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Rating Action:

Moody's downgrades ratings of seven Hungarian banks

05 Apr 2011

Note: On September 14, 2011, the press release was revised as follows: Corrected the releasing office to Moody's Italia S.r.l. from Moody's Investors Service Ltd. Revised release follows:

Milan, 05 April 2011 -- Moody's Investors Service has today downgraded the standalone bank financial strength ratings (BFSRs) of five Hungarian banks, which has resulted in the downgrade of those banks' deposit and debt ratings. These banks are: K&H Bank, Budapest Bank, FHB Mortgage Bank, Erste Bank Hungary and MKB Bank.

For two other banks -- OTP Bank and OTP Mortgage Bank -- Moody's has downgraded the local-currency deposit ratings, and downgraded the foreign-currency debt ratings for OTP Bank. Full details of the rating actions for each bank and their rationale are provided below.

Today's rating actions reflect the impact of the challenging operating environment on the banks' financial fundamentals.

RATINGS RATIONALE

Moody's says that overall, the rating actions reflect two major concerns for the Hungarian banking system, namely (i) sustained deterioration in asset quality, driven by the foreign-currency exposures in retail mortgage and commercial real-estate portfolios; and (ii) declining net profits.

ASSET QUALITY DECLINES, DUE TO FOREIGN-CURRENCY EXPOSURES, MORTGAGE MORATORIUM, AND MACROECONOMIC CHALLENGES

The rating agency noted that a key driver of the rating actions is the banks' high level of foreign-currency lending -- 70% of total loans are foreign-currency denominated -- especially loans originated in Swiss francs. "Many borrowers, particularly in the retail sector, are unhedged with regards to the currency risk on these loans. As a result, there is significant vulnerability to either a depreciation of the Hungarian Forint, or an increase in interest rates linked to these foreign currencies," says Simone Zampa, a Moody's Vice President and senior analyst.

Moody's notes that the Hungarian Government introduced a ban on foreign-currency lending in 2010. However, in Moody's view, the event risks imbedded in the system that stem from the foreign-currency exposures will remain for several years, given the long-dated maturity of the existing mortgage portfolios of the banks.

In addition, the moratorium on evictions relating to home-collateralised loans contributes to a further weakening of the banks' debtors payment discipline. The government introduced the moratorium in August 2010 on a temporary basis, aimed at protecting delinquent payers from being evicted. Moody's notes that the government recently extended the moratorium to July 2011 for home mortgages, although it was removed for home-equity loans. These loans represent about one-third of the home-collateralised loans within the system.

"The residential Hungarian real-estate market remains under pressure, with prices declining since 2008 and low liquidity in the secondary market. However, Moody's acknowledges that the gross debt-to-income ratio of households still remains below the EU average, which mitigates repayment pressures for borrowers," adds Mr Zampa.

NET PROFITS UNDER PRESSURE FROM DIMINISHING BUSINESS VOLUMES, HEIGHTENED RISK COSTS, AND NEW BANKING TAX

In 2010, the Hungarian banking system recorded a significantly lower level of profitability compared with 2009, with several banks reporting losses. Margins are maintained at solid levels compared with international peers, also due to the high interest-rate environment. However, the internal capital generation of the system has been significantly eroded by (i) the rapidly growing cost of risk; (ii) shrinking business volumes; (iii) more modest efficiency for some banks; and (iv) the tax on banks' assets. This extraordinary banking tax was introduced in 2010, accounted for about 25% of the pre-provision income of the system and will remain in place at least until 2012.

"These credit negative factors are affecting the ability of the less well-capitalised banks to maintain a sufficient capital buffer in the current uncertain macroeconomic environment. This may lead to further shrinking of risk-weighted assets and require retrenchment by some of the weaker entities," explains Mr Zampa.

Moody's acknowledges that in this environment, it is becoming more challenging for the Hungarian banks to sustain profitability and support economic growth. The economic outlook for 2011 is more promising, with Moody's forecasting GDP growth of about 3% and a decline in unemployment. However, the rating agency maintains the view that macroeconomic challenges will persist for the medium term.

