Wealthy, diversified, and resilient economy with stable political institutions;
Limited domestic asset-price volatility; and
Main beneficiary of EU enlargement.
Weaknesses:
Saturated and overbanked domestic market with modest profitability levels;
Rapid asset growth in less developed non-EU member countries with higher economic and industry risks; and
High proportion of foreign-currency-denominated lending.
Executive Summary
The relative health of Austria's economic and social environment is set to continue having a stabilizing effect on its banking system, although competitive pressure will remain strong, in Standard & Poor's Ratings Services view. Domestic credit risk from corporate lending has generally reduced due to the corporate sector's improved financial strength, and in contrast to many other systems, price inflation for real estate remains modest. Conversely, retail lending has become more risky due to the still growing proportion of foreign-currency-denominated lending to private households, the growing share of floating-rate loans, and the still rising number of insolvencies among private and small and midsize enterprise (SME) customers. The accession of neighboring Central and Eastern European (CEE) countries to the EU is likely to continue to benefit both the Austrian economy as well as those banks that have been operating successfully in this region for many years as it adds to political and economic stability.
Yet, industry risk remains higher than in most other Western European banking systems. The saturated and overbanked Austrian market is populated by a large number of banks that are owned by shareholders, who do not demand adequate returns on their capital, and ranks among the most competitive in Europe. Consequently, domestic profit margins continue to compare unfavorably with other systems.
The financial crisis currently facing trade-union-owned BAWAG (not rated), Austria's fourth-largest bank, and the reported losses at Hypo Alpe-Adria-Bank International AG (HBInt; not rated), one of the state-owned Landeshypothekenbanks, have both allegedly been caused by gross misconduct by management and a lack of efficient internal and external control processes. As BAWAG will reportedly receive support from the government and major domestic financial institutions, Standard & Poor's does not believe system stability is at risk.
The large Austrian banks were in the vanguard of expansion into neighboring CEE countries, pioneering the building of networks based on strong historical, commercial, and cultural ties in the region. Likewise, overall economic ties between Austria and CEE have strengthened over the past decade. Through organic growth and acquisitions, Bank Austria Creditanstalt AG (BA; A/Negative/A-1), Erste Bank der oesterreichischen Sparkassen AG (Erste Bank; --/--/A-2), and Raiffeisen Zentralbank Österreich (RZB; --/--/A-1) have firmly established themselves in the region and rank among the primary competitors in CEE countries. This business has been the main driver of their earnings improvements, benefiting from strong economic growth and demand for banking products, while the EU enlargement has reduced economic and political risk in the respective countries. The banks' track record in the region has been remarkably good, and growth prospects remain favorable. However, their resilience has not yet been tested and risk tolerance has apparently increased as demonstrated by the willingness to make increasingly expensive acquisitions and the rapid business growth in South Eastern Europe (SEE) and Commonwealth of Independent States (CIS) markets, against a backdrop of higher economic and industry risk. This is partly offset by the improved geographical diversification of large banks, but continues to require vigilance given both growing investment in and earnings reliance on the region.
Another area of potential risk--which is peculiar to the Austrian system, evidently emanating from fierce competition to win market shares in a slow growth environment--remains the still high proportion of foreign-currency-denominated lending, which exposes bank customers, and indirectly lenders, to foreign currency risk. A similar trend that is of concern can be observed in some CEE markets. Although regulatory minimum standards have been implemented, foreign currency lending continues to grow and exposes the Austrian system to higher risk relative to other systems.
Economic Risk
The Austrian economy, accounting for 3% of the Eurozone output, ranks among the most prosperous in the world and has been one of the least volatile among rated sovereigns. Austria's economic performance is closely tied to the export sector--accounting for more than 50% of GDP--similar to that of its largest trading partner Germany. Yet GDP growth has repeatedly outpaced that of Germany since 1992 and unemployment rates have remained significantly lower than levels observed across most of Europe. Due to its geographical proximity and historically strong ties, Austria has been among the main beneficiaries of EU enlargement. After three weak years in line with global trends, economic growth has regained momentum since 2004. Following GDP growth of 1.9% in 2005, and an estimated 2.4% in 2006, Standard & Poor's expects the Austrian economy to expand at its potential growth rate of 2.2% on average during the 2006-2009 period.
Since the turn of decade, the Austrian government has concluded most of its sizable reform agenda, while achieving remarkable success in terms of fiscal consolidation. Reforms have included the simplification of the tax system and the reduction of tax rates, with the corporate income tax rate cut to 25% from 34% in 2005, as well as an overhaul of the health care system.
Lending risk
The domestic credit growth of Austrian banks has picked up since 2004, but remains moderate compared with that of other European banking systems. While loans to domestic nonbanks rose only 16% between year-end 2000 and October 2005, credit growth was up 5% in 2005, the highest reading since 2000. Driven by the continued dynamic development of lending to private customers, offsetting the stagnation on the corporate side, total domestic credit to the private sector and nonfinancial public enterprises to GDP is expected to have remained at 106% in 2005, compared with Germany's level of 112%. The rising indebtedness of private households, the ongoing difficult situation of SMEs, the continued expansion of foreign currency lending in the retail business, and the growing proportion of short-term loans at variable rates in the current environment of rising interest rates are main areas of concern, which ultimately might lead to a reversal of the current benign credit environment with its low risk provisioning needs in coming years.
