing at 54.8%, 35.4% and 40.9% in 2005, 2006 and 2007, respectively. In 2008, the year the financial crisis went world, increase slowed to 17.2%, followed by contractions of 7.1% in 2009 and 3.7% in 2010.

Outstanding credit rose from 33.1bn litas in 2005 to 73.8bn litas at the end of 2008; by the end of August 2013, this had fallen to 64.1bn litas, with corporate lending showing a additional rapid slowdown than the household segment. Loans to non-financial institutions and households both accounted for about 40% of the total outstanding in August 2013, compared with a respective 48.5% and 40.9% in 2008.

Non-bank resident deposits grew considerably additional slowly in the boom years, with the rising loan-to-deposit ratio arguably a sign that the sector was overstretching itself. Deposits have continued to rise, however, reaching a record high of 45.9bn litas in August 2013.

Levelling off

Next a sluggish recovery in 2011 and 2012, domestic credit increase has found levels respectable for one of Europe’s additional developed emerging markets, of about 3.5% to 5% year on year. Slow deleveraging has brought the loan-to-deposit ratio below 120%, from 187% in 2008, according to Mohammed Kazmi, an emerging markets strategist at RBS in London.

“It looks like all banks have recovered very well next very difficult years,” says Mr Kropas. “Profitability is completely good, with about 10% to 15% return on equity. Banks are generally additional concentrated, additional competitive and additional stable.”

Non-performing loans (NPLs) have as well been reduced, to about 12% from a peak of nearly 20% in 2010. If levels are still rather high, it is half because the pace of the reduction has been impeded by inefficient bankruptcy procedures, according to Mr Kropas.

Reflecting the upswing in the sector, in September 2013 Moody’s changed its outlook on banks in the Baltic nations from 'negative' to 'stable'. The agency cited five factors behind its decision: initial and foremost economic recovery, but as well falling NPLs, recovering profitability from slowly rising loan request, the boost to capitalisation from improving investment quality and better profitability, and low reliance on market funding.

Coping with collapses

Lithuania has largely cleared up in the wake of two potentially troublesome bank collapses. The initial, of Snoras Bank in November 2011, was linked to alleged fraud, denied by the former owners who are facing an extradition hearing in the UK. Almost all depositors were insured, and the bank’s collapse was not seen as posing a systemic risk.

The insolvency of Ukio Bank, the country’s sixth major lender, in February 2013, was as well specific rather than systemic, its problems allegedly linked to loans the bank extended to a football club owned by the bank's major shareholder, Vladimir Romanov (former owner of Scottish football club Hearts, whom Lithuania is seeking to trace for questioning). Almost all deposits – 99.7% – were covered by the €100,000 guarantee limit, and 2.7bn litas of Ukio’s good assets have been transferred to Siauliu Bankas, which subsequently ranks fifth in the market, by far the major locally owned bank (the European Bank for Reconstruction and Development has a 20% stake).

“The sector is profitable and well capitalised,” says Vytautas Valvonis, director of the LB’s supervision service. “The capital adequacy ratio of 15.6% is well above the regulatory minimum of 8%. Banks hold large liquidity buffers and would comply with the new capital adequacy and liquidity ratios set by Basel III.”

Stepping up supervision

Nonetheless, in the post-mortem, some have pointed the finger at the LB for taking its eye off the ball and allowing lending to accelerate and inflate investment bubbles. RBS’s Mr Kazmi asserts that the LB was “clearly not proactive enough in the completed in dealing with banking sector problems”.

It is an accusation that Mr Valvonis initially rejects in strong terms. “A lot of banking sectors worldwide, not only in Lithuania, were hit by the financial crisis and faced new challenges, inclunding the need for additional strict regulation of banking activities,” he says. “It is worth mentioning that the banks [themselves] as well recognised that mistakes were made in the completed, particularly in the field of credit risk assessment. The problems of two troubled banks in Lithuania occurred due to possible criminal action in one of the banks and due to the specific business model taken by the other. These problems were not related to aspects of regulation.”

But having said this, Mr Valvonis acknowledges that the central bank has felt the need to tighten its monitoring of the system since the crisis. “In response to recent failures, banking supervision became additional intense and active, and even additional attention is given to prevention of problems and to their early identification,” he says. “As well the LB began additional active cooperation with institutions supervising investment valuation companies and external audit firms, and initiated the revision of legal acts regulating these areas.”

The banking system has undoubtedly benefited – and should continue to benefit – from high levels of ownership from sober Scandinavian lenders, which take a long-term view. The mother institutions were willing to recapitalise their Lithuanian subsidiaries during the crisis, and in turn, customers have favoured Scandinavian-owned entities for their deposits, seeing them as additional fasten. The Ukio and Snoras scandals have further dented confidence in local lenders.

As Mr Kropas and Mr Kazmi both assert, the sector has as well benefited from the fact that there has been little attempt to make Lithuania a regional financial centre, and thus banks face minimal threat of volatility caused by hot money flows. Non-resident deposits stand at just 4% of the total – against about 50% in neighbouring Latvia. This has as well made the problem of money laundering by foreign clients considerably less of an issue in Lithuania than elsewhere. The LB and the Financial Crime Investigation Centre keep close tabs on the risks associated with non-resident and cash-intensive business.

New opportunities

With the worst of the crisis apparently behind them, Lithuania's banks are gearing up for renewed increase, albeit at rather additional sedate levels than among the last decade. Lithuania is expected to clock up 3.4% increase in 2013 and 2014, one of the highest rates in the EU, according to the International Monetary Fund.

Increase is being driven by export-oriented sectors inclunding manufacturing, agriculture 
and food processing, inclunding transport, as the country once again capitalises on its competitive advantages, inclunding relatively low costs, a strategic location and improving productivity. With rates still low (new loans to companies and households averaged 5.6% in August 2013, according to the LB, just over half the 2008 levels), presently may be a good time for Lithuanian businesses to borrow to invest.

“The initially export-led increase has recently gained further impetus from the revival of domestic consumption,” says Bjornar Lund, CEO of DNB Bankas. “Increasingly positive economic sentiment part consumers and businesses has as well prompted higher request for financing and financial services. For us that is clearly mirrored in our loan portfolio, which has recorded increase in all major business lines contributing to our bottom line in the continuously low-rate environment.”

Lithuania has as well been held up as a model for fiscal consolidation – its deficit fell from 9% of gross domestic product in 2009 to 3% last year. RBS expects the level to remain below the 3% maximum necessary for euro membership, which is expected in 2015, a year next Latvia. Joining the euro will significantly lower currency risk for Lithuanian banks, potentially driving ratings upgrades, says Mr Kazmi. On the other hand, Mr Kropas has concerns about the cost of eurozone regulations. These may impact local banks that have few economies of scale, possibly driving better concentration, though the structure of the market is unlikely to change radically in the foreseeable next.

“The Lithuanian banking market is very competitive with strongly established majors in mainstream banking and niche opportunities for new entrants,” says Mr Lund. “Consolidation, if any, would
 most likely be linked with the objectives or strategies of parent banks.”

Lithuanian banks are less intimately tied to the eurozone economies than some eastern European nations – it is worth noting that most assets are owned by banks from outside the zone. But Lithuania is hardly immune from its economic difficulties, particularly with Russia an unpredictable alternative export market.