GUEST POST: Austria Joins the PIIGS

Thursday, December 17, 2009

Finding myself in the once 6th richest country of the world that is nose-diving into the biggest crisis since WW2 I want to thank all readers who provided me with more insight on the state of economic and financial affairs in Central Eastern Europe.
While I was reading, Spain based economist Edward Hugh did another one of his great macro write-ups, this time concerning Austria, a country that suddenly find itself in the position of the sick man in Europe, almost on a par with Greece. This article first appeared at his main blog Global Economy Matters.

Is Austria Set To Join The Honourable Company of PIIGs?
by Edward Hugh
Hypo Alpe Adria bank, the Austrian arm of the Bavarian bank Bayern LB and Austria's sixth largest bank, was nationalized on Monday for the symbolic price of three euros. This unexpected action brought to the world's attention something which has been obvious to some of us for a very long time: namely that all is not well with Austria's banking system, and it is not well for one very simple reason - over-exposure to Central and East European Markets. Of course, when some of us first started pointing the problem out, we were roundly rebuked from all quarters, what a ridiculous idea! Izabella Kaminska had a reasonable review of how the arguments were being marshalled back in January here, while Paul Krugman attracted the wrath of all Austria back in April by, as this blogger puts it, stating the obvious.

When will the world of officialdom wake up to the fact that when economists warn of impending dangers, this is not done to cause harm, but in an attempt to try to stop more damage being done? The posture they should adopt is not a defensive one of rejecting criticism at all costs, but a more open one of listening to multiple opinions in an attempt to best serve the interests of the citizens they represent. So when I issued an alert back in September to the effect that - There Is Another Shoe To Drop In The Global Economic and Financial Crisis, And The Focus Will Be On Europe’s Perifery - I wasn't doing this just to cause trouble, but to warn and raise awareness. Now it is becoming increasingly obvious that I was right, but another precious three months have been lost in the meantime.

As Emma Saunders on FT Alphaville points out Austrian bank stress tests have shown that the country’s top banks would lack capital if the global economy were to double dip. And as I have pointed in out here in the case of Germany (as later confirmed here) and here in the case of Japan (as later confirmed here), the risk of a double dip is not, at this point, a negligable one.

Indeed Central bank supervisor Andreas Ittner said only recently that the Tier one ratio of the six biggest banks would drop to 5.8 per cent by the middle of 2011 under this type of scenario scenario. “Our stress tests show that capital adequacy levels must be raised further in the medium term. This applies to both the quality and the amount of banks’ own funds,” he said. And, surprise surprise, the tests show Austrian banks being particularly hard hit in Eastern Europe.

Unsurprisingly the current stress in the Austrian banking system is dragging down the euro and at the same time putting currencies from Central and Eastern Europe under growing pressure. And as analysts at PNB Paribas also point out, this pressure on bank capital can lead to weaker bank lending, which can also add to the Eurozone "underperformance" issue. That is to say, these are all self reinforcing processes.

Austria nationalising Hypo Group Alpe Adria highlights the fundamental weakness of EMU’s banking system. Bayern LB will have to write down its stake in Hypo Adria to zero increasing the hole in its balance sheet by another EUR3bln. We remain convinced that European banks will have to repatriate funds ahead of the fiscal year end, but once this operation is complete the EUR will suffer. With interest we have followed the recent speech of ECB’s Trichet, suggesting that if banks would not use their profits to bolster their equity base it could case the next crisis. The weak equity position of banks explains weak lending in Europe which itself suggests Europe will become an economic under performer.


And as Prudent Investor points out, Hypo is likely only the tip of the iceberg:

Hypo Alpe Adria is certainly one of the smaller problems that the Austrian government faces. Both exchange listed banks, Erste Group and Raiffeisen still have to come forward and announce their East European subsidiary losses which had so far been hidden under Austrian accounting rules that allow banks to keep asset prices at the purchase level as long as they are part of the fixed assets of a bank.