Table 1
Domestic Customer Loans In Austria
--Year ended Dec. 31--
(Bil. €)
2001
2002
2003
2004
2005
Loans to domestic corporates
114.6
111.6
110.8
109.9
108.9
Of which in foreign currency
20.2
19.5
17.8
16.1
14.6
Loans to domestic private customers
79.8
84.6
87.4
97.1
107.3
Of which in foreign currency
19.5
22.1
23.7
28.5
32.7
N.B. Since 2004 the self-employed have been included under households instead of under corporates.
Corporate sector
Due to the ongoing lack of loan growth in 2005, the share of corporate lending of total domestic loans to nonbanks declined to 43% at the end of September 2005 from 46% in 2003, following years of stagnation or even declining exposures. Corporate funding continues to be dominated by bank loans, but due to the very favorable capital-market environment, companies significantly diversified their refinancing through both debt and equity markets in 2005. Due to the relative underdevelopment of Austrian capital markets, these opportunities are still largely restricted to the major companies, however.
The number of corporate insolvencies has been increasing continuously since 2001 at a rate of about 8% per year and in 2005 there were about 7,000 company failures. Against this trend, the amount of outstanding debt affected by corporate insolvencies decreased significantly during the same period by about 30%. This positive development reflects the absence of major insolvencies, as larger companies in particular have benefited from improved profitability and capitalization, and lower refinancing costs.
The Austrian corporate sector is dominated by SMEs as well as the self-employed, which together comprise the majority of corporate lending. As they are usually only modestly capitalized compared with international peers and more susceptible to a deterioration of the economic climate, SMEs are mainly responsible for the increase in insolvencies. Standard & Poor's believes, that low interest margins due to intense price competition from cooperative and savings banks do not adequately reflect the inherent risks in the SME segment.
Two peculiarities in the Austrian market set it apart from other European markets:
First, although mainly restricted to Austria's three largest banks, exposures to CEE countries are comparatively high. By mid-year 2005, CEE accounted for 61% of Austrian banking groups' consolidated foreign nonbank exposure. The credit loss records have been good so far, mainly as a result of cautious lending policies and the favorable economic development. Originally focused on commercial banking with large international and domestic investors and enterprises, and the public sector, increased price competition has caused the banks to expand lending with SMEs and private customers in recent years. These activities offer higher margins, but might also result in increased provisioning needs in the future.
Second, with 20% of total lending to domestic nonfinancial institutions at mid-year 2005--with a 30% share for private customers and 14% for corporate customers--Austrian banks have a high proportion of foreign-currency-denominated lending. Attracted by the ongoing favorable interest rate differential, private individuals currently refinance more than 50% of new loans largely denominated in Swiss francs. Although customers have benefited so far from favorable currency movements, banks will have to further adapt their lending criteria and require higher collateral to improve their own resilience and that of customers against unexpected currency valuation changes.
Private households
Due to significant credit growth in recent years, particularly in consumer loans, lending to private customers--including the self-employed--increased to 39% of domestic loans to nonbanks at the end of September 2005 from 36% in 2003. Although the gross indebtedness of private households--measured as a percentage of disposable income--rose to 65% at year-end 2005 compared with 56% at year-end 1995, the ratio remains significantly below the average ratio in the Eurozone of more than 80%. In addition, Austrian monetary household wealth was 2.8x higher than liabilities. Furthermore, unemployment rates are comparatively low.
The personal savings ratio, which had steadily decreased to its low of 7.5% in 2001 from almost 12% in 1995, recovered to 9% in 2004. As Austrian private households have only recently started to switch into more sophisticated products, the majority of savings is still invested in cash and sight deposits (see chart 3). Therefore, the wealth of private customers has been less affected by the volatility in equity markets, although valuation gains in recent years reflect a stronger inclination to invest in capital market products.
Although the key indicators remain sound, Standard & Poor's believes that credit risk has increased due to private customers' still growing exposure to currency and interest rate movements, which could negatively affect the affordability of households for credits.
Asset price inflation
As the small Austrian stock exchange--in terms of market capitalization as a percentage of GDP--has not experienced the high volatility seen on other European stock markets, and, given that the proportion of equity investment is still low, the wealth effect from substantial stock market volatility over the past decade has been limited.
Likewise, real estate prices have been less susceptible to market swings over the past decade, although fluctuations in commercial real estate markets in Austria's capital and economic center, Vienna, are more pronounced.
In general, neither rapid credit growth nor asset price inflation is putting stress on the Austrian financial system.
Trend in loan loss provisions
The development of loan loss reserves (LLRs)-to-customer loans over the past few years mirrors changes in the economic environment with a certain time lag. Following years of increases from its low in 2000, LLRs-to-customer loans slightly decreased in 2005. Net new loan loss provisions (LLPs), amounting to up to 60 basis points (bps) in 2005, still reflect the generally benign credit environment, helped by the absence of major insolvencies, which might not prove sustainable, however. After three consecutive years of improvement since 2001, this represents a small increase, as some banks reported a deterioration of credit quality in private customers business.
Table 2
Republic Of Austria--Leading Economic Indictors
2001
2002
2003
2004
2005
e2006
Nominal GDP (bil. €)
216
221
227
237
247
257
GDP (bil. US$)
193
209
256
294
307
320
Real GDP (% change)
0.70
1.00
1.40
2.40
1.90
2.40
Population (mil.)
