How does Hungary Deal with Non-Performing FX-Denominated Loans?

The Situation in Hungary

For the past few years, Hungarian banks have struggled with rising non-performing loan (NPL) rates in both the retail and commercial sectors. The effect of the crisis on the NPL rates was exaggerated by the fact that FX-denominated loans (ie, loan or leasing contracts that administer the debt in foreign currency but the actual drawdown and repayment are made in forints) became very popular during the pre-crisis area. Such FX-denominated loans became extremely hard to service for Hungarian families and SMEs when the crisis hit the Hungarian economy and the exchange rates of CHF, EUR and JPY launched skyward. In turn, the Hungarian government launched different programmes to make FX-denominated loans go extinct.

Past efforts

The mandatory prepayment programme, launched in 2011, provided an opportunity to debtors to entirely prepay FX-denominated housing loans in HUF at a preferential exchange rate if the exchange rate at disbursement was lower than the preferential rate. Banks were obliged to accept such prepayment. Another programme running in 2012 aimed to fix the exchange rates for a certain period, thus eliminating the fluctuation risk. The difference between the actual repayments (calculated on the fixed preferential rate) and the instalments calculated on the actual exchange rate was credited against a collection account in HUF. NPLs were excluded from the scope of both programmes, resulting in an increasing overall NPL rate in Hungary.

Current legislation

Background
In recent years, debtors of FX-denominated loans have initiated numerous lawsuits claiming that the application of the spread (ie, the application of the buying rate to the drawdown and the selling rate to the repayment) is null and void, and that unilateral amendments applied by the banks regarding fees and interest rates are invalid. The Hungarian Supreme Court, noticing that lower level courts are in dire need of a guideline, has issued a ruling (binding on lower level courts) that renders the spreads null and void, and sets forth criteria under which the unilateral amendment may be permitted. The Hungarian Parliament, in an effort of avoiding the court system being overloaded by the lawsuits of the debtors anticipated as a consequence of the ruling, adopted an Act incorporating the main points of the ruling.

The Act
Under the Act, the mid-market rate published by the Hungarian National Bank applies to both the drawdown and the repayment. The banks, applying the mid-market rate, must recalculate the debt and the instalments the debtors should have paid and settle the difference between the calculated and the actually paid amounts. The Act also presumes that all past unilateral amendments are unfair and thus null and void. The presumption may be contested by the bank at court. So far, no contest has been successful. As a result, any unilateral increase in the interest rate and fees are null and void, and the bank will have to settle the difference of the initial and increased interest and fees with the debtors.

Settlement
The overpayment of the debtors, either due to the spread or the unilateral amendment, must be set off against the capital of their debts. Because of the reduced historical amount of the capital, the paid interests must be recalculated as well. Overpayment of the interest will also have to be repaid by the banks. In case of ongoing contracts, the settlement may be made by set off. Contracts closed in the past five years are also subject to the settlement, and payment will have to be made, which might cause liquidity hiccups for the banks.

Future plans

The Hungarian National Bank announced this summer that it wishes to create a “bad bank”. The bad bank would purchase only corporate NPLs from the banks at a not-yet-defined discount rate. The funding of the bad bank has remained unclear. It is expected that it will be state owned, either directly or indirectly. There are estimates that even 400 billion forints may be required for the purchases, depending on the scope of its operation and the discount rate. The estimate is based on data that Hungarian commercial banks have already written off 60% of corporate NPLs. The success of the Hungarian bad bank depends on the details, which are not yet known.

Beside the bad bank concept, the Hungarian government, unsatisfied with the results of the efforts aiming at the extinction of FX-denominated loans, announced that the next step will be the mandatory conversion of FX-denominated loans to HUF loans at a pre-fixed rate. The details are yet to be announced, but rumour has it that the conversion will not be beneficial to the financial sector – again.

FX-denominated loans became extremely hard to service for Hungarian families and SMEs when the crisis hit the Hungarian economy and the exchange rates of CHF, EUR and JPY launched skyward. In turn, the Hungarian government launched different programmes to make FX-denominated loans extinct.

author: Gergely Szalóki