Hungary for yield? These government guaranteed Hungarian Development Bank (MFB) Euro bonds are currently yielding over 9%, are Ba1 rated, and mature in May 2016. The strategic mission of the state owned MFB is to provide development funds necessary to realize the economic development goals determined by the medium and long term economic strategy of the Hungarian Government, and to be an active participant in the renewal and development of the Hungarian economy. Therefore, we see the additional bump in yield these bonds offer as an intelligent advantage over similar maturity, similar risks, but lower yielding Hungarian government bonds denominated in Euros. As the European Central Bank continues to flex its muscle and harden itself against the debilitating troubles of a debt burdened Eurozone, the US dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against further erosion its buying power. We believe this 50 month bond provides an opportunity for adding exposure to an underweight euro, in an economy that we think may be far better positioned in the recovery process than others financial pundits have portrayed or are willing to concede, and it is why we have chosen to add it to our Foreign and World Fixed Income Holdings.
Wealth Preservation and US Dollar Concerns
The US Debt to GDP is now well over 100% and climbing as a result of the US Government’s continued inability to reign in deficit spending. After adding in the bludgeoning of a widening trade deficit (consider how many of your last five purchases were something made in the USA), the Federal Reserve’s only known economic pain medication (printing more money and pushing it out the door at superficially low rates), and an inflation rate (by any measure) that greatly exceeds the 2 or 3 year savings rate that any bankster or traditionally “safe investment” offers any saver or fixed income retiree, it’s not difficult to understand heightened wealth preservation concerns. With the Everyday Price Index measuring average annual inflation rate at 8 percent in 2011, regardless of whether stated as inflation or as a reduction in the purchasing power of our currency, short term CD investors are (safely) losing ground fast to the dredging of big banks. Measuring from just a short four years ago, the seasonally adjusted M1 money supply has risen from 1.3819 to 2.2289 trillion, a 61.3% increase. While this prescribed fix offers a certain relief to a plethora of bad debt certain “too big to fail” banks swallowed in their failed grab for glory, savers are left wondering how much its “healing power” can remain and be directed to the rest of the economy, or anyone else.
Hungary Development Bank
The stated duty of the Hungarian Development Bank (MFB) is to provide funding to create jobs and promote employment (both of notable value to Hungary and the European economy) for:
- Small- and medium-sized businesses, which through their development activities might increase the technological level and the rate of employment, and as a result, some of them might be able to link up with the supplier network of the largest enterprises and extend their activities abroad;
- Municipalities, by providing development funding for them;
- The retail sector, primarily in the area of energy efficiency and environmental investments.
- Large enterprises, by funding large-scale development projects that generate the strongest spinoff-effects in the economy whereby they promote economic growth;
For the first six months of 2011, MFB had a loss of only $3.54 million dollar after taking a charge for impairment of $31.8 million. However, with many other Hungarian based banks indicating the need for additional right-offs, the loss will probably be higher in the second half of 2011. In Feb 2012 they announced a new HUF 100Billion ($450 Million) loan program for infrastructural development and another project designed to support the construction and renovation of rental homes. Done properly, these loans should provide a significant boost to the economy while offering a good return to the bank. Since Hungary has the ability to print their own money, many analysts see Hungary as having far less default risk than many of the countries which are based on the euro. With that said, this sort of new funding announced by MFB is one of the best ways for the Hungarian government to deploy capital.
Given the Hungarian Government’s ownership and guaranteed backing of the MBF bank bonds that we are reviewing this week, we find it more appropriate to consider various aspects of the Hungarian economy rather than spend further effort considering the more difficult financial reports of a privately held Eastern European bank.
Hungary had a surprisingly strong performance in GDP last year, even in the midst of a very rough and tumble European slowdown. What appears to have surprised most analysts is that based on a preliminary estimate on Feb. 15, Hungary’s economic output rose 1.4 percent in the fourth quarter from a year earlier, as rising agricultural production helped growth. Over all of 2011, the economy grew 1.7 percent from the previous year. The GDP growth was surprisingly strong, especially considering the triple whammy of the European debt crisis, the plight of Greece, and the declining Hungarian currency, the forint. Industrial production, including exports of Audi AG cars and Nokia Oyj mobile phones assembled in the country, has helped Hungary recover from 2009, its worst recession in 18 years. Nokia’s announcement on Feb. 8 that it would cut 2,300 jobs in Hungary will undoubtedly have a negative impact, but with test production already under way, Daimler AG plans to start production of its new B-Class model at its plant in Hungary at the end of March.
