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AIG Lite: Margin Call Claimed First Foreign Casualty Of Austrian "Black Swan"

We’ve written quite a bit lately about Austria’s Heta, the bad bank gone... well, bad, or as we’re fond of calling it, Austria’s Black Swan. Recapping, an outside audit identified a €7.6 billion hole in the vehicle’s balance sheet, prompting the institution of a debt moratorium. Unfortunately, Austria’s Carinthia province had guaranteed more than €10 billion in Heta debt, which is five times the state’s operating revenue meaning it is, for all intents and purposes, insolvent and unless Austria wants to go the unprecedented route of allowing a provincial bankruptcy, the sovereign will need to step in in one way or another. The next shoe to drop was the German lender DuesselHyp which itself faced insolvency thanks to around €350 million of Heta debt it held on its balance sheet. 

While we wait to see which “well capitalized” bank will be the next to crumble under the weight of mountainous writedowns occasioned by the sudden souring of “riskless” assets, we get to read the DuesselHyp post-mortem, which shows that the bank was effectively AIG’d by Eurex. Here’s more via Bloomberg:

Eurex, Europe’s largest derivatives market, asked DuessHyp to post additional collateral as the German bank faced writing down its 348 million euros ($375 million) of bonds issued by Austria’s Heta, said the people.


The hit to the bank’s capital from the Heta losses and the extra posting of margin forced the lender, laden with swaps, to seek a rescue, said the people. The Association of German Banks, or BdB, on March 15 said it would back DuessHyp, a lender to public entities, and a day later agreed to buy the company from U.S. private equity firm Lone Star Funds…

Apparently, DuessHyp had more than $13 billion in interest rate swaps on its book, a holdover from the bank’s “old” business model which, according to Fitch, involved underwriting “all sorts” of things:

“This is mostly a legacy from the past, because before the crisis they underwrote all sorts of assets from different countries and in different currencies and they used swaps to hedge the risks.”


DuessHyp was in the process of changing its business model ever since it had to be bailed out for the first time in 2008. The bank planned to exit low-margin public sector lending and establish itself as a niche commercial real estate lender, it said in its annual reports since 2009.

It appears that due to the 0% risk weighting applied to public debt, the bank was grossly undercapitalized:

Its balance sheet continues to be dominated by legacy assets linked to public sector borrowers -- such as the Heta bonds due to their guarantee from the Austrian province of Carinthia. That allowed the bank to run on very little capital compared to its total assets.


With 59 percent of DuessHyp’s balance sheet being public sector loans, which are deemed risk-free under European banking rules, assets weighted for risk amounted to 2 billion euros. That left the bank with a core capital ratio of 11.6 percent by the end of June, more than twice the legal minimum.


Meanwhile, its leverage ratio, which compares capital to total assets, was 2.1 percent, or half the average of major European banks, according to data compiled by Bloomberg.

Or, as we put it nearly a month ago: “the very same bonds that are about to lead to a waterfall in impairments are the ones that were, according to EU regulations, ‘riskless.’ One can only imagine how much latent risk Europe's bank have as a result of the supremely idiotic decision to keep a major subsection of European debt as 0% RWA.”

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So, now that billions of soured “riskless” debt has claimed the financial lives of an Austrian province and a “well capitalized” German lender, we wonder how long it will be before someone wakes up to the fact that applying a 0% risk weighting across the board — as if every piece of paper that's ostensibly backed by the full faith and credit of a public sector borrower is somehow equivalent to a German bund — may not be prudent. 

We won't hold our breath, but at least the powers that be appear to have picked up the scent (via Bloomberg from earlier this month):

Government debt can no longer be considered a risk-free asset for banks, and international regulators should consider changing the existing legislation, the European Systemic Risk Board said.


“If sovereign exposures are in fact subject to default risk, consistency with a risk-focused approach to prudential regulation and supervision requires that this default risk is taken into account,” the ESRB said in a report on Tuesday, citing the majority view among its panel of experts. “Current prudential regulation of sovereign exposures is inconsistent with the conceptual approach that underlies the existing system of regulation.”


Mario Draghi, who heads both the ESRB and the European Central Bank, is pushing for a regulatory review prompted by five years of turmoil in government debt markets that almost splintered the euro area.