Moody's believes that a major stabilising factor for the banking system has been its high level of foreign ownership, representing about 80% of capital at year-end 2010. Financially stronger parents have so far provided support in terms of capital and liquidity throughout the recent financial crisis. Moody's believes that this support is likely to continue, also considering the wider CEE strategy of the Western European parent banks. Of the seven banks included in this rating action, four are foreign-owned (K&H Bank, Budapest Bank, Erste Bank Hungary and MKB Bank),

Moody's has taken the following rating actions:

OTP BANK

Moody's has affirmed OTP Bank's standalone BFSR at D+ (mapping to Baa3 on the long-term scale) given that the bank has proved itself resilient in the face of the crisis and showed the benefits of the diversification.

However, Moody's has lowered the bank's local currency long-term and short-term deposit ratings to Baa3/Prime-3 from Baa2/Prime-2, mainly reflecting the fact that Moody's views OTP's operations as predominantly in Hungary, which represents its core market, and its risk profile and access to funding as closely interlinked with the Hungarian government. As such, Moody's also lowered OTP's foreign currency senior debt rating to Baa3 from Baa2, its subordinated debt rating to Ba1 from Baa3 and its junior subordinated debt rating to Ba2 (hyb) from Ba1 (hyb). The bank's foreign-currency deposit ratings were affirmed at Baa3/Prime-3 given that they were already constrained by the foreign-currency deposit ceiling for the country.

OTP's liquidity and funding strategy have been cautious and the bank has progressively reduced its leverage and increased its capital ratios, with a Tier 1 ratio at 14% at year-end 2010. Non- performing loans increased substantially in 2010; however, there is a very high provisioning coverage and the bank benefits from a high margin income in Hungary and other selected countries (Russia, Bulgaria, Ukraine). OTP also has exposure to foreign-currency mortgages, although this is lower compared with its peer group in Hungary.

Overall, Moody's said that the negative outlook on the ratings -- except the BFSR which carries a stable outlook -- reflects (i) the pressures in the Hungarian economic environment; and (ii) the fact that increased non-performing loans and provisioning needs may exert further pressure on the group's medium-term profitability. While the outlook on the BFSR is stable, the bank could become more weakly positioned in this category, resulting in its BFSR being mapped to Ba1 rather than Baa3 on the long-term scale.

OTP MORTGAGE BANK

Moody's has affirmed OTP Mortgage Bank's standalone BFSR at D+ (mapping to Baa3 on the long-term scale) and its foreign-currency deposit ratings at Baa3/Prime-3. The bank's ratings are the same as its parent's ratings, given that the bank is 100% owned and fully guaranteed by OTP Bank and it is an integral part of OTP Bank's franchise, and operates as the mortgage division of OTP Bank.

In addition, Moody's lowered the local-currency deposit ratings of the bank to Baa3/Prime-3 from Baa2/Prime-2, which are at the same level of its parent. The outlook on the ratings is negative, except the BFSR which carries a stable outlook.

Moody's expects that OTP Mortgage Bank's ratings will continue to follow the movement of its parent's ratings.

K&H BANK

Moody's downgraded K&H Bank's standalone BFSR to D (mapping to Ba2 on the long-term scale) from D+ (mapping to Baa3 on the long-term scale) and its local-currency long-term and short-term deposit ratings to Baa3/Prime-3 from Baa2/Prime-2. Moody's says that the downgrades reflect the rapid deterioration in non-performing loans and the potential pressure on the profitability of the bank from increasing provisioning needs. In addition, Moody's considers the bank's current capital buffer -- with a preliminary Tier1 ratio of 8.6% under IRB foundation at year-end 2010 -- as just adequate in the currently difficult operating environment. Furthermore, the rating agency says that it considers that the significant exposure of the bank to Hungarian government securities, especially in the trading book, makes it more vulnerable in an adverse economic scenario for the country. The bank's foreign-currency long-term and short-term ratings were affirmed at Baa3/Prime-3. The outlook on the ratings remains negative.