8.13
8.08
8.12
8.15
8.19
8.23
GDP per capita, US$
23,338
25,637
31,556
36,096
37,340
38,608
Real GDP per capita (% change)
0.40
0.50
1.00
1.70
1.70
2.20
CPI (% change)
2.30
1.70
1.40
1.90
2.20
1.90
Unemployment rate (%)
3.60
4.20
4.30
4.80
5.20
5.20
Exchange rate at year-end (€/US$)
1.13
0.95
0.79
0.73
0.84
0.76
Total domestic credit to public sector and NFPEs
225
231
239
252
263
276
Total domestic credit to public sector and NFPEs/GDP
105
104
106
106
106
107
NFPEs--Nonfinancial public enterprises. e--Estimate.
Industry Risk: Business Dynamics
Competitive dynamics
Consolidation, privatization, and refocused strategies on extended home markets have been the key characteristics of the Austrian banking sector over the past decade.
Table 3
Total Assets Of The Largest Banks And Banking Groups With Operations In CEE
(Mil. €)
Total consolidated assets
RWA in CEE
Bank Austria Creditanstalt AG
158,879
21,350
Erste Bank der oesterreichischen Sparkassen AG
152,660
16,563
Raiffeisen Zentralbank Oesterreich
93,864
27,800
RWAs--Risk-weighted assets.
At June 2005, the combined market share of the five-largest institutions by total unconsolidated bank assets amounted to 46%.
The structure of the Austrian banking industry became radically more concentrated in 1997, when the two largest institutions merged to become BA, and Erste Bank was created through the merger of two major savings banks. In 2000, the state sold PSK to BAWAG, creating a new sizable domestic competitor, while Österreichische Volksbanken AG (ÖVAG) acquired Investkredit in 2005. With BA majority-owned by UniCredito Italiano SpA (UniCredito; A+/Negative/A-1), and Erste Bank and RZB deeply rooted in their respective banking sectors, the room for further consolidation on a larger scale is limited. The ailing BAWAG is expected to be sold, but doubts remain whether the large Austrian banks will be willing to make an acquisition, which would require major restructuring work to eliminate overlaps, as they already have to cope with major integration projects and have to allocate scarce capital resources in the more promising and fast-growing CEE markets. Public sector ownership--once a characteristic of Austrian banking--today is essentially limited to a small number of regional savings and Landeshypothekenbanks, which will lose their guarantees on April 2, 2007. Therefore, state support is set to diminish in the future.
Despite these changes in the system, domestic profitability levels have remained modest due to competitive pressure and a lack of growth opportunities in a highly saturated market. This prompted larger institutions to establish a presence in neighboring growth markets. At June 2005, the subsidiaries of the 11 Austrian banks with participations in CEE accounted for only 23% of their parent companies' total assets, yet for a substantial 42% of their operating income.
Operating flexibility
Although the legal and regulatory environment provides a reasonable level of operating flexibility, Austrian banks have generally been slow to adapt to a changing environment. The industry structure, with the relative lack of pressure from shareholders, has contributed to this trend. For example, Austrian labor laws are less restrictive than in Germany, yet the number of employees in the domestic banking system has remained almost static. Notable exceptions are BA, and to lesser extent, Erste Bank, both of which--as publicly listed companies--are more committed to contain cost growth and improve returns.
Retail banking customers in particular are protected by a set of consumer protection laws, which in recent years have focused on preventing banks from providing misleading advice to consumers. The resulting administrative burden for the banks will increase further against the background of growing harmonization within the EU.
Franchise: Depth and diversity
The Austrian banking system is dominated by universal banks, which are entitled to engage in a wide range of banking activities. Specialized subsidiaries, such as mortgage banks (Hypothekenbanken), building savings banks (Bausparkassen), investment funds (Kapitalanlagegesellschaften), and insurance companies complement their range of products. Larger commercial banks have also built extensive foreign operations through networks of branches and subsidiaries mainly in CEE.
Physical branch networks are expected to remain the cornerstone of customer relationships, protecting the position of banks from potential new market entrants. Despite the growing acceptance of Internet banking, online banks have had limited success so far, achieving only small market shares mainly in deposit business. Apart from Unicredito's majority ownership in BA, foreign banks are predominantly active in niche markets, such as investment banking, public finance, consumer finance, and leasing.
Austria is likely to remain a highly intermediated market, with banks expected to maintain their dominant role in the financing of the economy. Capital markets are still underdeveloped, but, driven by the extraordinary positive performance of the equity market over the past three years, are slowly catching up in terms of providing alternative funding sources and offering investment opportunities. In April 2005, Raiffeisen International (RI), RZB's subsidiary, which holds all of its shares in CEE network banks, went public, floating a 30% stake through an IPO worth about €1 billion. On the deposit side, threats to the intermediation role of banks are also limited because banks manage the vast majority of alternative investments, such as mutual funds.