Although Hungary has scaled back its projection for economic growth this year, their Prime Minister’s chief of staff Mihaly Varga maintains that the country will probably avoid a recession and has estimated a range between stagnation and 0.5 percent growth. Hungary is expecting to maintain its agricultural output level, which boosted growth last year, and Roland Natran, the deputy state secretary at the Economy Ministry, was recently quoted saying, “Significant investments currently under way will also help maintain the contribution of manufacturing to economic growth.” What we find incredibly impressive about this forecast, which is above many other European countries projections for growth, is that it wasn’t many years ago when it was Hungary that was considered the root of many European debt problems. However, after 40 years of socialist rule, they moved aggressively towards a uniquely free market mode and are subsequently weathering this financial storm better than many neighboring countries, and far better that most analysts seem to have thought possible prior to its arrival.
From the chart above it is easy to see that in 2010, Chile, Korea, and Hungary were a small set of select of countries whose Government actually spent less than it took in. Knowing that the Hungarian government has (and still is) achieving significant and rare progress towards debt reduction was a certain factor in selecting its short term debt as this week’s best bond. Also making it worthy of consideration is that fact that Hungary has one of the higher reserve levels of the countries that we have reviewed:
|Country||DEBT – GDP||GDP GROWTH||RESERVES – DEBT||YIELD ON 5 YEAR DEBT|
|United States||100 %||1.6 %||00.9 %||2%|
|Hungary||80 %||1.7 %||35.0 %||10%|
Hungary and the United States rank similarly on the Sovereign Fiscal Responsibility Index, with Hungary being 28th and United States one better, at 27. This close proximity was achieved as a result of Hungary making many large steps towards a free market economy over the last 10 years, and several positive steps towards a fiscal discipline that, during this same period, seems to have been much more elusive for the United States.
On the political front, Viktor Orban won the election in a landslide last year, and his party received a 2/3 super majority in the parliament. This will mark the first time since the communist era ended that the Hungarian government will be run without a political coalition. Mr. Orban ran on the promise to cut taxes, curb tax evasion, create jobs and reduce state bureaucracy. Since taking office, Hungary has announced a 10% reduction in government employment and a reduction in the government’s funding of pension funds. These large austerity measures could speed Hungary’s return to fiscal health, as a return to free markets often precludes a growth in prosperity within the private sector, which typically results in a more organic and sustainable harvest for government coffers.
The (Euro)pean Currency
We have finally seen what we been looking for in the Euro currency charts. After many banks announced billions in losses relating to a Greek debt restructuring, the euro currency strengthened against the dollar. In our opinion, when the currency began a strong move up at the same time the news for it was very poor, this is often a sign of a bottom and that the worst for it has probably passed. We have therefore just started introducing the euro into our Foreign and World Fixed Income Holdings, and this is only our second euro based recommendation, the first being our recent article on 14% Cyprus Government bonds. We now suspect that the euro, like many other currencies, may be poised to outperform the US dollar.
The most obvious risk is that of default. The Republic of Hungary was recently downgraded to a Ba1 rating for their sovereign debt, even though it has shown (as noted above) to be improving their fiscal situation rather than worsening. Given the Hungarian government’s ownership and backing of the Hungarian Development Bank, we think the greater risk of this bond resides in the currency it is denominated in, which in this case is the euro.
Although Hungary does not use the euro as its primary currency, the euro and the forint do have a correlation. With so many of the recent troubles stemming from, but not isolated in, Greece, the FX currency markets have been, and may continue to be for some time, very volatile. While Hungary’s location in the heart of Europe precludes escaping severe or major economic eruptions happening around it, we believe that the sovereign forint does offer some degree of insulation to possibly a more systemic weakening of the euro.
Hungary’s economy is slowly recovering, and in many ways may be out-performing its regional peers in its ability to mitigate the effects of the global financial crisis. However, fiscal consolidation and better management of public finance are still needed, and the high level of government spending is holding back private-sector growth. For further consideration and comparisons of emerging economies, please see our other Hungarian and Foreign Bond articles.
With so many uncertainties lingering in the US and global economies, we believe that a good income portfolio should include issues denominated in foreign and world currencies that could potentially prove to be beneficial both in the higher yields they offer as well as in lowering overall portfolio risk by protecting principle through greater diversification. Therefore, we think that the combination exposures that this bond gives to the Hungarian economy and to the euro, at much higher yield than is typically available, represents a savvy risk to reward opportunity that stands to capture the potential appreciation of the euro and assist our clients in protecting against a possible further loss in buying power of the US dollar, and it is why we are recommending the addition of this 50 month Hungarian Development Bank Euro Bond to our Foreign and World Fixed Income Holdings.
Yield to Maturity: 9.21%
Disclosure: Durig Capital clients may already own a position in Hungarian Development Bank bonds in their fixed income portfolios.
To know more about this Hungarian bond call our fixed income specialist at 971-327-8847.