The Austrian government's recent decision to overturn the guarantee provided by the State of Carinthia to holders of Hype Alpe Adria's subordinated debt has come back to haunt it. Citing reduced government support, inadequate capital and poor performance, the ratings agency
This downgrade follows on from Moody's recent announcement that the Austrian government's decision with regard to HAA would be “credit negative” for the Austrian banking system and possibly also for the sovereign.
VBAG is 50% owned by the Association of Volksbanken, the collective that represents Austria's network of regional savings banks. It is also, since the financial crisis, 43% owned by the State of Austria. But that does not mean that the State of Austria is going to provide further support. After all, HAA has been state-owned since the financial crisis, yet no further support is forthcoming and it is now being wound up. Moody's downgrade is a measure of how much attitudes to bank bailouts have hardened since the financial crisis.
VBAG was already thought to be short of capital. The Austrian magazine Der Standard recently reported a central bank source as saying that VBAG would need EUR500-1000m to meet the EU stress test minimum capital ratio of 5.5%. As VBAG is majority owned by savings banks, it can't raise capital on the capital markets: if the government won't provide additional support, then unless the Volksbanken can stump up more cash, VBAG must recapitalize by de-leveraging and retaining earnings, and as a last resort by imposing haircuts on creditors and/or bailing them in.
Moody's commends Volksbanken for its progress in de-leveraging:
AG has made substantial progress in further de-leveraging its legacy, non-core portfolio which still accounted for EUR7.1 billion assets according to their FY 2013 accounts. On 28 July 2014, VBAG announced that it sold EUR495 million or almost half of its portfolio of non-performing loans in Romania. During the review period, VBAG also announced the sale of its private equity portfolio, VB-Leasing International's subsidiaries in Poland and Romania and
Volksbank Malta.
But it seems unlikely that this will be enough to close the capital hole. And there are several reasons for this.
From the Moody's downgrade announcement (my emphasis):
A potential remapping of VBAG's E BFSR could result from additional capital needs that may necessitate a capital injection at the level of the sector. On 6 May 2014, the Austrian regulator informed VBAG that the Association of Volksbanken (unrated) needs to maintain an equity ratio of 13.6% under Basel 3, compared to a 14.6% capitalization as of 1 January 2014. Capital needs may also be triggered by the European Central Bank's Comprehensive Assessment which the sector is subject to, in particular the ECB's requirement to maintain a 5.5% CET1 ratio in its stress case scenario.
Key drivers for potential capital needs are that (1) major parts of VBAG's current capital base will be derecognized once Basel III has been fully phased in, including EUR300 million participation capital injected by the government during the financial crisis, and (2) VBAG's continued weak operating performance and profitability as reflected in recent losses.
Moody's believes that there is a reasonable likelihood that additional capital will be needed at the level of the sector. In Moody's central scenario, the sector continues to be able to address capital needs on its own, which may include additional capital raising at the level of the sector. In addition, Moody's expects that VBAG's de-leveraging will also be a crucial element for the sector to comply with the minimum capitalization needs from the Austrian regulator.
Unpicking this:
- VBAG may not have enough capital to meet ECB minimum stress test requirements
- VBAG's existing capital includes sizable amounts that do not meet Basel III definitions of “core capital”
- VBAG's poor performance makes it unlikely that the additional capital requirements can be met by retaining earnings.
So, VBAG will have to raise more capital. De-leveraging will contribute, but an injection of capital will probably be needed from the majority shareholder.
But Moody's is concerned about that majority shareholder. The Association of Volksbanken's own capitalization is dangerously close to Basel III limits. As it stands, it may not be able to provide VBAG with the support that it needs without destroying its own capital adequacy. As it seems that further government support will not be forthcoming, Moody's therefore warns that the Austrian Volksbanken AS A WHOLE (the regional savings banks as well as VBAG) will need to raise capital.
As far as I know this is the first time that an entire small bank sector has been warned by a ratings agency that it will need to raise capital. Austrian Volksbanken are exempt from the ECB's Asset Quality Review and stress tests, and also from the Single Supervisory Mechanism. But because they collectively are the majority shareholder in VBAG, which is not exempt, they in effect have to comply with ECB and Basel III capital requirements themselves. It's an interesting example of the way in which the consequences of large bank regulation can trickle down to other sectors.
And it also raises questions about the future of the Volksbanken. The implication of the HAA decision is that the Austrian government can no longer be relied on to support the banking system. This manifests itself not only in the downgrade of VBAG, but also in Moody's comments about the capitalization of the Volksbanken sector. The Volksbanken are on their own. Government support and guarantees are being withdrawn: they must be replaced with private capital. Welcome to the new, uncertain world of local banking.
