The Hungarian Loan Consolidation Program

Prior to the implementation of the LCP, the Hungarian government passed three laws that amended and established requirements related to banking, bankruptcy, and accounting standards. The Banking Act of 1991 required banks to provision for loan losses and achieve a CAR of 8% by January 1994. The Accounting Act of 1991 required that companies prepare financial statements that conformed with International Accounting Standards (Ábel and Szakadát 1997). The Bankruptcy Act of 1991 set an automatic trigger for bankruptcy, requiring firms with debts more than 90 days past due to initiate bankruptcy (Nováková 2003). These regulatory changes revealed the high level of NPLs in Hungary and had an “unprecedented impact on the financial sector” (Ábel and Szakadát 1997).

At the end of 1991, the government issued guarantees to banks for a portion of the loans transferred as part of the 1987 financial sector reform; these loans were increasingly deteriorating in quality. The guarantees covered loans that had been extended primarily to the state-owned coal mining sector, with a total of HUF 10.5 billion in debt at face value covered by the government guarantees. The measure proved insufficient to address the full scope of banking sector problems—many inherited loans were nonperforming, and banks continued to lend in an “imprudent” manner because of the possibility of a future recapitalization or government guarantee (IMF 1995).

In 1992 and 1993, the Hungarian government adopted both a bank-oriented LCP and firm-oriented LCP to address the prevalence of nonperforming loans and weakness in the banking sector (Balassa 1996). For the firm-oriented program, the debt of certain state-owned enterprises (SOEs) was eligible for exchange; this program was not directly targeted at the banks, but banks were an indirect beneficiary as the government purchased eligible SOE debt from the banks (Ábel and Szakadát 1997). Beyond the consolidation programs, the government took resolution and restructuring action for three banks in 1993 (Balassa 1996; Ábel and Szakadát 1997).

Despite removing NPLs from the banking system, the Hungarian banks continued to experience high levels of NPLs, and the Hungarian government followed the LCP with a recapitalization program in 1993–1994 (Ábel and Szakadát 1997). Under the recapitalization program, a bank received capital from the government on the condition that it entered into an agreement (a consolidation contract) regarding plans for reorganization and debt resolution (IMF 1995).

Legal authority for NPL acquisitions came from government resolutions and the annual budget laws that provided for the issuance of consolidation bonds (Balassa 1996). Specifically, the 1993 budget law authorized the government to issue the credit consolidation bonds (Bonin and Schaffer 1995).

According to Balassa (1996), the government “would have been warranted to specify the goals and rules of the entire [bank restructuring] process in the form of a law enacted by Parliament.” However, the government did not submit a bill, and Balassa attributes it to factors including “the uncertainties in forecasting the dimensions of the entire series of actions, the step-by-step evolution of the methods applied, the technical complications of the matter and the rightful concern that the preparation and discussions of the bill would take so long that the necessary measures would not have been possible to implement.”

The LCPs differ from other AMC-type interventions because the government did not establish a centralized resolution agency. The Hungarian LCPs were administered by the MoF, which did not receive special legal authority. A portion of the bank-oriented LCP debt was sold to the state-owned Hungarian Investment and Development Bank (HIDB) which did not appear to have special legal authority. For the firm-oriented LCP, the two state-owned agencies—the State Property Agency (SPA) and the Hungarian State Holding Company (HSHC)—were responsible for resolution and disposal of the debt purchased by the state. The HSHC forgave all of the outstanding claims against the eight companies within its portfolio, but the MOF legalized this action only after it occurred. The SPA did not have such legal authority because of its status as a budgetary agency, and thus used other methods to resolve the debt (see Key Design Decision No. 13 on recovery and disposal) (Balassa 1996).

The Hungarian government intended for the LCP to transfer bad debt off the balance sheets of Hungarian banks. The HIDB, SPA, and HSHC were established independently of the LCPs, but these agencies were responsible for the resolution of a portion of the LCP debt. These agencies had separate purposes and resolution methods available to them. For example, the HSHC forgave its entire portfolio of debt from the firm-oriented LCP. Under the firm-oriented LCP, enterprises were chosen based on their strategic importance: the government considered their “survival for reasons of ‘industrial policy’ as necessary” despite their indebtedness. These companies were also considered important from an employment policy standpoint (Balassa 1996). Therefore, an important consideration in the resolution of debt under the firm-oriented LCP was ensuring the survival of these strategic enterprises.