Moody's also acknowledges that (i) K&H Bank has a strong position in the Hungarian market in both corporate and retail businesses; (ii) its liquidity profile is better than most of its rated peers in the country; (iii) it has a less prominent position in lending to the problematic commercial real estate; and (iv) in 2010, the bank recorded a satisfactory level of profitability.

BUDAPEST BANK

Moody's downgraded Budapest Bank's standalone BFSR to D- (mapping to Ba3 one the long-term scale) from D (mapping to Ba2 on the long-term scale) and its local-currency long-term and short-term deposit ratings to Baa3/Prime-3 from Baa2/Prime-2. Moody's says that the downgrades reflect the rapid deterioration in non-performing loans and the potential pressure on the profitability of the bank from increased provisioning needs. Although Moody's notes that so far the bank has managed to sustain its financial performance, due to the difficult operating conditions Moody's believes that Budapest Bank's BFSR is better positioned at D-.

Moody's adds that the bank's high level of capitalisation, with a Tier 1 ratio of 12.8%, gives more comfort that it would be able to withstand a more adverse scenario, which is reflected by the stable outlook on the BFSR and the long-term local-currency deposit rating. However, the long-term foreign-currency deposit rating carries a negative outlook, in line with the foreign-currency deposit ceiling for the country.

FHB MORTGAGE BANK

Moody's downgraded FHB Mortgage Bank's standalone BFSR to D (mapping to Ba2 on the long-term scale) from D+ (mapping to Ba1 on the long-term scale) and its local-currency and foreign-currency long-term and short-term deposit ratings to Ba1/Not Prime from Baa3/Prime-3. Moody's says that the downgrades reflect the deterioration in non-performing loans, the bank's main focus on the difficult mortgage market and its significant exposure to wholesale funding. The capital buffer is satisfactory, with a Tier1 ratio at 11.3%. However, Moody's considers that the bank faces significant challenges (as discussed above), and as such, the outlook on the ratings remains negative.

FHB is among the three mortgage banks in Hungary with a license to issue covered bonds and has a robust market position in mortgage-loan refinancing, to other banks. Profitability in 2010 -- when excluding one off items -- was lower than in 2009. The bank has managed to maintain relatively good margins, due to (i) its capacity to pass higher funding costs to clients; and (ii) the high interest-rate environment. However, its non-performing loans and exposure to foreign-currency lending are substantial. The bank's market-fund ratio is high (although improving), following the increases in the deposit base over the past one and a half years.

ERSTE BANK HUNGARY

Moody's downgraded Erste Bank Hungary's standalone BFSR to D- (mapping to Ba3 on the long-term scale) from D (mapping to Ba2 on the long-term scale) and its local-currency and foreign-currency long-term and short-term deposit ratings to Ba1/Not Prime from Baa3/Prime-3. Moody's says that the downgrades reflect the rapid deterioration in non-performing loans and the significant pressure on the profitability of the bank from increased provisioning needs and the additional government tax, which accounted for about 17% of the bank's pre-provision income. Given the difficult operating environment and the just adequate capitalisation of the bank (with a Tier1 ratio at 7.6%), Moody's maintains a negative outlook on the BFSR. The outlook on the long-term local-currency and foreign-currency ratings is stable and reflects Moody's expectations of external support, especially from its parent, Erste Group Bank (A1/P-1/C- (BCA of Baa1), stable outlook).

Erste Bank Hungary has one of the largest retail franchises in Hungary. The bank recorded poor results in 2010, with margins remaining fairly good, while the much higher cost of risk and the bank levy have eroded the bank's profitability over the past year. The significant level of foreign-currency lending, especially in Swiss francs, has contributed to higher problem loans for the bank. The loan-to-deposit ratio is high, although most of the wholesale funding is covered by the parent. The bank also has some concentrations in the problematic commercial real-estate sector, with particularly high levels of non-performing loans.