Deregulation
Regulation and supervision have been strengthened to bring both in line with EU financial sector directives and international best practices. However, organizational changes for financial market supervision in 2002 are fairly new, and effective implementation will take some time. Standard & Poor's expects that a thorough investigation of the BAWAG crisis will address remaining weaknesses in internal and external control processes. Savings accounts can no longer be opened without identification and, since June 2002, anonymous deposits or withdrawals are no longer permitted. Major forthcoming changes are the more widespread use of IFRS, which the top-three institutions have already been applying for some years, and Basel II in 2007. These changes are welcomed by Standard & Poor's as they might promote greater disclosure and transparency.
Ownership Structures
The Austrian National Bank distinguishes between the banking sectors described below:
Commercial and private banks
The 44 commercial banks are privately owned. Shares of those that operate as joint-stock companies are generally not listed or have limited free float due to the dominance of large, stable shareholdings. Their market share by total assets amounted to 32% at the end of September 2005. The dominant institution is BA--part of the Italian Unicredito group--which with total consolidated assets of €159 billion makes BA Austria's largest bank. The second-largest sector bank, BAWAG-P.S.K., is set to be sold in 2006 by its 100% owner, Österreichische Gewerkschaftsbund (ÖGB; Austrian Federation of Trade Unions), because it has to be bailed-out by the state and Austria's major financial institutions.
Savings banks
The savings bank sector consists of Erste Bank as the central institution and 56 local savings banks. The sector's market share by total assets amounted to 18% at the end of September 2005. Erste Bank, a joint-stock company, is the second-largest bank in Austria with total consolidated assets of €153 billion at year-end 2005. Since 2002, Erste Bank has consolidated the member banks of the savings banks' protection scheme. Erste Bank's major shareholders are: DIE ERSTE österreichische Spar-Casse Privatstiftung, which holds 30.5%, and the Austrian savings banks, which hold 6.9%.
Consolidation has reduced the number of local savings banks from 80 back in 1994. Savings banks operate under the Austrian Savings Bank Act (Sparkassengesetz). The savings banks' owners typically cannot participate in the banks' equity or profits, that is, they are restricted from injecting or withdrawing capital. Since the 1993 amendment to the Savings Bank Act, permitting savings banks to operate in the form of joint-stock savings banks, more than one-half of the savings banks have adopted this legal form, which has paved the way for new, external owners in the sector.
Cooperation and cohesiveness has been significantly strengthened since 1997, when Erste Bank became the sector's central institution. An agreement aimed at further strengthening the cooperation and mutual support among members of the sector, and the security of customer deposits became effective on Jan. 1, 2002. The new protective scheme comprises the overwhelming majority of savings banks, accounting for about 95% of customer deposits, allowing Erste Bank to consolidate all member institutions (see section entitled "Deposit insurance schemes" in this report).
Credit cooperatives
In contrast with Germany, the Raiffeisen and the Volksbanken cooperative sectors in Austria are separate. The two sectors accounted for 23% and 5%, respectively, of total bank assets at September 2005.
The Raiffeisen cooperative banking sector has a three-tier structure. It consists of 566 local banks and nine regional central banks (Raiffeisenlandesbanks), with RZB acting as the central bank. With total consolidated assets of €148 billion at year-end 2004, it is the largest banking sector in Austria--although is smaller than BA. It operates the largest branch network, with almost 2,300 outlets and employs more than 23,000 staff. Consolidation has reduced the number of independent local banks more than 800 back in 1992. These banks, whose business profiles are similar to those of the savings banks, offer a full range of banking services, but concentrate on retail customers and small businesses. They have about 1.7 million members, who are both customers and the owners of these local banks. The sector's strong position in domestic retail banking is reflected in its market shares: 26% of domestic customer deposits and 22% of domestic customer loans.
Raiffeisenlandesbanks, which are owned by the local banks, provide services that cannot be carried out by the local banks, including payment and foreign transactions; securities business; technological support; and advisory functions. Furthermore, they act as liquidity centers and commercial banks. RZB, which is 88%-owned by the Raiffeisenlandesbanks, acts as central clearer, holder of minimum reserves and liquidity center for the Raiffeisenlandesbanks, and also operates as a commercial bank. The sector offers a complete range of financial services through specialized entities, including insurance, mutual funds, building savings products, and leasing. Solidarity within the sector has traditionally been strong and was further strengthened through the introduction of explicit customer protection schemes at the central and regional level in November 2000 (see section entitled "Deposit insurance schemes" in this article).
The Volksbanken sector has a two-tier structure; there are no regional banks. At the base level there are 67 Volksbanken, and the sector's central bank, ÖVAG is situated at the top level. ÖVAG is a joint-stock company, with 58% of its shares owned by the local cooperatives, while 25% is held by DZ BANK AG Deutsche Zentral-Genossenschaftsbank (DZ BANK; A/Stable/A-1), the central institution of the German cooperative banking sector. The Volksbanken operate their own deposit protection scheme.
Landeshypothekenbanks
Founded by the state governments, these 10 regional banks accounted for almost 9% of total Austrian bank assets at the end of September 2005. Landeshypothekenbanks originally specialized in mortgage financing and the issuance of mortgage-backed bonds (Pfandbriefe), but are now universal banks with a focus on local SME lending and retail customers. In addition, they continue to serve as banker to their respective states and usually assist in promoting the local economy. Traditionally organized as institutions under public law, with the respective states acting as owners and deficiency guarantors, today the banks operate in the form of joint-stock companies and have been partly privatized to form strategic alliances.