The Hungarian government rejected proposals for a centralized asset management agency—multiple government agencies including the MoF, NBH, and the State Banking Supervision (SBS) objected to the proposal for a centralized AMC. According to Balassa (1996), the reasons for objections included the predicted difficulty in staffing such an agency, the threat that the agency would have forgiven the debts, and the concern that the method would not utilize the existing knowledge and relationships of the banks.

The Hungarian LCP differs from traditional AMCs because the majority of bad debt purchased by the government remained with the banks for resolution, at least in the short term. A portion of the bad debt purchased by the Ministry of Finance from the Hungarian banks was sold to the Hungarian Investment and Development Bank (HIDB), which was fully owned by the government (Ábel and Szakadát 1997).

Under the firm-oriented LCP, the government transferred the acquired debt to the Hungarian State Holding Company and the State Property Agency, both of which were government-owned property management companies (Balassa 1996).

The Hungarian MoF was responsible for the administration of the LCP, and the HIDB was able to purchase a portion of bad debt under the bank-oriented LCP. For the firm-oriented LCP, the government transferred SOE-related bad debt to the Hungarian State Holding Company and the State Property Agency.

As a part of the acquisition process, a state agency was responsible for confirming that the banks had classified the loans that were to be transferred properly (Balassa 1996).

The Hungarian government did not announce a predetermined size for the LCP. Banks could voluntarily and independently determine which loans they wanted to sell to the government, and prior to the program launch, banks sought to remove HUF 150 billion from their balance sheets (Ábel and Szakadát 1997). However, the government ultimately purchased bad debt with a book value of HUF 102.5 billion in exchange for HUF 81.3 billion in consolidation bonds in 1992. In 1993, the government purchased an additional HUF 17.3 billion in bad debt from banks at face value; therefore, the total book value of debt purchased from Hungarian banks under the bank-oriented LCP was HUF 120.5 billion, in exchange for approximately HUF 100 billion in consolidation bonds. Under the firm-oriented LCP, the government purchased a book value of HUF 61.3 billion in bad debt in exchange for HUF 57.3 billion in consolidation bonds (Balassa 1996).

According to Balassa (1996), the Hungarian government had two options for assuming the financial burden of the banking system restructuring: either pay in cash or use government securities. At the time, the Hungarian government would not have been able to use cash unless it received a loan from a multilateral institution, such as the International Monetary Fund or World Bank, but the government was not able to receive a loan from such an institution. Therefore, issuing government securities was the only available funding source for the consolidation program. Consolidation bonds, which were transferred in exchange for bad debt, were authorized under the state budget law and increased the state debt (Ábel and Szakadát 1997; Balassa 1996).

For the bank-oriented credit consolidation, domestic banks with CAR of less than 7.25% as of the end of 1992 could participate. A total of 14 banks and 69 savings cooperatives participated in the credit consolidation (Ábel and Szakadát 1997).

The firm-oriented credit consolidation program did not specify the eligible financial institutions; rather, there was a government-identified list of eligible SOEs for which it would purchase outstanding bank debt in exchange for consolidation bonds.

Eligible domestic banks could sell loans that were classified as “bad” that had been issued prior to October 1, 1992 (IMF 1995). From these loans, the bank could choose which loans to transfer—the LCP did not require that banks transfer all such assets to the government. Housing loans, consumer loans, and loans to foreigners or financial institutions were not eligible for transfer under the LCP (Ábel and Szakadát 1997).

In setting the time-based criteria for the loans, the MoF elaborated on its rationale, noting that including more current loans would have increased moral hazard, “stimulat[ing] the banks to be irresponsible in their lending policies” (Ábel and Szakadát 1997). Therefore, the MoF sought to mitigate moral hazard risks when it set the criteria for eligible assets.

For the firm-oriented LCP, the government determined a list of specific firms whose outstanding debt was eligible for purchase. These included Hungarian Railways (MÁV), 13 industrial SOEs, eight food processing firms, and several agricultural cooperatives and state-owned farms (Ábel and Szakadát 1997). These firms were considered “strategic” to the economy and designated as “privileged enterprises,” as the government considered their survival to be necessary even though the firms were heavily indebted (Balassa 1996).