MKB Bank

Moody's downgraded MKB Bank's standalone BFSR to E+ (mapping to B1 on the long-term scale) from D (mapping to Ba2 on the long-term) and its local-currency and foreign-currency long-term and short-term deposit ratings to Ba2/Not Prime from Baa3/Prime-3. As such, Moody's also lowered MKB's foreign currency senior debt rating to Ba2 from Baa3 and its foreign-currency subordinated debt rating to B1 from Ba1. Moody's says that the downgrades reflect the rapid deterioration in non-performing loans, the significant challenges the business model is facing also reflecting the high concentration in the problematic commercial real estate and the significant losses posted in 2010. The losses reflected the more than doubled provisioning needs, lower operating income and higher costs, which entailed capital injections from the parent banks. Given the difficult operating environment, the modest capitalisation (with a Tier1 at 7.5%) and the high sector concentration, Moody's views MKB Bank as being more vulnerable in an adverse scenario, reflected by the negative outlook on the bank's debt and deposit ratings. This stems from the fact that the bank could become more weakly positioned within the E+ BFSR category, leading to a lower mapping on the long-term scale.

MKB is among the largest banks in Hungary with a relatively good corporate franchise and with subsidiaries operating in difficult markets, such as Romania and Bulgaria. The bank has significant problematic commercial real-estate exposures within its loan book. The loan-to-deposit ratio is high, with funding support by the parent BayernLB (A1/P-1/D- (BCA of Ba3), on review for possible downgrade on the A1 rating) having increased over recent years. The bank also had a modest cost-to-income ratio in 2010.

The specific rating changes implemented today are:

OTP Bank

- Local-currency deposit ratings downgraded to Baa3/Prime-3 from Baa2/Prime-2

- Foreign-currency senior unsecured debt rating downgraded to Baa3 from Baa2

- Foreign-currency subordinated debt rating (Lower Tier 2) downgraded to Ba1 from Baa3

- Foreign-currency junior subordinated debt rating (Upper Tier 2) downgraded to Ba2 (hyb) from Ba1 (hyb)

- Foreign-currency deposit ratings affirmed at Baa3/Prime-3

- BFSR affirmed at D+, mapping to a BCA of Baa3

The BFSR carries a stable outlook, whilst all the other ratings -- including the BCA -- carry a negative outlook.

OTP Mortgage Bank

- Local-currency deposit rating downgraded to Baa3/Prime-3 from Baa2/Prime-2

- Foreign-currency deposit ratings affirmed at Baa3/Prime-3

- BFSR affirmed at D+, mapping to a BCA of Baa3

The BFSR carries a stable outlook, whilst all the other ratings -- including the BCA -- carry negative outlook.

K&H Bank

- Local-currency long-term deposit rating downgraded to Baa3/Prime-3 from Baa2/Prime-2

- BFSR downgraded to D from D+. The D BFSR maps to a BCA of Ba2

- Foreign-currency long-term deposit ratings affirmed at Baa3/Prime-3

All the above ratings carry a negative outlook.

Budapest Bank

- Local-currency deposit rating downgraded to Baa3/Prime-3 from Baa2/Prime-2

- Foreign-currency long-term deposit ratings affirmed at Baa3/Prime-3

- BFSR downgraded to D- from D. The D- BFSR maps to a BCA of Ba3.

The foreign-currency long-term deposit rating carries a negative outlook, whilst all the other ratings carry a stable outlook.

FHB Mortgage Bank

- Local and foreign-currency deposit ratings downgraded to Ba1/Not Prime from Baa3/Prime-3

- BFSR downgraded to D from D+. The D BFSR maps to a BCA of Ba2.

All the above ratings carry a negative outlook.

Erste Bank Hungary

- Local and foreign-currency deposit ratings downgraded to Ba1/Not Prime from Baa3/Prime-3

- BFSR downgraded to D- from D. The D- BFSR maps to a BCA of Ba3.

The BFSR carries a negative outlook, whilst all the other ratings carry a stable outlook.

