Austria threatens Europe's financial stability

The Austrian authorities have taken yet another step on the mined field of financial "stability" of the so-called hard core of the Eurozone.

Amid the nearing of the deadline for the moratorium set on the payment of the debts of Heta Asset Resolution, the bad bank set up for the takeover of the non-performing land of Hypo Alpe-Adria, the creditors have been presented with the buyback terms for the bonds guaranteed by the land of Carinthia.

Their total par value is 11 billion Euros, and the "offer" includes the payment of 75% of the par value for senior bonds and 30% of the value of subordinated bonds, which means a total loss of approximately 3.2 billion Euros for lenders.

"Creditors that refuse the offer could wait for as long as ten years for a ruling of the judicial system in their favor", said Hans-Joerg Schelling, the Austrian finance minister, according to Bloomberg. Schelling further said that "the offer is excellent", according to Bloomberg, and creditors "should be rational and accept it". For the buyback of the Heta bonds, Austria has set up a special investment vehicle, Kaerntner Ausgleichszahlungs-Fonds (The Fund for the Payment of Compensations of Carinthia).

Unfortunately for the authorities in Vienna, the notion of "rational" is understood differently by creditors.

"What the Austrian authorities have done is unprecedented in the developed world: they have announced a figure that they consider acceptable and they have asked the creditors to accept the offer", the partner of Swiss company Gold Partners AG who owns 200 million Euros worth of Heta bonds, told Bloomberg.

The list of creditors that oppose the offer includes far bigger names however, such as German banks Commerzbank AG and NordLB, as well as PIMCO, the American investment fund manager owned by Allianz AG.

Bloomberg estimates show that the exposure of those who have rejected the proposal of the Austrian authorities is about 5 billion Euros and represents approximately 45% of the total debt, as the terms of the offer are non-negotiable, and its acceptance by two thirds of the creditors involves its unconditional application and for the other creditors as well.

In the first half of February 2016, minister Hans-Joerg Schelling has announced that Austrian lands that control financial institutions whose portfolios include bonds issued by Heta agree to the government's offer, according to an article by Reuters. If that were to happen, the rate of support for the offer would increase by 15 percentage points, according to Schelling's estimates, but it is unclear whether the two thirds threshold has been exceeded.

"Given the opposition of the creditors, most of them insurers and banks from Austria and Germany, the offer being accepted by a qualified majority seems improbable", Philipp Jaeger, an analyst with Berenberg, told Bloomberg. Under these circumstances, the next step will be Heta and the Carinthia land being declared insolvent, the Austrian finance minister said.

In an article published by Forbes, Frances Coppola presented the main problems with the offer made by the government in Vienna. These include the partial suspension of creditor precedence (author's note: the normal application of the bail-in assumes total losses for the subordinated debt, prior to imposing losses for senior bondholders) and the coercive, if only partial removal of the guarantees offered by the land of Carinthia to the bonds issues of the Hypo Alpe-Adria bank.

Last summer, the Constitutional Court said that the revocation of the guarantees offered by Carinthia to subordinated creditors, in 2014, is unconstitutional, and they have been reestablished.

Other legal issues have been emphasized by a court of justice of Frankfurt, which said that the offer of the Austrian authorities can not apply to bonds issued under German jurisdiction. Furthermore, "the banking resolution regulations are not applicable to Heta, which has been set up for the liquidation of non-performing assets of Hypo Alpe-Adria and has no banking license", according to Bloomberg.

According to a document by the ISDA (International Swaps and Derivatives Association), which monitors the implementation of the European bail-in directive in the national legislations, Austria has finalized the process since the beginning of 2015, and an amendment approved in the last three days of 2015 has specified the exceptions of the bail-in procedure.

The group of creditors that have rejected the proposal of Austrian authorities thinks that the bonds that they hold are risk-free, according to the prospectus, and they feel that a contractual obligation exists to fully repay the debts. Moreover, the creditors are accusing the government in Vienna of violating the Constitution and of discrimination, because it only imposes losses to the private sector, but not to creditors from the public sector, Forbes further writes.

Following the capital deficit of almost 8 billion Euros, the regulator of the Austrian financial market (FMA) has imposed a moratorium on the payment of the debts of Heta on March 1st, 2015, which will expire on May 31st, 2016.

"The Finance Ministry has said that Heta is not insolvent, and the guarantees offered by Carinthia and the federal government for Heta's debts will not be affected by the decision", Reuters wrote at the time.

The suspension of the payments of Heta has been justified by the need to draw up a resolution plan, which would ensure equal treatment of all creditors, according to the press release of the FMA.

Back in 2015, the Austrian Finance Minister said that the bail-in procedure will also be applied to creditors, as the Bank Recovery and Resolution Directive (BRRD) was transposed into the country's national legislation and came into effect on January 1st, 2015.

Now, honoring the government's debt doesn't seem to matter in Vienna anymore, and judging by his own statements, the minister of finance is convinced that the financial situation of the country and its borrowing costs will not be affected.

Unfortunately, reality, in particular the one that is giving the European authorities nightmares since the beginning of the crisis, does not "bend" to political will.

Frances Coppola further writes that "Carinthia's insolvency will lead to a heavy fiscal adjustment for Austria, amid an increase in borrowing costs", and the "value of no risk investments will see a massive drop, because government can no longer be considered safe".

"The implications, not only for the financial stability of Austria but for that of Europe as well, are terrible", the Forbes journalist concludes.

If we also add in the uncertainties concerning the application of the bail-in framework, it is almost certain that Europe will need bigger crises than the Brexit and the refugees' "cover" the growing cracks in its financial foundation.