OREANDA-NEWS. The improvement in asset quality at Hungarian banks in 2015, when the stock of non-performing loans (NPL) fell by 26%, should continue in 2016, says Fitch Ratings. This is positive for a banking sector that has struggled with asset quality problems since the 2008-2009 financial crisis.

The most significant improvements are in the corporate loan books but the conversion of Swiss-franc mortgages into local currency in 2015 also provided some relief to retail borrowers. We expect this trend to continue because a supportive operating environment is stalling the inflow of new NPLs, defined as loans overdue by at least 90 days, and legacy loan books are already well seasoned. The Hungarian regulators also introduced incentives for banks to clean up their impaired commercial real estate (CRE) exposures.

NPL ratios are nevertheless still high, with NPLs representing 11.7% of total banking sector gross loans at end-2015. Household portfolios display the weakest ratios (17.5%, equivalent to 60% of total sector NPLs) but the quality of corporate lending is also troubled (7.9%). Corporate NPLs are largely linked to CRE development and investment projects that were impaired in the aftermath of the financial crisis.

In 2015, corporate NPLs fell by HUF371bn (EUR1.2bn), equivalent to 35% of the stock of non-performing corporate loans held at end-2014. This reflects accelerated efforts by the banks to reserve, write off and sell the NPLs. We think this trend will continue, spurred, in part, by regulatory measures. In October 2015, the Hungarian central bank's Financial Stability Council announced the introduction of a systemic risk capital buffer, effective from 2017. Banks will have to hold additional capital against their distressed CRE exposures. We believe this will provide a strong incentive for banks to continue to sell or write off these exposures over the coming months.

The establishment of MARK in November 2015, a state-funded investment vehicle that will acquire non-performing CRE portfolios from banks, could, we believe, provide a useful mechanism through which banks can shift NPLs off their balance sheets. MARK has the capacity to acquire up to HUF300bn (EUR1bn) of NPLs. This is equivalent to 40% of total corporate NPLs in the sector at end-2015. However, MARK's ultimate success will depend on whether an agreement can be reached with the banks on NPL values.

The quality of the retail portfolio is likely to remain weak for an extended period because foreign-currency mortgage conversions are unlikely to cure the majority of already defaulted borrowers, demand for new loans is muted and foreclosure procedures are largely ineffective, slowing recoveries.

Hungary's operating environment is improving and this should prevent a renewed build-up of NPLs. We forecast GDP growth of 2% in 2016 and the outlook for the sovereign's 'BB+' rating was revised to Positive in November 2015, reflecting the country's strong economic performance.