Austrian Financial Market Update

UNCLAS SECTION 01 OF 02 VIENNA 000642 SIPDIS TREASURY FOR FTAT, OCC/SIEGEL, AND OASIA/ICB/ATUKORALA TREASURY PLEASE PASS TO FEDERAL RESERVE AND FINCEN TREASURY ALSO PASS TO SEC/E.JACOBS E.O. 12958: N/A TAGS: EFIN AU SUBJECT: Austrian Financial Market Update REF: (A) VIENNA 0484; (B) VIENNA 0365; (C) VIENNA 60 ¶1. SUMMARY. This cable updates recent issues in Austria's banking sector: -- Solvency / Liquidity: A fourth large Austrian bank (BAWAG) has accepted state equity capital. Bank Austria's negotiations on a GoA capital injection are complicated by signs that Italian parent UniCredit may move business from Vienna to Milan. Raiffeisen International (RI) has set aside large loan loss provisions but is adamant it will stay invested in Central/East Europe (and may get equity capital for those subsidiaries from the EBRD). -- Central Bank Health: the Austrian National Bank (OeNB),which reported a meager profit for 2008, cannot create increase reserves because the GoA takes (by law) 90% of its after-tax profits. -- Credit Markets: recent data show few indications of a credit crunch in Austria. The GoA will soon reallocate EUR 10 billion from its interbank lending guarantee facility to guarantee industry loans. -- Bank Medici fraud case: Austrian prosecutors are investigating the leadership of now-defunct Bank Medici (a conduit for Madoff funds) for crimes ranging from fraud to money laundering. In late May, Bank Medici lost its Austrian banking license. END SUMMARY. GoA Equity for Banks - - - - - - - - - - - ¶2. Since Post's last financial market update (ref A),BAWAG (a subsidiary of U.S. private equity fund Cerberus Capital Management) has reached agreement on a EUR 550 million GoA equity injection. The GoA will also provide a 5-year guarantee for troubled BAWAG assets at a book value of EUR 400 million. Owner Cerberus will provide EUR 205 million in fresh capital to BAWAG, and the bank will issue a Tier II bond of EUR 50 million. BAWAG posted a larger than expected loss of EUR 547.5 million in 2008 (after a loss of EUR 452.5 million in 2007),mainly from exposure to Lehman and Iceland. ¶3. Bank Austria/BA a subsidiary of the Italian UniCredit group, has launched negotiations on a GoA equity injection. BA is eligible for up to EUR 2.7 billion from the GoA (on top of EUR 3.8 billion for UniCredit from the Italian government),but Austrian authorities have signaled they will provide at most EUR 2 billion (i.e., half of the capital increase for the whole group). Negotiations have reportedly stalled due to UniCredit signals that it would move its profitable CESEE business and other responsibilities from Bank Austria to UniCredit headquarters in Milan (NOTE: this is not the first time UniCredit has sought to centralize the group). In late May, BA CEO Erich Hampel announced his resignation, effective September 30, under pressure by UniCredit headquarters (his contract would have expired in April 2010). FinMin Proell is reportedly engaged on the question of BA's role within the UniCredit group and Hampel's departure may have been an Austrian "concession" in the negotiations (Hampel was also reportedly tainted by the Bank Medici affair as detailed below). The GoA is seeking new private equity from Unicredit's owners or other investors (Note: GoA equity bears a lower interest rate if private investors subscribe at least 30% of the capital increase / see ref A). ¶4. Nationalized Kommunalkredit has not applied for GoA equity but is expected to apply once its survival is assured under a restructuring plan (to be presented soon). Since the bank underwent emergency nationalization in November 2008, the GoA has budgeted EUR 1.5 billion to cover lost subsidies, according to FinMin Proell. In April, the GoA extended a EUR 1.2 billion guarantee to cover its balance sheet for 2008, showing a loss of "only" EUR 1.5 billion. Raiffeisen: Higher Loan Loss Provisions, But Staying in the Game - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - ¶5. Raiffeisen International (RI) will raise up to EUR 2 billion in new equity on the capital market. (NOTE: as a holding company with