It was over a year ago when we first heard about solvency issues of the Austrian bank Hypo Alpe Adria. Six months and price of bonds dropped by half and the institution itself became bankrupt with 7.6 bn EUR deficit. You can point fingers and shift the blame but let us take a closer look at this patient and define the ‘cause of death’ which is more and more common these days.

Hypo Alpe Adria’s bonds were secured by government and thanks to guarantees of politicians bankers continue to lend money on even riskier conditions. Analysis of banker’s mind is simple: our gains, your losses. As long as the economy is growing, risking pays off. Speculation is a very profitable business and managers are kindly rewarded for providing great numbers for shareholders.

When the economy doesn’t perform that well potential risk materialises and the situation starts to look grim. Credits are not repaid and bank’s profits are slashed. Who cares when the government is the guarantor of our balance sheets? Until losses are bigger than the budget of the whole province.

Bail-in – designed shut down

Facing 7.6 bn EUR deficit – triple the budget of Carinthia – politicians refused to be responsible for repaying this sum. Austrian financial markets supervisory body could push this obligation onto Vienna but due to the amount of the deficit, the idea hasn’t received much acceptance.

To regain control over situation some sort of plan had to be implemented. The well known bail-in procedure, attested by the EU in the European Recovery and Resolution Directive, came in handy.

According to the EU law all individual clients’ obligations were cancelled and whatever was left of 7.6 bn EUR was paid from preferential clients – mostly financial institutions. Assets of shareholders and bondholders were seized. ‘Fortunately’, losses were small enough to be covered from those sources and depositors were untouched.

Clients with their savings had luck this time. The situation could be dramatically different when we hear news about more banks going bankrupt and equities of the whole sector plummeting. Investor’s capital may not be enough to cover even small deficit which can threaten the stability of any institution.

Restructuration plan of Hypo Alpe looks like this:

a) 100% bail-in for all subordinated liabilities

Subordinated liabilities are not secured in any way and have at least 5 years since creation under their belt. This is the first group to be taken from when assets are being confiscated and the last one to be paid their money back then it comes to bankruptcy proceedings. In fact, everyone who had long-term, unsecured bank bonds lost 100% of their capital.

b) 54% bail-in for preferential liabilities

Preference is derived from the status of the preferential creditor. They are higher in the hierarchy than subordinated liabilities. This classification is a result of specific contracts between institutions that own preferential assets.

Owners of preferential bonds lost over 50% of their capital

c) The cancellation of all interest payments from 1st March 2015

Anyone having a deposit will not receive any interest from this date. This is not a problem since hardly any deposit is paying any money. Be grateful that you are getting your money back!

d) Postponing all maturing liabilities to 31st December 2023

Putting off your liabilities until 2023 is basically an escape from your obligations. Bank is given 7 years during which its assets cannot be sold. This will result in devaluation of the debt held by investors. Clever move and it is not the last time we are going to watch it especially when economic crisis unravels. Printing money to cover a welfare state cause inflation to soar and this in turn significantly lowers the real value of debt in EUR.

Postponing the problem of liabilities vis-à-vis shareholders and bondholders for 7 years lowers the value of those payments thanks to inflation too. Bank will get away from its creditors paying their dues with worthless currency.

Summary

The case of Hypo Alpe Adria is very important. It shows how the system we have works and what we can expect from it. Apart from the destruction of banks’ balances and the tempo in which situation escalates, we can observe how politicians act. Carinthia was a guarantor of 10.2 bn EUR. Amount impossible to stomach for the province with the budget of 20% this sum.

To show the scale of what I’m talking about: Poland – country with population 4 times of Austria – has its Banking Guarantee Fund (created to be used during situation similar to Hypo Alpe Adria) amounts only to 1/3 of Austria’s bank liabilities.

Now I encourage you to check whether banking sector in your country gives you any guarantees and for how long you will be waiting until your money comes back to you. In Poland it's 20 days (BGF data) but what stands in the way to use the solution of Hypo Alpe Adria? Delay payments for a year or seven? How much your money will be worth then?

 

Trader21