Fitch has stripped Austria of its AAA rating, adding that 'within a short space of time the debt dynamics of Austria have deteriorated significantly'
By Ambrose Evans-Pritchard
6:37PM GMT 03 Mar 2015
![young families skiing, in the background Dachstein Mountain, Reiteralm, Styria, Alps, Austria](http://i.telegraph.co.uk/multimedia/archive/03218/alps_3218950b.jpg)
The 550,000-strong province on the Slovene border must fend for itself as losses spin out of control Photo: Alamy
The Alpine region of Carinthia faces probable bankruptcy after Austria’s central government refused to vouch for debts left by a disastrous banking expansion in eastern Europe and the Balkans.
It would be the first sub-sovereign default in Europe since the Lehman Brothers crisis, comparable in some respects to the bankruptcy of California's Orange County in 1994 or the city of Detroit in 2013.
Austria’s finance minister, Jörg Schelling, said Vienna would not cover €10.2bn (£7.4bn) in bond guarantees issued by the Carinthian authorities for the failed lender Hypo Alpe Adria, or for the "Heta" resolution fund that succeeded it. This leaves the 550,000-strong province on the Slovene border to fend for itself as losses spin out of control.
“The government won’t waste another euro of taxpayer money on Heta,” he said, insisting that there must be an end to moral hazard. The Hypo affair has alredy cost taxpayers €5.5bn. The Austrian state has said it will cover €1bn of its own guarantees “on the nail” but nothing more.
Sources in Vienna suggested that even senior bondholders are likely to face a 50pc writedown, becoming the first victims of the eurozone’s tough new “bail-in” rules for creditors. These rules are already in force in Germany and Austria, and will be mandatory everywhere next year.
“We are at a very delicate phase when Europe’s banking system switches from a bail-out regime into a much tougher bail-in regime, and Austria has just thrown this into sharp relief,” said sovereign bond strategist Nicholas Spiro. The biggest bondholders are Deutsche Bank’s DWS Investment, Pimco, Kepler-Fonds and BlackRock. The World Bank also owns €150bn of Hypo debt.
Austria’s banking regulators surprised markets by intervening over the weekend to wind down Heta and suspend debt payments until 2016 after discovering a further shortfall in capital of €7.6bn. The surge in the Swiss franc in January after the collapse of Switzerland’s currency floor against the euro appears to have been the last straw, setting off another wave of likely losses from eastern European mortgages denominated in francs.
“This is getting bigger and bigger,” said Marc Ostwald from Monument. “They kept kicking the can down the road but it is finally catching up with them, and Heta won’t be the last. There is a whiff of the Irish situation in this story. Carinthia stood as guarantor for debts that it could not possibly cover,” he said. There are many regions that could slide into difficulties, including Belgium's Wallonia, or the Italian region of Sicily.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_bank_expos_3218868d.jpg)
The Hypo bonds were underwritten in the boom years before the Lehman crisis by Austria’s populist leader Jorg Haider, then governor of Carinthia, leaving it to a subsequent social democrat team in Klagenfurt to sort out the mess.
Carinthia’s governor, Peter Kaiser, said his government is not liable for the debts unless Heta is definitively declared bankrupt – as opposed to just a moratorium - and vowed to defend his region in the courts. He warned that Carinthia would face a “dramatic situation” if bankruptcy does in fact go ahead, as widely expected.
Austria has not suffered any immediate fallout from Heta’s latest woes. It was able to sell five-year bonds on Tuesday at yields below zero for the first time ever as investors scramble to amass EMU sovereign debt before the European Central Bank launches quantitative easing next week. The ECB aims to buy €60bn of bonds each month, but there is already a chronic shortage of assets available on the market.
The IMF says Austria is lagging on reforms
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_subsidies_3218898d.jpg)
This "QE-effect" masks the underlying reality that Austria is no longer a blue-chip borrower. Fitch stripped the country of its AAA rating last month, cutting it one notch to AA+. “Within a short space of time the debt dynamics of Austria have deteriorated significantly,” it said.
The agency said the debt ratio was likely to peak at 89pc of GDP this year – 15 percentage points higher than expected just 18 months ago – due to the lingering effects of the banking crisis and weak growth in nominal GDP. The various bank bail-outs have cost 11pc of GDP, twice as bad as Britain’s travails.
Fitch warned that Austrian bank exposure to Russia, Ukraine and the rest of eastern Europe is €194bn, or 59pc of the country’s GDP, though part of this is acting as a conduit for investors in western Europe.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_taxes_on_l_3218922d.jpg)
William Jackson, from Capital Economics, said Austrian banks face a double squeeze as borrowers in Hungary and the Balkans struggle with both deep property slumps and a slide in their local currencies. “These foreign currency debts are a slow-burn issue. The non-performing loans emerge over time,” he said.
