KOTOR, Montenegro: Slightly smaller than Connecticut, the Balkan state of Montenegro is a good place to view the clear waters of the Adriatic, charming medieval cities such as Kotor, and a financial crash in suspended animation.
Defaults and late bank payments are soaring, threatening the banking sector and overall economy of the European Union-applicant country. Formerly part of the Yugoslav Republic, Montenegro uses the euro currency from outside the eurozone.
Similar scenarios have played out in countries as varied as Ireland, Iceland and Latvia. And although tiny Montenegro is unlikely to rock the Western financial world, it could signal continued ructions in emerging Europe.
Gambling on a recovery in real estate prices, some Montenegrin banks are seeking to buy time with schemes including refinancing, opaque property funds and revolving credits.
"Banks are looking for a way to take out the toxic assets," said Dragan Prelevic, a leading real estate lawyer.
Global finance experts say some banks are also shuffling loans between themselves. One executive who spoke on condition of anonymity described banks borrowing from each other to finance loan repayments, a pattern of repeat borrowing that some clients also follow on a smaller scale.
"We do that every few months, that's how you survive," the executive said. "Unfortunately, it is legal."
Bankers across ex-Communist Eastern Europe may have been too slow to recognise possible losses from bad debt in wake of the collapse of property markets, experts say.
Bank delay in declaring loans in default and disposing of the property used as collateral may not be a problem if real estate prices recover. If they don't, it could affect such parent banks as Hungary's OTP, Hypo Group Alpe Adria of Austria, Societe Generale and Slovenia's NLB.
Just on Dec 14 Austria nationalised Hypo, which has a big presence in the Balkans including Montenegro, amid concerns it was on the brink of collapse. The bank's Montenegro spokeswoman declined comment for this article, citing its "very sensitive" current situation.
Central bank head Ljubisa Krgovic says a quarter of all credits in Montenegro are paid late, and 10% are non-performing and likely to be booked as losses.
By comparison in Ukraine -- where economic chaos prompted the International Monetary Fund recently to delay the release of a US$3.8 billion (RM13.05 billion) loan instalment -- about 30% of all loans were impaired at the end of the second quarter.
Montenegrin banks are required to keep just 10% of deposits on hand, so have had more leeway than in countries such as Serbia, which has a 40% reserve requirement.
Dave Perrault, an American former stock day-trader, has first-hand experience: he invested a €1 million (RM4.95 million) of his own money in real estate in the state of 650,000 in 2005.
Banks in Montenegro, which won independence from Serbia in 2006, "are at various stages of denial as to how badly they overvalued various properties in the boom", he said.
Some are extending grace periods or renegotiating terms, a move which keeps bad debt off their books.
Montenegro's largest bank, Crnogorska Komercijalna Banka (CKB), an OTP subsidiary, has restructured between a quarter and a third of its loans, said executive director Gyorgy Bobvos. International banks have tougher standards, he said.
Lawyer Prelevic said some banks in Montenegro are going further. "They are making parallel real estate funds that take it over. This is just buying time," he said.
In the past, some loans to real estate special purpose vehicles (SPVs) could stay off bank balance sheets on the assumption they were safe investments. As falling real estate prices made the loans riskier, banks have been obliged to increase provisions for the loans that went bad.
Predrag Drecun, director of the largest domestically owned bank, Prva Banka, said the bank had wanted to create its own SPV to sell assets to a foreign investor, but it was barred by regulators following a government bailout last year.
Branka Pavlovic, chief executive officer of Societe Generale's Podgoricka Banka, said her bank had not used SPVs to keep assets off the books, but was considering creating one to fund a new headquarters office.
Crtomir Mesaric, chief executive officer of NLB Montenegrobanka, said its subsidiary had renegotiated less than 20% of retail loans.
Foreign banks have lent US$3.6 billion to clients in Montenegro, according to Bank for International Settlements data for first-half 2009. Italian banks had the biggest exposure -- US$2.23 billion, mainly through direct loans to Montenegrin banks and firms -- followed by German banks at US$1.15 billion. This is tiny compared with the hundreds of billions European banks have lent to emerging Europe.
"If (Montenegrin) banks do not get rid of the toxic real estate they financed at huge prices, they will be faced with the need to tremendously capitalise the banks," the lawyer Prelevic said. "In that case I think some of them will be bankrupted."
The crisis has not diminished the charm of real estate in places such as Kotor, where medieval walls climb a steep mountain above the town and a placid bay.
In the mid-2000s Russians, lured by visa-free travel and the welcoming Montenegrins who share their Orthodox Christian faith, led a charge of foreign investors into the popular tourist country. Around Kotor, the British and Irish were also big buyers.
Land and property sales in Kotor and its surrounding region tripled in euro terms from 2005 to 2006 and again the next year.
While foreigners financed abroad, domestic banks lent easily to locals, often using optimistic property valuations to back up loans. Some borrowers used the same property as collateral at different banks.
"The risks... were compounded by the fact that one, the loans had largely been collateralised by real estate; and two, the widening credit/deposit gap was financed by the domestic banks borrowing from their foreign mothers," said Jan-Peter Olters, the World Bank representative in Montenegro.
In the walled city of Kotor, Mayor Marija Maja Catovic reflects on a situation often seen elsewhere: "It was euphoria and most people were thinking only about quick money, not the long term."
Now the real estate market has essentially frozen. Even a visit by Playboy model and actress Pamela Anderson to view property earlier this year was no help. She left without buying.
Some see parallels with eurozone member Ireland, flung into crisis after its booming property market slumped in 2007.
"The same as in Ireland, a lot of the developers will have to throw the keys back, as we say in Ireland, because they just can't service the debt," said Kieran Kelleher, managing director for real estate agency Savills in Montenegro and Croatia.
The real estate boom helped make Montenegro one of the big success stories in the Balkans in recent years, with GDP growth of 8.6%, 10.7% and then 7.5% for the three years ending in 2008. This year it is likely to contract 4% or 5%.
Many expect Montenegro to turn to the IMF in 2010. The government estimates it will need €100 million to €200 million in external financing, the central bank puts this at €300 million, and some bankers see the shortfall nearer €500 million.
As is common in the Balkans, politics complicates the picture. Prime Minister Milo Djukanovic's brother, Aco, is the largest shareholder of the biggest domestically owned bank, Prva Banka, which received a 2008 bailout loan of €44 million.
That loan has since been repaid, and the central bank banned the bank from making new loans. But central bank head Krgovic said regulating the bank was a challenging task. "You are under special pressure," he told Reuters.
The prime minister said he bows out of Prva Banka decisions: "We should extend a hand to any bank, no matter who the shareholders are," he told Reuters.
Drecun of Prva Banka said 10% of its loans are "problematic" but the bank still had greater liquidity than required by law.
He said his bank, anticipating a revival, was now moving more aggressively than its rivals to collect the real estate collateral for non-performing loans, and had gathered between €20 million to €30 million worth in recent months.
"If you wait until the second half of next year, we are awaiting the recovery of the real estate market," he continued. "It is no problem for us to hold for two years. But we think that in six months to one year we will sell all assets." -- Reuters
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