In exchange for bad loans, the government issued consolidation bonds. Under the bank-oriented LCP, bond issuance totaled nearly HUF 100 billion while the total bonds issued under the enterprise-oriented LCP totaled HUF 57.3 billion (Balassa 1996). Initially, there were two types of bonds: Series A and Series B. Series A bonds were issued in exchange for principal while Series B bonds were exchanged for interest arrears and fees. The Series A bonds paid a market-based interest rate, had a 20-year maturity, and were freely negotiable (IMF 1995). Series B bonds, which were planned to pay only half of the market interest rate, were later converted by the government into Series A bonds (Ábel and Szakadát 1997; IMF 1995). Initially, as part of the Series B bonds, the government planned to impose a consolidation fee on the banks, which would have decreased the interest income stream by 50%, but the government ultimately removed the consolidation fee by converting the Series B bonds to Series A bonds (Ábel and Szakadát 1997).

The government exchanged consolidation bonds for loans classified as “bad” as of the end of 1992. The purchase price was dependent on when the loan was classified as bad:

• For loans classified as bad before 1992, the government paid 50% of face value;
• For loans classified as bad in 1992, the government paid 80% of face value (Balassa 1996).

The discounted portion of debt was charged against the banks’ provisions (IMF 1995).

In certain cases for specific debtor companies, the government paid 100% of face value (Balassa 1996). For example, debt that had been guaranteed by the government and debt that was held from a company that was restructured by the State Property Agency or the State Assets Holding Company could be transferred for 100% of face value with the approval of the MoF (Ábel and Bonin 1993).

The Ministry of Finance sold HUF 40 billion in face value of bad debt from the bank-oriented LCP to the Hungarian Investment and Development Bank (HIDB) for management. The HIDB opted to purchase the debt from companies “whose reorganization and improvement seemed promising” and ultimately acquired debt from 56 enterprises. The HIDB had three options for resolution or disposal: debt-to-equity conversions, debt rescheduling, or debt forgiveness. Of the claims purchased by the HIDB, 95% were against companies under liquidation. Overall, 19 companies were successfully reorganized (Balassa 1996).

For the remaining debt, the Ministry of Finance entered into three-month contracts with the selling banks where the bank remained responsible for the management of the debt. These contracts were renewed every three months through the middle of 1994 (Balassa 1996). The MoF offered the remaining debt for sale to companies that engaged in the management of bad debt, but only a small portion (HUF 7 billion) was sold in this manner (Balassa 1996; Ábel and Szakadát 1997). In 1995, the HIDB began to manage the remaining HUF 63 billion in debt on behalf of the MoF (Balassa 1996; Ábel and Szakadát 1997). The HIDB was allowed to retain 35% of the net revenue on the recovery of the remaining debt. As of 1997, the total recovery on the bank-oriented LCP totaled approximately HUF 6 billion (Ábel and Szakadát 1997).

For the firm-oriented LCP, the government transferred nonperforming loans to the Hungarian State Holding Company and the State Property Agency (IMF 1995). In 1994, the Hungarian State Holding Company forgave all HUF 24 billion in debt at book value that it acquired from eight SOEs (IMF 1995; Balassa 1996). This blanket forgiveness was initiated despite the lack of viable reorganization plans, and it was legalized ex post by the MoF (Balassa 1996). Because the State Property Agency would have required parliamentary approval to forgive debt, it swapped HUF 16 billion in debt for equity and then transferred the remaining debt to the newly established State Privatization and Holding Company (ÁPV Rt.) (Balassa 1996; Ábel and Szakadát 1997). It is not clear how the ÁPV Rt. managed, disposed, or recovered its portfolio of debt.

It does not appear that the Hungarian government specified a timeframe for the LCP or a deadline for NPL resolution. The Hungarian government discussed proposals to clean up bank balance sheets in 1992 and announced the final version of the program on December 29, 1992. The proposal was later “’refined’” by the Minister of Finance on March 8, 1993 (Várhegyi and Boros-Kazai 1994). The government entered into a fixed contract with banks on March 16 and began operations of the LCP at that time (Várhegyi and Boros-Kazai 1994; Ábel and Bonin 1993). The firm-oriented LCP launched in the fourth quarter of 1993 (IMF 1995).