The International Monetary Fund said in its latest healthcheck on Austria that three large banks – Raiffeisen, Erste and Volksbanken – are vulnerable to any shocks. “Risks remain elevated. Bank profitability suffers from rising non-performing loans, risk costs and write-offs,” it said.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_services_b_3218894d.jpg)
The IMF said Austria’s reforms have largely stalled. The country has one of the highest barriers to services in Europe, the worst subsidies at 3.75pc of GDP, the highest tax share on labour at 58pc, a high rate of early retirement, and high state spending at 52pc of GDP, compared with 45pc in Germany.
While Austria remains a rich and successful country, it is slithering towards the bottom of the reform league. France looks less sluggish by comparison, and Greece looks almost Thatcherite.
“We are at a very delicate phase when Europe’s banking system switches from a bail-out regime into a much tougher bail-in regime, and Austria has just thrown this into sharp relief,” said sovereign bond strategist Nicholas Spiro. The biggest bondholders are Deutsche Bank’s DWS Investment, Pimco, Kepler-Fonds and BlackRock. The World Bank also owns €150bn of Hypo debt.
Austria’s banking regulators surprised markets by intervening over the weekend to wind down Heta and suspend debt payments until 2016 after discovering a further shortfall in capital of €7.6bn. The surge in the Swiss franc in January after the collapse of Switzerland’s currency floor against the euro appears to have been the last straw, setting off another wave of likely losses from eastern European mortgages denominated in francs.
“This is getting bigger and bigger,” said Marc Ostwald from Monument. “They kept kicking the can down the road but it is finally catching up with them, and Heta won’t be the last. There is a whiff of the Irish situation in this story. Carinthia stood as guarantor for debts that it could not possibly cover,” he said. There are many regions that could slide into difficulties, including Belgium's Wallonia, or the Italian region of Sicily.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_bank_expos_3218868d.jpg)
The Hypo bonds were underwritten in the boom years before the Lehman crisis by Austria’s populist leader Jorg Haider, then governor of Carinthia, leaving it to a subsequent social democrat team in Klagenfurt to sort out the mess.
Carinthia’s governor, Peter Kaiser, said his government is not liable for the debts unless Heta is definitively declared bankrupt – as opposed to just a moratorium - and vowed to defend his region in the courts. He warned that Carinthia would face a “dramatic situation” if bankruptcy does in fact go ahead, as widely expected.
Austria has not suffered any immediate fallout from Heta’s latest woes. It was able to sell five-year bonds on Tuesday at yields below zero for the first time ever as investors scramble to amass EMU sovereign debt before the European Central Bank launches quantitative easing next week. The ECB aims to buy €60bn of bonds each month, but there is already a chronic shortage of assets available on the market.
The IMF says Austria is lagging on reforms
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_subsidies_3218898d.jpg)
This "QE-effect" masks the underlying reality that Austria is no longer a blue-chip borrower. Fitch stripped the country of its AAA rating last month, cutting it one notch to AA+. “Within a short space of time the debt dynamics of Austria have deteriorated significantly,” it said.
The agency said the debt ratio was likely to peak at 89pc of GDP this year – 15 percentage points higher than expected just 18 months ago – due to the lingering effects of the banking crisis and weak growth in nominal GDP. The various bank bail-outs have cost 11pc of GDP, twice as bad as Britain’s travails.
Fitch warned that Austrian bank exposure to Russia, Ukraine and the rest of eastern Europe is €194bn, or 59pc of the country’s GDP, though part of this is acting as a conduit for investors in western Europe.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_taxes_on_l_3218922d.jpg)
William Jackson, from Capital Economics, said Austrian banks face a double squeeze as borrowers in Hungary and the Balkans struggle with both deep property slumps and a slide in their local currencies. “These foreign currency debts are a slow-burn issue. The non-performing loans emerge over time,” he said.
The International Monetary Fund said in its latest healthcheck on Austria that three large banks – Raiffeisen, Erste and Volksbanken – are vulnerable to any shocks. “Risks remain elevated. Bank profitability suffers from rising non-performing loans, risk costs and write-offs,” it said.
![](http://i.telegraph.co.uk/multimedia/archive/03218/austria_services_b_3218894d.jpg)
The IMF said Austria’s reforms have largely stalled. The country has one of the highest barriers to services in Europe, the worst subsidies at 3.75pc of GDP, the highest tax share on labour at 58pc, a high rate of early retirement, and high state spending at 52pc of GDP, compared with 45pc in Germany.
While Austria remains a rich and successful country, it is slithering towards the bottom of the reform league. France looks less sluggish by comparison, and Greece looks almost Thatcherite.
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