• Province of Carinthia prepares deal for failed bank's bonds
  • Standoff may ensue as some holders threaten legal action

The six-year saga over the downfall of one of Austria’s biggest banks is about to enter yet another chapter.

Carinthia is preparing to bid for 11 billion euros ($12 billion) of bonds issued by Hypo Alpe-Adria-Bank International AG while it was owned by the province. It will offer less than face value and force the haircut on other creditors should two-thirds of them accept.

By potentially imposing losses rather than having investors volunteer, it’s the kind of deal that Greece has so far avoided as the country sought to remain in the euro. Some investors are planning to call Carinthia’s bluff and if necessary seek full redemption in the courts like the hedge funds that sued Argentina after its 2002 default.

“Imagine the shockwave in the markets if a province in one of Europe’s richest countries tells creditors to get stuffed,” said Urs Faehndrich, a managing partner at Gold Partners AG, a Swiss asset manager that owns about 200 million euros of the bonds. “Greece cooperated with creditors, it would be absurd if Carinthia didn’t.”

Saving Taxpayers

The offer involves bondholders getting a down payment from the company winding down Hypo Alpe, called Heta Asset Resolution AG, plus the 1.2 billion euros that Carinthia says it can afford to pay. Heta’s two most-traded bonds are quoted at about 67 cents on the euro to yield about 70 percent, an indication of the amount traders expect to be repaid. They were quoted at close to face value as recently as June 2014.

It will test the resolve among policy makers in Europe to relieve taxpayers of the burden of bank failures. Hypo Alpe already burnt through 5.5 billion euros of state support.

In theory, there is a consensus that creditors should share the cost of bank failures, yet in reality it’s not that easy. In Hypo Alpe’s case, the complications stem from its past as a state bank, which in Austria and Germany came with a statutory guarantee on their bonds until the European Union changed the law.

When Hypo Alpe was in the midst of its breakneck expansion in the former Yugoslavia, the bank gorged on cheap state-backed liquidity as long as it could, backed by populist right-wing Carinthian leader Joerg Haider. With a population of a little more than 500,000 and an economy reliant on Alpine tourism, the province guaranteed 25 billion euros of debt by 2007, more than 10 times its annual tax revenue.

The region now simply can’t pay up, Governor Peter Kaiser said, and even if bondholders turn down the buyout offer, they wouldn’t get more if they force it into insolvency. Creditors disagree. Carinthia was labeled by the Austrian authorities as just as risk-free as the federal government before the Hypo Alpe debacle, they said.

“Carinthia has the necessary means to settle all claims from Austrian and international creditors and can thus secure a constructive solution,” Leo Plank, a lawyer at Kirkland & Ellis who represents the “Ad Hoc” group of creditors owning about 2.5 billion euros of Heta bonds, said in November. “Carinthia is unwilling to pay, not unable to pay.”

The group declined to comment further on Thursday.

Uncharted Waters

Regardless of the outcome of Carinthia’s bond offer, the troubles won’t be over. If it succeeds, holdout creditors will go to court.

As the Hypo Alpe drama takes more twists and turns, Austria as a country probably won’t face higher financing costs if the bond offer fails, Markus Stix, who heads the Austrian Treasury, told journalists on Thursday. What would happen to the country’s provinces and other sub-sovereign borrowers is much less clear, he said. 

“The scenario would have to happen to see how the market reacts,” Stix said. “Austria has never experienced such a case.”

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