Austria Weighs Contagion Risk as Hypo Alpe Bonds Plummet

Austria will risk contagion should it allow Hypo Alpe-Adria-Bank International AG to fail or force bondholders to take losses, the central bank said, as the nationalized lender’s debt slid for a second day.

Hypo Alpe has 14 billion euros ($19 billion) of debt outstanding which is guaranteed by the southern province of Carinthia. A haircut could impact the borrowing of all of Austria’s provinces, central bank governor Ewald Nowotny said.

“We do have a discussion in the European Union about how to bail-in investors, although at a later date,” Nowotny told journalists in Vienna today. “The guarantees the Carinthia province has given mean that the problem is entirely different here. The question in this specific case is what consequences this could have for this province and for other provinces.”

Reports that Austria may demand holders of some of Hypo Alpe’s bonds to swap them into securities worth a third less rattled investors this week. Austria is still counting the cost of rescuing Hypo Alpe, which is on track to become its most costly bank failure. The government has injected 4 billion euros into the bank and it has European Union approval to spend a total of 8 billion euros.

The yield premium over benchmark euro-area debt of Hypo Alpe’s 4.375 percent bond maturing in 2017 more than doubled this week to 697 basis points from 304 basis points last Friday, according to Bloomberg data. That’s the biggest rise since they were sold in 2007.

Austria’s governing coalition hasn’t agreed on a plan to wind down about 19 billion euros of Hypo Alpe’s assets in a way that limits the cost to taxpayers as talks to renew the coalition continue.

Bond Haircut

Hypo Alpe may offer bondholders a two-for-three haircut, according to a proposal by Attorney General Wolfgang Peschorn, Der Standard newspaper reported this week, citing an unidentified finance ministry official.

“For the Austrian government, this proposal could appear charming as creditors would share the costs of rescuing Hypo Alpe-Adria,” Berenberg Bank analysts led by Philipp Jaeger in Dusseldorf, Germany said in an e-mailed report to clients today. “From an economic standpoint, the costs of the loss of trust and potential contagion seem significantly higher than the benefits from such a debt restructuring.”

Other Austrian banks’ bonds also weakened. The spread of Raiffeisen Bank International’s 6 percent Tier-2 bond maturing 2023 went up 30 basis points to 415 basis points this week.

Finance ministry spokesman Andreas Perotti declined to say whether a plan for such a haircut existed. Peschorn declined to comment. Hypo Alpe spokesman Nikola Donig said the bank isn’t aware of such a proposal and isn’t pursuing it.

Hypo Alpe Chairman Klaus Liebscher said last week that insolvency would have “unforeseeable consequences” and isn’t an option. Austrian acting Chancellor Werner Faymann said this week that insolvency would be a gamble and could get “out of control.”

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