Bank bondholders: down but not out.

Photographer: Steve Marcus

Austrian U-Turn Is Good News for Bank Bonds

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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The Austrian government has just capitulated in a standoff with investors who lent money to Heta, a failed state bank. It’s the first good news investors in European bank bonds have had for months. But it’s also a reminder that the tectonic plates beneath an essential market for funding financial institutions are still shifting, in unpredictable and often unwelcome ways.

It’s been a terrible time to be an investor in bonds sold by European banks. At the turn of the year, Portugal trashed the value of five bonds by unilaterally assigning them to its bad bank, ignoring the principle that creditors occupying the same place in a borrower’s capital structure deserve equal treatment. In January, new rules came into force under the European Union’s Bank Recovery and Resolution Directive making lenders liable if a bank fails. Last year, Italian retail bank bonds were entangled in failing banks. And last month Deutsche Bank was forced into offering to repurchase 3 billion euros ($3.3 billion) of debt after a surprise fourth-quarter loss triggered protests. 

Bank Liquidity

Here’s the short version of Austria’s complicated tale. Heta was nationalized six years ago, and its financial health has continued to deteriorate under the burden of bad debts. Its home Austrian province of Carinthia guarantees about 11 billion euros of its debts. It’s offering to repay about 8 billion euros. A group of the bondholders balked, arguing that Carinthia can afford to pay their claims in full, and that it was reasonable to assume there was implicit central government backing for the liabilities. The Austrian government disagreed, and set a March 11 deadline for the deal, which needs two-thirds acceptance to proceed.

Now, the government has backtracked. It’s offering bondholders who participate in the deal the opportunity to buy Austrian Treasury notes that don’t pay any interest, but will pay out at 25 percent more than they cost when they’re repaid in 18 years. “The idea is that we pay out cash and those funds can be invested in a long-term safe asset,” Austrian Finance Minister Hans Joerg Schelling said on Tuesday. “What you get is an Austrian bond with federal backing.”

Suddenly, investors are being offered government securities in part compensation. Doesn’t that directly contradict the finance ministry’s previous argument that Carinthia’s burdens are Carinthia’s alone?

There are added complications in the Austrian case. Austrian law doesn’t have a mechanism for what happens when a state can’t pay its debts; so a Carinthian default would take the country into uncharted waters. What Austrian law does have, however, is a concept called “Muendelsicher,” which translates roughly as “gilt-edged.” It’s meant to describe investments which are as safe as can be -- think of a restriction on what the executors of wills for widows and orphans are allowed to invest their inheritances in -- and the Heta bonds were in that category. If the debt isn’t repaid in full, the designation becomes meaningless for every other security that currently enjoys that status.

This drama is playing out against a broader backdrop. The Austrian government is keen to play its part in enforcing the new Europe-wide regulatory environment that wants bondholders to be on the hook when a bank fails, taking the pain before taxpayers have to.

The Heta bondholders, meantime, aren’t just looking at what the state of Carinthia owes them; they’re worried about the precedent it will set if a regional government wriggles out of its obligations. Europe’s equivalent of the municipal bond market is diffuse; unraveling which investments might similarly turn out not to have government backing might play havoc with regional financing.

So what happens next? The March 11 deadline is still in place; Austria’s improved offer suggests the government isn’t keen to find out what the consequences of a default would be.  

The group of creditors that pledged in December to stand firm might start to splinter, losing their blocking majority. Heta hasn’t paid anything since Austria declared a debt moratorium a year ago; depending what price a particular investor paid for their bonds, the new offer might be enough to tempt them to settle.

Friedrich Munsberg, who leads a creditor group with about 1.5 billion euros of debt as chief executive officer of Dexia Komunalbank, has said he won’t accept even a 1 percent loss. “We’re ready and able to fight until the very end because we won’t accept this injustice,” he said last month. He did, though, suggest a plan that extended the repayment dates but guaranteed eventual full payout would be acceptable, which suggests both sides have left themselves some wiggle room.

Here’s the rub. If governments continue to play fast and loose with the bank-bond market -- Portugal, Italy and Austria have all rocked the boat in recent months -- they won’t have room to complain if there’s a buyers’ strike. That in turn will undermine the European Central Bank’s efforts to revive the economy by pumping money into financial institutions. Maybe Mario Draghi should have a quiet word with the Austrian finance minister.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor responsible for this story:
Therese Raphael at traphael4@bloomberg.net