Austria to Close Potential Heta Bond Guarantee Loophole

  • Bank-law tweak clarifies bond guarantees kick in on bail-in
  • Aligns resolution law with Germany on legacy state guarantees

Austria plans to close a potential loophole that could allow authorities to renege on legacy bank debt guarantees in cases where creditors of failing banks are forced to share losses.

The Finance Ministry in Vienna, struggling with 11 billion euros ($12.4 billion) of guaranteed debt at “bad bank” Heta Asset Resolution AG, is proposing tweaks to Austria’s bank-resolution law to clarify that holders of bonds with a deficiency guarantee can demand compensation if losses are imposed on them during a wind-down. The current law on bank resolution leaves too much room for interpretation, according to a draft reform published on the website of Austria’s parliament as part of a public consultation.

“Voiding the guarantee promise by a third party would constitute an inappropriate infringement on property because it wouldn’t be directly linked to the resolution,” the explanatory notes to the bill state. “The legal relationship between creditor and guarantor shall not be infringed by the application of the bail-in instrument, and isn’t intended.”

Austrian state-owned banks relied on guarantees to raise cheap funding until 2007, when the European Union outlawed the practice as unfair state aid. Most of the legacy guaranteed debt expires in 2017. The issue has become relevant because of Heta, which is managing the remnants of Hypo Alpe-Adria-Bank International AG, one of the most damaging Austrian bank failures after the 2008 financial crisis.

Deficiency Guarantees

Deficiency guarantees make creditors whole if they can’t recover the full value of their loans. They were thrown in doubt by Austria’s implementation of European Union bank resolution laws, which stated that bonds which are bailed-in to cover a failing bank’s losses are considered partially repaid to the extent that they are cut in value.

The proposed changes to the law now determine explicitly that the guarantees remain intact in that case. The ministry said it modeled the new language on the basis of banking law in Germany, whose public-sector Landesbanken relied on similar guarantees until the EU banned them.

The 11 billion euros of Heta’s debt the province of Carinthia is still on the hook for is more than four times its annual tax revenue and local politicians are seeking ways to void the guarantees, which threaten the province with insolvency. Finance Minister Hans Joerg Schelling plans to help Carinthia buy up Heta’s debt at a discount, in return for the province contributing its disposable assets.

Heta’s most liquid securities, a 2 billion-euro 4.375 percent bond due 2017 and a 1.25 billion-euro 4.25 percent note due 2016, both trade at around 64 cents on the euro, prices compiled by Bloomberg show.

Before it's here, it's on the Bloomberg Terminal.