And only yesterday (Tuesday) Die Presse reported that the Austria's three banking supervisory authorities FMA, Fimbag and the Austrian central bank have discreetly put Oesterreichische Volksbanken, the 4th largest bank in the country, under surveillance, fearing that it may become yet another casualty of the spreading banking crisis, although news wires have reported this morning that the bank has said that there is no need for it to be nationalised.



Hypo, which is the sixth-largest bank in Austria, expanded rapidly into the Balkans in recent years, and these will be the countries most immediately affected by this weeks Austrian decision. And the Balkans, it should be remembered, is a region where Greek banks are also significantly exposed. In particular, the implications of what just happend seem to be quite important for Slovenia. Hypo (Klagenfurt) has subsidiaries in every ex-Yugoslavia state, but in Slovenia media are reporting that it is not the slovenian branch of Hypo itself which in trouble, but Hypo leasing, which has more than a 30 % market share in the Slovenian leasing business and around 60 % of the real estate and mortgage business.

Hypo have also been heavily involved in lending to the financial holding company Istrabenz which has itself been the big news local story in recent weeks, keeping bankers, polititians and most of the public in Slovenia well occupied during most of 2009. Istrabenz seems to be leveraged like a typical hedge fund, with the slight negative detail that they have almost no cashflow. A consorium of 19 banks (Slovenian and Austrian) are currently busily trying to recover something from the total of around 1 billion euros which was lent to Istrabenz.

A friend of mine who is an analyst in Slovenia sent me this mail this morning:

The whole banking system is in a mess, but so far the state has been more or less sucessful patching the leakages (issuance of govermnent bond – aprox 2 b €, issuance of bonds by banks, just now issuance of hybrid bonds and so forth…). Just today, there was an article in the press, that with before mentioned Istrabenz Holding, that a bankruptcy of Iztrabenz would pose serious problems for Probanka, Abanka and Hypo (the Slovenian one). For the others (NKBM,…) problems in construction sector could be the second biggest threat (if you ask me, waiting to happen, this troubles – on a national wide basis, most of past GDP growth was due to stimulus packages – unnecessary ones in unneeded infrastructure projects even before the crisis. This issue is connected to the fact there was election in Slovenia just before the crisis occurred and former government tried to »make up« economic situation to win again the election) – with the construction - city of Ljubljana bought half of one of the biggest residential projects here in Slovenia with the wish to help the construction investor almost going bust. Another anecdote about the real estate sector is, that banks are pressuring real estate companies to give more collateral as they have huge inventory (again prices in the balance sheets are mostly not corrected for the situation in the economy) and now the real-estate companies are assisting themselves with non cash transactions (buy from each other, thus lowering inventories and increasing receivables). That is just postponing the inevitable.


All of this sounds very much like Spain to me. And what a strange world we live in where Greece and Austria suddenly appear as the joint new "sickmen in Europe".

According to CMA DataVision, the Austria’s credit-default swap spreads widened over 8bps to 81bps on Tuesday, which means it now costs €81,000 a year to insure a notional €10 million of Austrian sovereign debt against default for five years. On Monday it would have cost €72,000.

So when will Europe's leaders finally wake up? Everything cannot simply be swept under the carpet forever. One day or another the cracks which have been slowly appearing in the whole edifice will simply become gaping holes. We need sound analysis, we need a will to do something, and we need a plan of action. Simply saying the critics do not know what they are talking about no longer holds water.

ABOUT: Edward Hugh is an independent macro economist, based in Barcelona. Edward specializes in growth and productivity theory, demographic processes and their impact on macro performance, and the underlying dynamics of migration flows. He is a regular contributor to a number of economics weblogs, including Roubini Europe Econ Monitor, A Fistful of Euros, Global Economy Matters and Demography Matters. At the present time he is focused on the economic issues arising in Eastern and Southern Europe.

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