Until April 2, 2007, when these guarantees will be abolished, counterparty credit ratings on the four rated Landeshypothekenbanks remain based on the deficiency guarantee (Ausfallsbürgschaft), under which the states are liable to the banks' creditors if, under a liquidation scenario, the creditors are unable to obtain full payment from the banks' assets.
The negative outlooks on these banks serve to indicate that in the absence of explicit support of deficiency guarantees, future counterparty credit ratings will only be in the range of 'A+' to 'BBB+' (see article entitled "Austrian Landeshypothekenbanks Unguaranteed Debt Ratings: Fundamentals Likely To Stay Steady Ahead Of 2007 Loss Of Guarantees", published on April 13, 2006, on RatingsDirect).
Table 4
Ratings On Austrian Landeshypothekenbanks
Long-term senior unsecured unguaranteed rating*
Long-term issuer credit rating*
Long-term senior unsecured guaranteed rating*
HYPO TIROL BANK AG
A
AAA/Negative/A-1+
AAA
Landes-Hypothekenbank Steiermark AG
BBB+
AA/Negative/A-1+
AA
Niederoesterreichische Landesbank Hypothekenbank AG
A+
AA+/Negative/A-1+
AA+
Oberoesterreichische Landesbank AG
A
AAA/Negative/A-1+
AAA
*Ratings at June 14, 2006.
From April 2, 2007, onward guaranteed obligations of Landeshypothekenbanks will continue to benefit from deficiency guarantees until maturity (grandfathering).
Unguaranteed ratings essentially reflect a Landeshypothekenbank's individual stand-alone business and risk profile, but also includes potential benefits from the banks' ownership structures, although to a limited extent of up to three notches. This reflects:
The expectation that the respective states will retain meaningful stakes in their Landeshypothekenbanks in the medium term, and that support would be forthcoming in the event of a crisis.
The assessment that strategic shareholders will build stronger integration and cooperation with Landeshypothekenbanks, and might take larger ownership stakes to support the state of transition.
Building savings banks (Bausparkassen)
The four Austrian buildings savings banks accounted for about 3% of total bank assets at the end of September 2005 and offer medium-term and interim homeowner financing. Three of the building savings banks act as specialists for their respective banking sector.
Banks with special functions
There are 96 special-purpose banks, which in their majority comprise investment management companies that are not allowed to pursue any banking activity other than investment fund business. The largest institution, which is jointly owned by the major Austrian banking groups, is Oesterreichische Kontrollbank AG (ÖKB; AAA/Stable/A-1+), which provides state-sponsored export financing and acts as a securities clearing house and settlement agency.
Financial Trends
Performance
Despite a good year in 2005, profitability and margin levels at Austrian banks have been modest and significantly lower than levels at other EU countries. Raising revenues has proved difficult and slow in the saturated Austrian market.
Operating profit before risk provisions/average assets
0.73
0.75
0.75
0.82
Net profit/average assets (ROA)
0.25
0.36
0.47
0.56
According to Austrian National Bank projections for 2005, which are based on unconsolidated accounts and only include dividends from foreign subsidiaries, the trend of steady interest margin declines remains unbroken. The average net interest margin of Austrian banks dropped further to only 1.3% in 2005, compared with 1.9% in 1995. During the same period, total revenues to average assets declined to 2.3% from 2.8%, because other operating income has not been able to offset the weakening interest income. As operating revenues have developed better than operating expenses since 2002, the cost-to-income ratios of Austrian banks have gradually improved, and stood at 64% in 2005 (69% in 2002). However, most banks have remained reluctant to rigorously address inefficiencies, and rising contributions from CEE and commission income might prove more volatile income sources. Profit before risk provisions to average assets rose to 0.82% in 2005 from 0.73% in 2002. Due to the significantly better credit environment ROA further recovered to 56 bps in 2005 from its historical low of only 0.25% in 2002. Austrian banks expect operating profit before risk provisions to be 19% higher for full-year 2005, based on 9% higher operating revenues--stable interest income with commission income (16%) and income from participations (30%) as main drivers--but only 4% higher expenses. Profit after risk will increase less by 16%, as some banks, such as BA, increased risk provisions particularly for private customer loans in the final quarter 2005.
Successful strategies to improve earnings have regularly centered on exploiting opportunities in neighboring CEE markets. Erste Bank, RZB, and BA have further intensified their efforts to expand their already strong foothold by gradually shifting their focus from the new EU member countries in Central Europe to the economically less developed countries in SEE and CIS. At the same time, a shift from organic growth to increasingly expensive acquisitions has occurred. These markets generally offer attractive opportunities, as margins are comparatively higher and the long-term catch-up potential to Western European standards is even more pronounced. However, as the economic and industry risk profiles of these countries are less favorable, the operating performance of these banks might become more volatile in coming years. As CEE countries have continued to show robust and much higher economic growth than Austria, contributions from CEE operations account for 50% or more of the three large banks' pretax profits, highlighting the strong reliance on the stability in the region. The increasing focus on retail banking partly mitigates concerns that growing competition and declining interest rates will further reduce profit margins in these countries, but the often unsecured lending to SME and private customers could heighten business risks and capital strains involved with their expansion strategies.
