Austrian province looks at how to avoid insolvency

Moody’s recently downgraded the debt of Carinthia to just above junk grade

Austria's Carinthia province is studying ways to avoid going insolvent under the weight of debt guarantees for defunct lender Hypo Alpe Adria several times its annual budget, the region's government said.

Carinthia, which is in southern Austria, has an annual budget of €2.2 billion and would struggle to honour nearly €11 billion euros of backing for Hypo debt that creditors could demand. "Now all consequences . . . including solutions for a worst case of avoiding insolvency must be played through and evaluated," the office of Carinthia's governor Peter Kaiser said in a statement posted on its website.

Ratings agency Moody’s recently downgraded the debt of Carinthia province to Baa3 – one notch above junk grade – over its exposure to “bad bank” Heta handling assets of defunct lender Hypo Alpe Adria.

Hypo grew from a sleepy lender to a regional power but hit trouble in 2009 after a decade of breakneck expansion, forcing Austria to nationalise it.


Carinthia, whose main city is Klagenfurt, provided debt guarantees for years to fuel Hypo’s rapid expansion before such backing was banned in 2004. The last guarantees expire about 2017.

Mr Kaiser, a Social Democrat, said there was no precedent for a province going bankrupt, so it was unclear what lay ahead for a region with a population of about 500,000.

Carinthia decided to ask Austria’s state financing agency OeBFA for continued help to tap capital markets for an initial €30 million in April.

“It is getting increasingly difficult for the province of Carinthia . . . to finance itself via the capital market,” it said, blaming the Moody’s downgrade, in its request sent to Vienna.

“The provincial government approaches the Austrian government with an urgent request to make financing via OeBFA possible for Carinthia.”

The Austrian finance ministry said that Carinthia in part financed itself successfully through OeBFA last year, so the latest request was not out of the ordinary. OeBFA declined to comment on the case.

Capital hole

Austria’s financial watchdog the FMA took control of Heta earlier this month and halted payments on its debt after the government refused to plug a capital hole of up to €7.6 billion revealed in an audit.

Germany’s banks are emerging as the biggest losers in the wind-down, as the first bail-in under new European Union rules hits state-guaranteed securities once seen as risk-free.

German lenders stand to lose as much as 10 per cent of their profit, or more than €3 billion this year, on securities issued by Heta, according to Fitch Ratings.

That’s assuming German banks hold about 40 per cent of Heta’s relevant liabilities and take writedowns of 50 per cent on what they’re owed, Michael Dawson-Kropf, a Fitch analyst, wrote in a report from Frankfurt.

“Losses are likely to be material for German banks, but should be manageable,” Fitch said in the report.

The case is “illustrating the potential of a single resolution to dent the performance of even large, diversified banking systems under the EU Bank Recovery and Resolution Directive regime,” it said.

At least nine German banks have disclosed holdings of its bonds, and German investors also own the notes through funds, according to data compiled by Bloomberg.

German banks are being hit harder than those in Austria because they relied on Heta's state-guaranteed debt as collateral for covered bonds known as Pfandbriefe, according to Fitch. The banks were allowed to issue the covered bonds backed by the Heta notes to fund loans because they were guaranteed by the Austrian state of Carinthia.

That province, which is on the hook for more than €10 billion of Heta’s debt, probably won’t be able to shoulder the losses and has asked Austria’s federal government for credit and started preparations for potential insolvency.

The losses have already provoked legal action. FMS Wertmanagement, a German bad bank, has sued Heta over its failure to repay a bond, Andreas Henry, a spokesman for FMS, said.

Deutsche Pfandbriefbank and a German unit of Belgium’s Dexia have disclosed the largest holdings, with €395 million of Heta bonds each, filings show.

Duesseldorfer Hypothekenbank may need to tap the German state for capital to survive losses on the bonds, Fitch said.

Pfandbriefe are perceived as sacrosanct in Germany because they are considered devoid of default risk.

Highest risk

Deutsche Bank, Commerzbank and a unit of UniCredit are among the 37 members of the Association of German Pfandbrief Banks.

BayernLB Risk Bayerische Landesbank, Germany’s second-biggest state-owned bank, has the highest risk related to Heta because of €2.35 billion of loans it had outstanding at the end of last year.

The company still has an adequate buffer, according to Fitch. The banks’ losses won’t exceed 15 basis points of their common equity Tier 1 ratio, Fitch said. (The CET1 ratio shows capital as a share of risk-weighted assets and is a key measure of a bank’s strength. A basis point is equivalent to 0.01 percentage point.)

Heta is the first bank to be wound down under the EU’s new resolution directive as nations take steps to embed the regime into national law and adopt new so-called bail-in tools.

The losses probably won’t have much effect on German bank ratings given most of the affected lenders belong to larger banking groups or have creditworthiness indicators which already reflect “vulnerable asset quality and concentration risk,” Fitch said. – (Reuters/Bloomberg)