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The banking system in eastern Europe is increasingly vulnerable to a severe economic downturn, Moody’s has warned, saying western European banks with local subsidiaries are at risk of ratings downgrades. “The relative vulnerabilties in east European banking systems will be exposed by an increasingly tougher operating environment in eastern Europe as a result of a steep and long economic downturn coupled with macroeconomic vulnerabilities,” Moody’s said in a report. The ratings agency said it expected “continuous downward pressure on east European bank ratings” because of deteriorating asset quality, falling local currencies, exposure to a regional slump in real-estate and the units’ reliance on scarce short-term funding. Eurozone banks have the largest exposure to central and eastern Europe, with liabilities of $1,500bn – about 90 per cent of total foreign bank exposure to the region. Shares of the handful of banks with substantial investments in eastern Europe – led by Austria’s Raiffeisen and Erste Bank, Société Générale of France, Italy’s UniCredit (which owns Bank Austria) and Belgian group KBC – tumbled after the ratings agency said it was concerned about the impact of a slowdown and the ability of the parent banks to support their support units in the region. The Austrian banking system is the most vulnerable, with eastern Europe accounting for nearly half of its foreign loans, while Italian banks are exposed to Poland and Croatia and Scandinavian institutions to the Baltic states. Central and eastern European currencies have come under intense pressure in recent weeks. The credit crisis has raised fears over the region’s ability to finance its current account deficits and slowing global growth has heightened concerns over the health of its export-dependent economies. The Polish zloty plunged to a five-year low against the euro on Tuesday, while the Czech koruna hit a three-year trough against the single currency and the Hungarian forint falling to a record low. The Prague and Warsaw stock indices meanwhile fell to their lowest levels in five years, while the smaller markets of Budapest, Zagreb and Bucharest skirted close to multi-year lows. The euro dropped to a two-month low against the dollar on Tuesday on heightened concerns over eurozone banks’ exposure to the worsening conditions in eastern Europe. Amid the growing sense of crisis in eastern European economies, Hungary on Tuesday outlined plans to save Ft210bn (€680m, $860m) this year to prevent an increase in the budget deficit. Hungary’s economy is expected to contract by up to 3 per cent this year, much more than earlier expectations. Antje Praefcke at Commerzbank said eastern European currencies were in a “self-feeding depreciation spiral.” “The creditworthiness of local banks, companies and private households, who hold mainly foreign currency denominated debt, is deteriorating with each depreciation in eastern European currencies, thus further undermining confidence in the currencies,” she said. Ms Praefcke said further depreciation of eastern European currencies was thus a distinct possibility, which was likely to undermine the euro. “The collapse of these currencies is likely to constitute a risk for the euro,” she said. “So far markets have largely ignored this fact, but are unlikely to be able to maintain this approach if the weakness of the eastern European currencies continues.” Western European banks have piled into the former Communist countries in recent years as economic growth in the region outpaced domestic gains. The accession of 10 new members to the European Union in 2004, and of Romania and Bulgaria in 2007, added to optimism about the region. In 2007, Raiffeisen and Erste Bank earned the vast majority of their pre-tax profits in eastern European countries including Russia and Ukraine. Since the onset of the global financial crisis, Hungary, Latvia and Ukraine have all received emergency loans from the International Monetary Fund, with other countries in the region expected to follow.

Laurentian thrives in trying times PETER HADEKEL, Freelance Published: 7 hours ago In the midst of the worst banking crisis in decades, small, regional-based Laurentian Bank is beating the pants off its much larger rivals. Earnings are up more than 30 per cent so far this year, and Laurentian stock has risen 37 per cent since January. That compares with a 14-per- cent decline for Bank of Montreal shares, a one-per-cent drop at Royal Bank and a 21-per-cent fall at CIBC. The TMX financials index is down nine per cent over the same period. Laurentian has plenty of cash and its capital ratio is among the best in the industry, Réjean Robitaille says. So much for the talk that a small financial institution could not survive in an age of behemoths. Laurentian, the country's seventh-largest bank, had only a tiny exposure to the asset-backed commercial paper market that collapsed in Canada and no exposure to the U.S. mortgage market. It's one of the few feel-good stories in the current financial mayhem. In contrast, big mortgage lenders and an investment bank in the U.S. have gone down, and huge writeoffs have been taken at most of the big banks in Canada. "It's bad," Laurentian CEO Réjean Robitaille said yesterday when I asked him about the troubles hitting the financial system. This week, the U.S. nationalized mortgage lenders Fannie Mae and Freddie Mac, while investment bank Lehman Brothers teetered on the brink. But investors shouldn't lump all financial institutions together, he says. In this case, small really is beautiful. "Look around the world, there's a lot of institutions that may not have the same size as others but that are doing quite well. Why is that? Because they have a good focus, and strong execution. "Look at what happened in the United States to the big players. ''Nobody four or five years ago would have said that Bear Stearns or Lehman Brothers" would get into trouble, Robitaille said. Clearly, being a giant is no advantage right now. Laurentian may not have the same scale as some of its rivals, but it can react more quickly. Give it credit for making some smart moves. Its total exposure to the troubled non-bank, asset-backed commercial paper market, frozen last year under the so-called Montreal Accord, is just $20 million. Of that amount, about $4.3 million has been written off. It wasn't dumb luck. The Laurentian credit committee wasn't comfortable with the ABCP market or with other exotic securities that other banks piled into, Robitaille said. "We've got a lower risk profile. ... We weren't in subprime lending or structured investment vehicles or derivatives," he said, rhyming off some of the complex products that have backfired on bigger banks. As a result, the balance sheet is strong and conservatively funded to a large extent by personal deposits. Laurentian has plenty of cash - about $4.5 billion - and its capital ratio is among the best in the industry, Robitaille says. In this case, lack of ambition has served it well. Five years ago, it sold 57 branches in Ontario to TD Bank, deciding that it couldn't afford to spread itself too thin. "We can't be everything to everyone," Robitaille says. The bank has identified three areas where it's focusing its energy and investment. These include the retail and small business market in Quebec, commercial real estate lending across Canada and financial products marketed to independent financial advisers. The bank also maintains a foothold in the investment business through Laurentian Bank Securities. Ironically, given the troubles banks have had in housing in the U.S., Laurentian is doing well by securitizing mortgages in Canada. It packages federally insured Canada Mortgage and Housing Corp. home loans for resale to investors, earning a profitable spread when it does so. "It's a very good product," Robitaille says, and this has turned out to be "the cheapest way to fund the bank." Third-quarter earnings per share were a record for Laurentian. "In a challenging year for banks, this is exceptional," said Desjardins Securities analyst Michael Goldberg in a research note. phadekel@videotron.ca