Bail-in lessons from a bank called Heta

In April 1912, RMS Titanic hit an iceberg in the North Atlantic on its maiden voyage from Southampton to New York and sunk to the bottom of the ocean.

The word “titanic” comes from the Titans of Greek mythology and has always meant “huge”; it is now often used to refer to a huge disaster.  The first ship on the scene to rescue survivors from the Titanic was RMS Carpathia, which was sailing from New York to Fiume, a port in Austria at that time.  As Royal Mail Ships, both Titanic and Carpathia were proud to carry packages from Europe to America.  Six years later, Carpathia was itself on the ocean floor, having been torpedoed by a German U-boat off the coast of Ireland in one of the last naval engagements of the First World War.

The Austrian bank Hypo Alpe Adria suffered its own disaster of titanic proportions during the global financial crisis after sustaining massive losses on loans in the Balkans.  The bank received a bail-out from its German parent in 2008 and was nationalised by the Austrian federal government a year later.  The banks non-performing assets were transferred to a “bad bank” named Heta.

While you or I might be cautious about dealing with anything named after a letter of the Greek alphabet, the Austrian local authority of Carinthia guaranteed Heta for €25bn, despite only having an annual budget of €2bn itself.

Six years later, German banks are trying to sink the State of Carinthia by calling in those guarantees.  Many German institutions bought Heta bonds assuming they were risk free, since the government owned the bank and the regional state had guaranteed it, and packaged these bonds into other bonds for the American market.

But Heta is still making titanic losses and Vienna is now refusing to pour any more money in to the bad bank, quoting the EU Bank Resolution and Recovery Directive.  Along with the UK and Germany, Austria adopted the BRRD’s bail-in provisions a year before the January 2016 deadline, and these prohibit a government bail-out until there has been a substantial bail-in of investors.

However,  this seems to have come as a surprise to the German bondholders, who are suing both Heta and the Austrian government in an attempt to get their money back.  And Carinthia, of course, cannot divert the next 12 years’ income to German banks if it still intends providing local services to its residents

What lessons does this have for UK local authorities?  Firstly, government owned does not mean government guaranteed.  Austria is not rescuing Heta for a second time, and you can’t assume that the UK government will rescue Lloyds or RBS for a second time, should the need ever arise.

Next, investors can only take comfort from a guarantee if the guarantor is strong enough to meet it – Iceland’s deposit insurance scheme springs to mind here.

Lastly, local authorities should be cautious about issuing guarantees over other people’s debts – they might get called in one day. And it’s a timely reminder, only four months after the BRRD became law, that we are now well and truly into the era of the bail-in; institutional investors really are on the hook for future bank failures.

Small events can have unexpected consequences.  No-one expected the assassination of an Austrian archduke in the Balkans to start the First World War.  No-one expected Lehman Brothers’ losses on re-packaged US bonds and its subsequent collapse to cause such a deep global financial crisis.  And no-one expects the death of a small Austrian bank that lent heavily in the Balkan states to start a second financial crisis.  But then there’s precedent for a strange mixture of Greek letters, Austrian politics, American packages and German strong-arm tactics to not end well.

David Green is Client Director at Arlingclose Limited. This is the writer’s personal opinion and does not constitute investment advice.