Lending And Asset Quality
Asset quality in the Austrian banking system is satisfactory, as it benefits from the relative stability, robustness, and wealth of the Austrian economy and the absence of unsound asset-price inflation. Whereas the absence of larger corporate insolvencies mainly benefit the larger institutions, the declining level of domestic insolvency liabilities and simultaneously of provisioning needs illustrate that the credit environment has improved in line with domestic economic conditions. The central problem remains the lack of discipline with respect to risk-adjusted pricing in the Austrian market, which for example can still be observed in the SME segment and the ongoing boom in foreign currency lending to private customers.
Foreign assets accounted for 34% of total bank assets at the end of September 2005. This understates foreign exposures, as the Austrian National Bank's statistics are based on unconsolidated figures and do not include the local lending of subsidiaries in CEE. With respect to the largest institutions, provisioning needs in CEE countries show a generally rising trend due to strong credit growth, but credit losses have been modest and risk-adjusted margins remain higher than in Austria by far.
Funding
The funding of Austrian banks is generally well diversified, with a significant share of domestic customer deposits funding 83% of domestic customer loans. Austrian banks' subsidiaries in CEE often run deposit surpluses due to a relative shortage of sufficiently attractive lending opportunities in the private sector. The overall funding structure on an unconsolidated basis at the end of September 2005 shows customer deposits accounting for 35% of the balance-sheet total, complemented by 31% interbank funding and 22% in own issues. Funding profiles vary significantly between predominantly retail-funded savings and cooperative banks and the larger institutions with a significant wholesale business.
Capital
Although Austrian National Bank statistics suggest that the general capitalization of the Austrian banking system appears to be strong on average and has been fairly stable in recent years, Standard & Poor's regards the capital strengths of the system as only adequate. The reasons for this are as follows:
The capital ratios based on unconsolidated accounts overstate capitalization due to the double leverage as a result of the ownership structures of the cooperative and savings bank sectors.
The higher level of credit and operational risk of the equity stakes in banks and nonbanks is not adequately reflected in the ratios.
The profitability levels of the system are moderate and compare unfavorably by international standards.
However, Standard & Poor's does not foresee any threats to the overall solvency of the banking system. The regulatory Tier 1 ratio of Austrian banks has always been above 9% on average for many years (10.0% at the end of September 2005). Only the state-guaranteed Landeshypothekenbanks were well below the industry average, with an average Tier 1 ratio of 6.3%. The overall issuance of hybrid Tier 1 capital, which Standard & Poor's considers a weaker form of capital, has generally been limited, but is expected to gradually become more important, given that the sectors' central institutions are funding a growing proportion of their acquisitions, which create sizable amounts of goodwill, with hybrid instruments. The banking system's total regulatory ratio was 14.4% at the end of September 2005.
Ratios on a consolidated basis are lower and better reflect the capital strengths of the banking sectors. For example, the consolidated Tier 1 ratio of the Raiffeisen banks amounted to a still satisfactory 7.4%, that of the Erste Bank including the member savings banks was 6.8% at year-end 2005, while that of BA stood at 8.3%. Furthermore, in its analysis, Standard & Poor's places more weight on the overall strength of purer measures of capital, provided by its adjusted common equity (ACE)-to-risk assets ratio.
Table 6
Major Austrian Banks--Core Capital Ratios
2003
2004
2005
Bank Austria Creditanstalt AG
ACE/risk assets
5.94
6.33
5.97
ATE/risk assets
5.94
6.66
6.49
Erste Bank der oesterreichischen Sparkassen AG
ACE/risk assets
4.75
5.01
5.02
ATE/risk assets
5.49
6.03
6.14
Raiffeisen Zentralbank Oesterreich
ACE/risk assets
6.19
7.35
6.65
ATE/risk assets
6.85
8.13
7.19
ACE--Adjusted common equity. ATE--Adjusted total equity.
Regulatory Environment
The Austrian Financial Market Authority (Finanzmarktaufsicht; FMA)--created on April 1, 2002--acts as the primary supervisor for banking, insurance, pensions, and capital markets. The FMA--a public entity with legal independence--is the result of the 2001 Financial Market Supervisory Act and responds to the increasingly complex requirements for prudent supervision. The FMA is supported by the Austrian National Bank (OeNB), which conducts on-site inspections and examines regular reports from the banks and the reports of external auditors to ensure that all banks are inspected periodically. At the beginning of the 2006, both the FMA and OeNB provided the banks with in-depth guidelines for aggregate risk management (ICAAP) as well as for the management of operational risk. Challenged by the current problem cases--BAWAG and also HBInt--and the additional workload of Basel II, further recruiting and training of FMA's staff will be required to improve supervision.
The legal basis for banking supervision in Austria rests on the Financial Market Supervision Act (Finanzmarktaufsichtsbehördengesetz; FMABG), the Banking Act (Bankwesengesetz; BWG), and the new Financial Conglomerate Act (Finanzkonglomerategesetz; FKG). Supplementary laws, notably, are the Securities Supervision Act, the Savings Bank Act, and the Mortgage Bank Act. Supervision is aimed at safeguarding the viability of the banking industry by protecting creditors and regulation covers for example: capital and liquidity requirements; surveillance of the lending business as well as market and interest rate risk management; information requirements and audits; licensing; and enforceability and sanctions.
