Negative outlook on Austrian banking remains

The outlook for Austria's banking system remains negative, unchanged since 2009, Moody's Investors Service said in a new report reflecting an expectation that, despite growing evidence of economic stabilisation, banks’ fundamentals will remain weak because of exposures to volatile Central and Eastern Europe (CEE) markets that account for 30% of banking assets.
The outlook also takes into account Austrian public authorities' reluctance to provide support to senior unsecured creditors of troubled banks, thus affecting the overall creditworthiness of rated banks.
Moody's said it expects Austria's real GDP growth to accelerate to 1.7% in 2014 — reversing two years of economic slowdown. The rating agency attributes the GDP recovery to an upturn in external demand from main trading partner Germany, coupled with similar trade links with the Czech Republic, Slovakia and Poland whose GDP is forecast to grow by 2-3% this year.
However, Austrian banks are also exposed to more volatile economic conditions in other CEE countries including Russia and Ukraine whose economic outlook has deteriorated in recent months. The challenging operating environment in these countries will likely constrain asset quality and profitability of local banks, including the CEE subsidiaries of Austrian banks.
Notably, the European Central Bank's Comprehensive Assessment, which includes a review of banks' asset quality, could lead to an increase in the volume of reported non-performing loans — in particular, large foreign-currency lending exposures in Austria and CEE countries could be prone to reclassifications.
Moody's expects the aggregate problem loan ratio to weaken to around 11% in 2014 which includes two distinct underlying regional trends. In Austria and export-led CEE countries (Czech Republic, Poland, Slovakia), Moody's expects asset quality to improve on the back of accelerating economic growth and the low indebtedness of corporate and household borrowers. In other CEE markets, including Russia, Moody's expects corporate and retail loan delinquencies to rise.
Moody's also observes that Austrian banks exhibit fairly limited loss-absorption capacity, as illustrated by weak profitability and an aggregate Tier 1 ratio of 11.6% at year-end 2013 (under Basel 2.5), which lags behind that of European peers.
Moreover, Austrian banks remain vulnerable to shocks, although capitalisation levels will likely continue to improve this year because of a reduction both in risk-weighted assets and in earnings retention. Under Moody's adverse scenario, the aggregate Tier 1 ratio for the system would drop below regulatory minimums primarily as a result of losses stemming from the large exposures in CEE countries.
Nonetheless, Moody's noted that Austrian banks' funding profile has improved over the past few years, as the loan-to-deposit ratio dropped to 126% at year-end 2013 from 141% in 2010. Austrian banks also benefit from large deposit franchises in their home market and have been using this source of stable and relatively low-cost funding to extend loans in higher-margin CEE countries via their local subsidiaries.
In the past, Austrian banks have benefited from a highly supportive government. However, Moody's foresees a diminished willingness of the Austrian government to provide support to ailing banks, which will, in turn, affect the overall creditworthiness of Austrian banks. In addition, the negative outlook takes into account uncertainties associated with the forthcoming bank resolution framework which details how shareholders and creditors could be required to share in resolution costs via a bail-in.