MKB Bank

- Local and foreign-currency deposit ratings downgraded to Ba2/Not Prime from Baa3/Prime-3

- Foreign-currency senior unsecured debt rating downgraded to Ba2 from Baa3

- Foreign-currency subordinated debt rating (Lower Tier 2) downgraded to B1 from Ba1

- BFSR downgraded to E+ from D. The E+ BFSR maps to a BCA of B1

The BFSR carries a stable outlook, whilst all the other ratings -- including the BCA -- carry a negative outlook.

PREVIOUS RATING ACTIONS & METHODOLOGY USED

Moody's most recent rating action on OTP Bank was on 7 December 2010, when the local-currency deposit ratings and foreign-currency debt ratings were downgraded to Baa2 from Baa1. The foreign-currency long and short-term deposit ratings were downgraded to Baa3/Prime-3 from Baa1/Prime-2. The foreign-currency subordinated debt rating (Lower Tier 2) was downgraded to Baa3 from Baa2.

Moody's most recent rating action on OTP Mortgage Bank was on 7 December 2010, when the long-term local-currency deposit rating was downgraded to Baa2 from Baa1 and the foreign-currency debt ratings were downgraded to Baa3/Prime-3 from Baa1/Prime-2.

Moody's most recent rating action on K&H Bank was on 7 December 2010, when the long-term local-currency deposit rating was downgraded to Baa2 from A3 and the foreign-currency debt ratings were downgraded to Baa3/Prime-3 from Baa1/Prime-2.

Moody's most recent rating action on Budapest Bank was on 7 December 2010, when the foreign-currency deposit ratings were downgraded to Baa3/Prime-3 from Baa2/Prime2. The local currency deposit ratings were confirmed at Baa2/Prime-2.

Moody's most recent rating action on FHB Bank was on 7 December 2010, when the local and foreign-currency long and short-term deposit ratings were confirmed at Baa3/Prime-3.

Moody's most recent rating action on Erste Bank Hungary was on 7 December 2010, when the local and foreign-currency long and short-term deposit ratings were downgraded to Baa3/Prime-3 from Baa2/Prime-2.

Moody's most recent rating action on MKB Bank was on 7 December 2010, when the local and foreign-currency long and short-term deposit ratings were downgraded to Baa3/Prime-3 from Baa2/Prime-2. The foreign-currency senior unsecured rating was downgraded to Baa3 from Baa2 and the foreign-currency subordinated debt rating (Lower Tier 2) was downgraded to Ba1 from Baa3.

The principal methodologies used in rating this rating were "Bank Financial Strength Ratings: Global Methodology" published in February 2007, and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" published in March 2007, and "Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt" published in November 2009.

Headquartered in Budapest, Hungary, OTP Bank reported consolidated total assets of HUF9,781 billion (EUR35.04 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, OTP Mortgage Bank reported consolidated total assets of HUF1,681 billion (EUR6.02 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, K&H Bank reported consolidated total assets of HUF3,223 billion (EUR11.54 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, Budapest Bank reported consolidated total assets of HUF911 billion (EUR3.26 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, FHB Mortgage Bank reported consolidated total assets of HUF873.3billion (EUR3.13 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, Erste Bank Hungary reported consolidated total assets of HUF2,984 billion (EUR10.7 billion) as of 31 December 2010.

Headquartered in Budapest, Hungary, MKB Bank reported consolidated total assets of HUF2,939 billion (EUR10.53 billion) as of 31 December 2010.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, and confidential and proprietary Moody's Investors Service information

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

The rating has been disclosed to the rated entity or its designated agents and issued with no amendment resulting from that disclosure.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entity or its related third parties within the three years preceding the Credit Rating Action. Please see the ratings disclosure page www.moodys.com/disclosures on our website for further information.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Milan
Simone Zampa
Vice President - Senior Analyst
Financial Institutions Group
Moody's Italia S.r.l
Telephone:+39-02-9148-1100

London
Yves Lemay
MD - Banking
Financial Institutions Group
Moody's Investors Service Ltd.
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Moody's Investors Service Ltd.
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Moody's downgrades ratings of seven Hungarian banks
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Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be reckless and inappropriate for retail investors to use MOODY’S credit ratings or publications when making an investment decision. If in doubt you should contact your financial or other professional adviser.

Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.