Contagion from Austrian bank debacle spreading

By Andrew Jay Rosenbaum

ANKARA

Contagion from the default of the Austrian Heta Asset Resolution is spreading with European authorities preparing for it to get worse.

The European Central Bank on Friday asked banks across Europe to review their exposure to Austria in the wake of the Austrian government’s refusal to bail out Heta, which was shown to be effectively bust in early March after an audit revealed it needed €7.6 billion ($8.3 billion) of funds to keep going.

“It is indeed a challenge for European countries when a core EU member decides not to honor its debts," Felix Hufeld, president of German banking regulator BaFin told a conference in London on Friday.

German mortgage lender Duesseldorfer Hypothekenbank failed in March because of non-payment from Heta and was taken over by the German banking authority.

And the Austrian province of Carinthia could be facing default, as it has guaranteed more than €10 billion ($11 billion) of Heta debt, in what could be the first such default by a provincial government.

No ordinary bank

Finance Minister Hans Joerg Schelling told reporters on Friday that the government would back Carinthia, but no official decision has yet been taken.

Austria’s Financial Market Authority took control of Heta on March 1 and imposed a debt moratorium until May 2016 after an external audit showed €7.6 billion was needed to shore it up.

Meanwhile, European banks and other financial services firms are owed at least €5.5 billion ($5.9 billion) – giant Commerzbank is due $450 million.

Heta was not an ordinary bank.

It was created in the wake of the insolvency by Austrian bank Hypo Adria in 2009, and its sole purpose was to act as "bad bank", taking over the toxic assets of Hypo Alpe Adria.

False values

Hypo Alpe Adria, a retail bank in Carinthia, ran into trouble after overspending on expansion via acquisitions and questionable investments.

The network of foreign acquisitions that Hypo Alpe Adria made is being sold off to international buyers this year.

It is not clear exactly what happened at Hypo Alpe Adria but prosecutors are investigating, following notification from the FMA in January, whether Hypo's 2009 balance sheet falsely valued loans and leases too high, a spokesman for the prosecution said.

Austria nationalized the bank and then hived off its toxic assets to Heta Asset Resolution.

But Heta’s assets were overvalued by regulators at the time.

Bondholder haircuts

When Heta was set up last year, its assets were valued at €18 billion ($19.6 billion).

But they were later found to be worth less than half that amount.

Austrian authorities had assumed about €5 billion ($5.1 billion) in Heta debt that it still intends to pay back, but the government announced at the beginning of March that it would not pay more.

The government invoked a new European Union law (in force from January 2015) called the Bank Recovery and Resolution Directive, which allows financial authorities to shift the burden of a bailout to bondholders.

Previously there was an implicit understanding that governments would pay bondholder debt in these circumstances, but now, bondholders have to take at least part of the haircut, in a new procedure referred to as a "bail in".

Bail-in concerns

There are now concerns about banks all over Europe, as details emerge of institutions that were owed substantial amounts by Heta.

There are also concerns about how future bail-ins might work.

In May, Moody's changed the outlook to negative on 82 European banks' long-term debt ratings to reflect the likelihood of a reduction in state support and an increased risk of senior creditors potentially having to bail-in.

Some analysts say that investors now realize that creditors are far less protected than they used to be when things go wrong.

Tim Skeet, the chairman of the working group on bail-ins at the International Capital Market Association, warned in August last year: "This is a further wake-up call for investors to re-evaluate the nature of the risks they're facing when investing in banks."