What’s a state debt guarantee worth these days? Not as much as it used to be, following Austria’s plan to write down the debt of Austria’s Heta Asset Resolution. The decision risks undermining investor confidence in European sub-sovereign debt.
If it were Greece, it wouldn’t come as a surprise. But rich Austria, one of the core members of the European Union?
The southern Austrian province of Carinthia said this month it was checking whether it can escape €10.2 billion in debt guarantees for defunct lender Hypo Alpe Adria that are still outstanding at its wind-down vehicle Heta.
Hypo, formerly owned by publicly-owned Bavarian Landesbank BayernLB, expanded rapidly in Austria and the Balkans, aided by low borrowing costs made possible by state guarantees provided by Carinthia. It overstretched itself and came close to insolvency before the government in Vienna bought it in 2009.
“Investors are asking themselves: ‘What’s the value of a government guarantee?'”
State-owned Heta, charged with winding down the assets of Hypo, got in trouble partly as a result of the Swiss decision to let the franc surge against the euro this year, which boosted the need for loan loss provisions as many customers who had taken out mortgages in francs to lock in lower interest rates suddenly faced higher repayment bills.
After Heta revealed a capital hole of €7.6 billion, supervisors took control this month and suspended its debt payments.
Heta’s woes have hit Germany’s financial sector especially hard. Heta owes German banks some €5.5 billion and German insurers around €1.3 billion. The first victim was German property lender Duesseldorfer Hypothekenbank, stung by its exposure to Heta.
The German banking federation hammered out a rescue deal with banking regulators in mid-March, arranging a guarantee for DuesselHyp’s holdings of around €350 million in Heta bonds.
The new head of Germany’s banking watchdog, Felix Hufeld, joined criticism of Austria’s planned debt cut, saying banks needed to focus more on the creditworthiness of state debtors in future rather than assuming there’s zero risk.
“We firmly believe that the risk also needs to be assessed for state debtors,” Huffed, who took charge of the BaFin Federal Financial Supervisory Authority this month, told Handelsblatt in his first interview as head.
Hufeld is known for straight talking and hasn’t spared Germany’s banking sector from criticism in the past. But his remarks on the Austrian debt fiasco chimes with what many bankers in Germany are thinking.
“It wouldn’t be good if a core state of the EU takes political decisions to no longer honor public liabilities,” he said.
The expected debt cut has wrongfooted the sector. Investors thought they were safe because Heta has a debt guarantee from Carinthia. But new Austrian legislation which came into force at the beginning of the year was so deftly tailored to Heta and to this guarantee that Carinthia looks likely to be absolved of it.
That has sent shock waves through the European banking sector; for the first time, private creditors don’t face losses in a crisis-hit country like Greece, but in the rich heart of Europe.
“Investors are asking themselves: ‘What’s the value of a government guarantee?” said Florian Gerlich, a bond analyst at NordLB, a state-owned German bank.
“Investors won’t trust state guarantees as much as they used to,” warned Michael Kemmer, general manager of the Association of German Banks.
The volume of outstanding bonds with state guarantees in the European Union totals €1.3 trillion. Banks and investors are starting to have doubts about this gigantic market.
“We can imagine that in reaction to the events at Heta investors will pay more attention to the exact makeup of state guarantees and to whether a debtor is in an economic position to repay a loan — regardless of a promised guarantee,” said Carola Schuler, European banks analyst at rating agency Moody’s.
Martin Blessing, the head of Commerzbank, Germany’ second-largest commercial bank, weighed in by warning that even bonds issued by the Landesbanken, publicly-owned German regional banks, may no longer be viewed as rock-solid if Carinthia is let off the hook. “How can you then still rate the paper of German Landesbanks, backed by state guarantees, as being risk-free?” he said.
Many risk managers agree with him, and are starting to take a closer look at German public debtors, “We’re checking whether we need to factor in more equity capital for deals with sub-sovereign debtors,” said one banker at a large institution, adding that this also applied to German regional states and municipalities.
The risk manager of one German bank said: “In loans for municipal companies or cities in Germany we’re primarily focusing on whether their individual financial position is solid enough.”
To him, guarantees provided by municipalities or regional states are second tier. That could mean that loans issued to profitable city power utilities will be cheaper than for a city’s loss-making public transport system.
“We’re being more cautious in our new business,” said one risk manager.
In purely legal terms, there’s no reason to be more skeptical about German Landesbanken or municipalities in the wake of the Heta collapse. Germany has clear rules ensuring that guarantees continue to apply for institutions that are being wound down.
But risk managers are doubtful. “It’s better to do business with non-state customers. The state can write its own laws if it needs to,” said one German risk manager.