Banks are generally required to meet the capital requirements according to the BWG, whereas banks operating internationally with significant foreign exposures are also required to meet the Bank for International Settlements (BIS) guidelines. The latter differs regarding the regulatory approval of hybrid instruments as Tier 1 capital. BIS rules limit the inclusion of dated hybrid capital instruments in Tier 1 to a maximum of 15% of Tier 1 capital. In contrast, the BWG distinguishes between perpetual hybrids without step-up provisions that can qualify for up to 30% of consolidated Tier 1 as well as perpetual hybrids with step-up provisions that are only eligible up to 15%. Standard & Poor's considers hybrid capital instruments to represent lower quality capital and--given their increasing use to finance large-scale acquisitions in CEE--is concerned that increasing substitution of common equity with these instruments might ultimately weaken the financial strength of institutions individually, as well as the industry as a whole.
Since Jan. 1, 2005, combinations of banks, insurance, and financial services companies have been separately regulated by the FKG Act to protect the financial system by preventing problems arising from possible double-gearing within financial groups. At present, there are four financial conglomerates in Austria: Erste Bank, Grazer Wechselseitige Versicherung (including Capital Bank, and 46% of HBInt), RZB Group (including Uniqua), and Wüstenrot.
Liquidity is measured by two ratios:
First, the regulatory liquidity ratio shows the proportion between a narrow definition of liquid assets available on demand and up to one month, and a certain percentage of payment obligations callable up to six months; and
Second, the liquidity ratio shows the proportion between a broader definition of liquid assets and a certain percentage of payment obligations callable up to 36 months.
The liquidity of the institution is deemed to be adequate if its liquidity ratio does not fall below one.
Crisis management
The BWG provides the FMA with the power to take preventive action in times of stress. The FMA can, for example:
Request information, inspect, and initiate external audits on an institution any time at its discretion;
Prohibit any capital measures, including dividend payments in cases where the funds of creditors might be endangered;
Appoint a government commissioner, who can impose temporary measures to suspend business that puts the fulfillment of obligations to customers at risk;
Revoke an institution's or management's license; and
Close an institution.
If a general political or economic crisis were to lead to a systemic crisis for the economy or the payment systems, the federal government has the power to temporarily stop payment transactions.
There have been relatively few bank failures in Austria, partly because problems have been resolved through collective action within the respective sectors without regulatory intervention. Noteworthy examples are Tiroler Sparkasse, which was taken over by Erste Bank in 2001, and the very small Sparkasse Melk, which was rescued in 2003. In 2000, Bank Burgenland (not rated) was close to failure, but received support from its guarantor and main owner, the respective state government. The current bailout of BAWAG is the most serious event to date, due its relative importance for the stability of the banking system. While the interplay of owners, auditors, and regulators has demonstrated weaknesses, Standard & Poor's considers the BAWAG crisis an isolated incident, which is not symptomatic of the system as a whole. As BAWAG will reportedly receive support from the government and major domestic financial institutions, Standard & Poor's believes that system stability is not at risk and expects that deficiencies in control and governance processes will be addressed.
Deposit insurance schemes
The regulatory environment in Austria, in connection with the established individual deposit-insurance systems operated by the various bank sectors, is well positioned to safeguard the health of the banking sector as a whole and to resolve smaller problems that might arise at individual banks. The protective schemes operated by the Raiffeisenbanks and the savings banks, in particular, go well beyond legally required provisions and aim to protect the solvency of institutions.
Following the revision of the BWG, the EU deposit-protection directive was implemented. Austrian deposit institutions must be a member of one of the five deposit-protection schemes of the respective banking sectors. Deposit-protection facilities were established as separate legal entities and guarantee repayment of deposits up to €20,000 for each depositor within three months, should a member institution become unable to pay. Deposits of legal entities are only 90% protected within the limit of €20,000 each.
Protective scheme of the Raiffeisen banking group
The sector has demonstrated cohesiveness and solidarity in the past on a voluntary basis and has been successful in preventing bankruptcies and losses for creditors and member shareholders. Furthermore, in November 2000, the sector introduced explicit customer protection schemes at the central and regional level, funded by contributions from the member banks according to the proportion of each bank's protected liabilities. The overwhelming majority of Raiffeisenbanks, representing about 90% of deposits, participate in the scheme. At the central level, the scheme is managed by an association (Raiffeisen-Kundengarantiegemeinschaft Österreich; RKÖ), of which RZB and the regional Raiffeisen banking associations are members. Both regularly report to RKÖ on their present and future financial positions. The amount available to absorb losses was €5.7 billion at year-end 2004.
The agreement falls short of a strong and timely cross-guarantee, however, because it does not guarantee all claims, includes certain limits with regard to secured obligations of distressed members, and becomes effective only if a member bank commences insolvency proceedings. Nevertheless, the interdependence of the member banks means that the incentive to prevent bankruptcies remains very strong and is enhanced by the scheme.
Protective scheme of the Austrian savings banks
The protective scheme is operated by a special-purpose company (Haftungsgesellschaft; HG), which is 51%-owned by Erste Bank. Member banks are obliged to furnish HG with financial information on a regular and timely basis so that potential problems can be detected at an early stage. HG will also decide about the necessity, form, and implementation of support for troubled member banks, ranging from advice to capital contributions. According to the agreement, financial support will be funded by the member banks, which is capped at the overall limit of 1.5% of risk assets and 75% of expected pretax profit on a combined basis. For the participating savings banks this limit amounted to about €900 million, more than one-half of which is contributed by Erste Bank and its fully owned savings bank subsidiaries.
