OREANDA-NEWS. December 30, 2011. Renaissance Capital, the leading emerging markets investment bank, has initiated research coverage of Hungary’s OTP Bank with a HOLD rating and 12-month target price of HUF3,550. The key takeaways from OTP’s financials and the wider Hungarian macro picture lead Renaissance analysts to the following conclusions:

Despite all the headlines about economic woe in Hungary, OTP’s core home unit has maintained a respectable level of profitability throughout the period.

Leverage remains low, as OTP Hungary has a strong deposit franchise.

Capital is very robust, with equity/assets at nearly 20%.

Despite running provisioning charges at nearly 3% of average gross loans, due to OTP’s high margin base, the return on equity remains semi-respectable, slightly below the 10% level; while a return on assets of nearly 1.8% hides any signs of underlying stress.

The report, OTP Bank: Love Hate Love Hate, notes that OTP has among the highest margins and pre-provisioning return on equity of EMEA banks. OTP Group’s net interest margin was 6.6% at FY10 – a figure surpassed only by Sberbank within a liquid EMEA bank context. “This underlying earnings power is driven by the home market of Hungary where OTP has a dominant franchise and high inflation/interest-rate-led asset prices,” note Renaissance analysts, “and is further supported by Group expansion into higher-margin countries like Russia, Bulgaria and Ukraine.”

OTP Group has operations based in nine countries across CEE and the CIS, with Hungary remaining its principal hub and where the majority of its assets and earnings are derived. Given that this is an initiation of coverage report, Renaissance has taken the opportunity to delve deeper than normal into the macro backdrop that drives the OTP story, and in particular focus on Hungary’s political and macro dynamics in terms of structure and outlook.

Analysts note that Hungary’s country balance sheet is weak and indebted, while its government is populist and unorthodox in policy stance. Renaissance currently forecasts Hungary’s GDP growth in 2012 at 0.2%, with a downward bias, while the Firm expects an ongoing tightening policy bias as the central bank places currency support ahead of economic growth.

A much-discussed IMF deal for Hungary remains on the cards, but is inconclusive to date. “The current Fidesz ruling government is clearly enjoying its two-thirds majority in parliament, and not treading too lightly or diplomatically regarding policy actions,” cautions the report. “The banking sector is feeling the brunt of populist policies today, as the state looks to shield the individual at all costs while trying to rid the system of its FX imbalance and minimise its budget deficit at the same time.” From OTP’s side, there is a general understanding that the bank will need to provide financial support for any solution, the report notes.

Renaissance sees a lack of transparency and inclusion in policymaking (lobbying power today is near-zero) and ongoing speculation and talk about more legislation/rulings to come on this front, as the biggest unknown threats to system profitability, in the short-to-medium term.

“We hate sitting on the fence, but OTP has us wedged to it,” says David Nangle, Head of Equity Research, Renaissance Capital. “The stock simply looks too dangerous top-down for us to make a strong short-term call. Medium-to-longer term, we see how OTP could offer a real value story for investors. We love OTP’s earnings power and we hate Hungarian macro and politics which leaves us uncomfortable making that recommendation today,” he added.

Renaissance believes OTP’s share price will remain a prisoner of Hungary’s top-down macro and political developments, despite all the positive micro-level aspects of the OTP investment case. For the stock to be re-rated, investors would want to see more soundness, stability and predictability in OTP’s domestic market, concludes the report – although Renaissance analysts believe this is unlikely any time soon.