Austria is invoking a law used by Iceland as it tries to bypass a state guarantee and impose losses on investors in a bank that cost taxpayers billions to bail out and now may cost other lenders their credit ratings.
Finance Minister Michael Spindelegger proposed legislation today voiding 890 million euros ($1.2 billion) of subordinated debt to help cover losses at nationalized Hypo Alpe-Adria-Bank International AG, circumventing a guarantee for the bonds by the province of Carinthia. The law, which is citing a 2001 European Union directive, also voids 800 million euros lent to Hypo Alpe by its former parent Bayerische Landesbank.
“Loss participation of junior creditors, or bail-in, that’s going to come in the EU by 2016, but we’re anticipating it based on existing EU law,” Spindelegger told reporters in Vienna. “This is all against the backdrop that the taxpayers can’t pay everything.”
Spindelegger in March ruled out insolvency for Hypo Alpe, sparing holders of about 11 billion euros of senior bonds from losses. Heeding the advice of Austria’s financial elite in the face of public anger over rescuing the bank, he promised instead to tap other sources for sharing the cost of shutting down Hypo Alpe, including junior securities and former owners.
Even so, seven Austrian banks may have their ratings cut because it undermines the government’s commitment to backstopping lenders, Standard & Poor’s said yesterday.
‘Can of Worms’
“We still don’t understand why you would open such a can of worms for just 900 million euros,” said Philipp Jaeger, a bond analyst at Berenberg Bank based in Frankfurt. “Our concern isn’t even primarily Hypo Alpe, it’s the possible collateral damage for other guaranteed debt.”
Hypo Alpe has cost Austrian taxpayers 5.5 billion euros since its emergency rescue in 2009, and more than 3 billion euros are expected to be needed still to fund its wind-down.
The Hypo Alpe law splits the bank into a “bad bank” with roughly 18 billion euros of assets to wind down, and a “good bank” consisting of Hypo Alpe’s banks in former Yugoslavia, which are currently being sold. An Italian unit that’s also wound down will be kept as a separate unit as well.
A second part of the law voids junior debt maturing before June 2019 as well as the loans by former owner BayernLB. Spindelegger reiterated senior bonds are sacrosanct, and a 1 billion-euro subordinated bond with a federal guarantee won’t be touched either as it matures 2022.
A 2001 EU directive on the “reorganization and winding-up of credit institutions” is the basis for voiding the bonds as well as the BayernLB loans, said Justice Minister Wolfgang Brandstetter, whose ministry helped draft the act. The directive was also used by Iceland to impose losses on creditors and savers when its three biggest banks went insolvent in 2008.
Hypo Alpe’s senior bonds have rallied since Spindelegger’s pledge to spare them. The 2 billion-euro 4.375 percent bond due 2017 traded at a bid yield of 3.856 percent by 11:45 a.m., 6 basis points wider than yesterday, according to Bloomberg composite prices, after widening to as much as 11.82 percent in February. The junior bonds are trading only rarely.
S&P yesterday put the debt rating of Austria’s three biggest banks under review for a possible downgrade because of Austria’s move to bail in the bonds and circumvent the Carinthian state guarantee.
“This extraordinary development, which was not our base-case expectation, may trigger a lowering of our ratings on Austrian banks,” S&P said in the statement. “The proposed law indicates increasing uncertainty of potential extraordinary state support for the banking sector in times of stress.”
S&P’s warning had limited effect on trading in Austrian bank debt. Raiffeisen Zentralbank Oesterreich AG’s five-year credit-default swaps rose by 11 basis points to 70 points, the worst performer among Austrian banks.
Spindelegger said he didn’t understand the rating company’s surprise and its implications for other banks. “This is a singular event, and it’s a plan we’ve been sketching out since March 14,” the finance minister said.
Imposing losses on bondholders, or “bailing in” in the industry jargon, is an important part of new bank rules designed to avoid a repeat of taxpayer-funded bailouts.
Yet two factors complicate the case. It’s a legacy issue for which the new rules aren’t applicable and both the senior and the junior bonds were issued under a guarantee by its then owner, the province of Carinthia. Reneging on that guarantee is independent of the seniority of the underlying security.
“Loss participation of the subordinated guaranteed debt holders would only be possible through strong interference into the property rights of the respective debt holders,” Barclays Plc analysts Fritz Engelhard and Jussi Harju said in a note.
Austrian finance ministry officials said the subordinated bonds had always been a more risky investment and paid higher yields despite the state guarantee. At the peak, Carinthia guaranteed for about 25 billion euros of Hypo Alpe’s debt, while its own annual tax revenue is only 2 billion euros.
“Such a guarantee should never have existed in the first place,” said Harald Waiglein, a department head in the Finance Ministry. “A guarantee like that is meaningless by definition because the guarantor can never service it.”