Although the protective scheme falls short of a cross-guarantee system because of certain limitations, it demonstrates the overall strengthened cooperation and stronger cohesiveness within the sector and Erste Bank's commitment to fulfill its function as the central institution of the sector.
Accounting Policies
The lack of transparency in the financial reporting of Austrian banks still remains an area of dissatisfaction, and disclosure continues to fall short of that of many of its international peers. The reason for this is that creditor protection is the overriding rule in Austrian accounting. Nevertheless, EU regulation called for compulsory reporting of consolidated accounts under IFRS by 2005 for listed banks. Austria has extended this deadline to 2007 for banks that only have debt instruments quoted on an exchange. The largest institutions already report their consolidated results in line with IFRS, which limits the banks' ability to smooth earnings, but generally leads to a more volatile earnings performance.
Important differences between Austrian and IFRS accounting affect the following areas:
Sphere of consolidation
IFRS generally requires a wider range of consolidation of subsidiaries. Differences may arise from the inclusion of controlled nonbanking entities, for example real estate companies, but also from the exclusion of financial institutions because the parent does not exercise significant or complete control.
Securities portfolio
Austrian GAAP differentiates between three types of securities: trading, liquidity, and investment securities. Trading securities are allowed to be valued at the lower of cost or market principle, whereas liquidity securities must be valued according to this same principle, while investment securities are valued at cost or below cost if a value depreciation is considered permanent. The classification is, to a certain degree, at the discretion of management.
IFRS distinguishes between trading securities, securities available-for-sale, and financial investments (held-to-maturity). Trading securities and available-for-sale securities are marked-to-market. In contrast to trading securities, changes in fair values of available-for-sale securities are recognized in shareholders' equity, with no effect on income until gains and losses are realized at their disposal. Financial investments must be valued at cost or below cost if a value depreciation is considered permanent. The impairment directly affects the profit and loss statement.
Goodwill
Whereas Austrian banks have the option to deduct acquired goodwill directly from equity or to amortize, IFRS requires that purchased goodwill is recognized as an asset and that an impairment test must be performed annually. Impairment losses affect bottom-line profitability of the particular year in which it is booked.
Treatment of provisions for pension fund liabilities
Under Austrian GAAP the calculation of these obligations is strongly influenced by the treatment for tax purposes, which tends to significantly understate actual future obligations. IFRS, in contrast, results in the disclosure of unfunded obligations--charged to equity. IFRS uses a long-term market rate as a discount factor and accounts for future increases in salaries and retirement benefits, resulting in more volatile annual contributions, generally at higher levels.
Risk provisions
The almost complete lack of meaningful insight into the asset quality and provisioning policy of Austrian banks has always been an area of criticism. Banks can, and do, compensate the net evaluation result of their liquidity securities portfolio--all securities that are not classified as trading or financial investment securities--with the evaluation of their credit risks. This makes it difficult to interpret the resulting net figure for risk provisions in the profit and loss statement and to draw comparisons over time or between banks. Austrian banks are also not required to report their credit losses, level of risk provisions, or the classification of NPLs, loans past due, or restructured loans. Regarding specific provisions, the somewhat vague guidelines state that doubtful debts are to be shown at their realizable value and that bad debts must be written off; however, it is at the discretion of the banks and their auditors to decide when a loan becomes doubtful. The fiscal authorities decide each case on its own merit.
Under IFRS, provisions for credit risks have to be assessed based on objective evidence of impairment, and movements in provisions (release/use) are disclosed in accounts. The risk provisions are reported as a separate line item under loans.
Appendix 1: Basic Data: Austrian Banking System
Number of banks
At year-end 2005, there were 880 authorized banks in Austria, of which 644 are cooperative banks (576 Raiffeisen and 68 Volksbanken), 57 savings banks, 44 private banks, and 10 Landeshypothekenbanks, with the remainder split between building savings banks and other, special-purpose banks. The international network of Austrian banks as a whole comprises 56 branches and representative offices in other countries. Some 11 Austrian banks have 54 subsidiaries in CEE. There are 25 banks in Austria with foreign majority ownership.
System deposits
The total deposits of Austrian residents--enterprises and private individuals, excluding public sector households--held in domestic banks and building savings banks amounted to €221 billion at year-end 2005, according to Austrian central bank data.
Deposits per capita
€27,000 at Dec. 31, 2005.
Form of regulation
The Austrian Financial Market Authority (FMA) acts as the primary supervisory body for banking, insurance, pensions, and capital markets. The FMA is supported by the Austrian National Bank (OeNB), which conducts on-site inspections, and examines regular reports from the banks and the reports of external auditors. All banks licensed in Austria must be audited annually and auditors have to be changed every six years. Detailed reports and information must be submitted to the regulators on a regular basis. The FMA supervises banks under the Austrian Banking Act (BWG) and several supplementary laws, notably the Financial Conglomerate Act, the Securities Supervision Act, the Savings Bank Act, and the Mortgage Act among others. Almost every kind of financial service that is offered commercially has to be approved by the FMA and is subsequently regulated.
Bank superintendent
The board of the FMA consists of Dr. Kurt Pribil and Dr. Heinrich Traumüller.