no separate banking license, RI is not directly eligible for GoA equity; instead, RI parent Raiffeisen Zentralbank/RZB will give RI part of RZB's EUR 1.75 billion GoA equity injection and EUR 915 million private capital increase. END NOTE) RI's operating profit for Q1/2009 was EUR 536 million (up 7.1% from Q1 2008) but consolidated net profit dropped 78% to EUR 56 million, mainly because of a quadrupling of loan loss provisions to EUR 445 million (Q1 2008: EUR 93 million); the non-performing loan ratio rose 2.5 percentage points to 4.8%. ¶6. Like other large Austrian banks, the Raiffeisen group shows no signs of pulling back from eastern Europe. On May 26, RI joined ten other Western banks at a European Banking Group Coordination Meeting (chaired by the European Commission and IMF) at which banks pledged to maintain their exposure to Romania and Hungary, including prudent capitalization of their subsidiaries. RI is reportedly among twelve European banks CESEE subsidiaries may receive equity injections from VIENNA 00000642 002 OF 002 the European Bank for Reconstruction and Development (EBRD). Austrian National Bank Tightens Its Belt - - - - - - - - - - - - - - - - - - - - ¶7. The financial crisis has reached the Austrian National Bank (OeNB). As a result of the decline in key interest rates, high volatility in foreign exchange markets, the depreciation of some reserve currencies against the euro and higher risk provisions, the OeNB's net profit for 2008 was only EUR 47 million, well below the EUR 247 million it earned in 2007. Since by law the federal government gets 90% of OeNB profits, all but about EUR 4 million will go to the GoA treasury (NOTE: In 1997, the GoA raised its profit take from 73.6% to 90% -- since then the OeNB has transferred EUR 8 billion in profits to the GoA). ¶8. As a result, the OeNB has increasing difficulty raising reserves. OeNB reserves have fallen from EUR 5.8 billion in 2000 to EUR 2.8 billion in 2008 -- too low according to OeNB Governor Ewald Nowotny and the bank's auditors, who in 2007 recommended the central bank form additional reserves of EUR 2 billion over the next ten years. In 2008, the OeNB could not allocate the necessary EUR 200 million to reserves, according to Nowotny. GoA to Guarantee Bank Loans to Austrian Industry - - - - - - - - - - - - - - - - - - - - - - - - - ¶9. In May, the GoA announced it will reallocate EUR 10 billion (from its EUR 75 billion interbank guarantee facility) to cover guarantees for loans to industry (pending Parliamentary approval, which is very likely). The GoA will not provide additional funds, but rather guarantee bank loans to industrial enterprises. The new program comes in reaction to industry complaints that bank capital is unavailable at reasonable conditions. The GoA hopes that Parliament will approve the program before its summer recess in mid-July. NOTE: state guarantees will cover only bank loans, not commercial bond issues. The GoA would guarantee 30-70% of the loan amount, depending on the company's credit rating and other criteria to be defined (such as number of jobs at stake). END NOTE. Medici Bank Investigation for Fraud, Money Laundering - - - - - - - - - - - - - - - - - - - - - - - - - - - ¶10. On May 28, Austria's embattled Bank Medici had its banking license annulled by the Austrian Financial Market Authority (the bank itself suspended its use of the license in March). Bank Medici, which is 75% owned by Sonja Kohn and 25% by Bank Austria, was deeply involved in the Madoff affair as a conduit for investments in those funds (ref C). Austrian authorities are reportedly investigating Bank Medici management for potential crimes including fraud, embezzlement, money laundering, and violations of the Security Supervision Act and the Investment Funds Act. Issues include Bank Medici's role as a Madoff conduit, questionable payments from Madoff to Kohn, alleged money laundering in connection with Herald Asset Management (Cayman Islands),and Kohn's alleged contact to Robert Allen Stanford (like Madoff, accused of large-scale financial fraud). The Bank Medici case has been a major headache for 25% owner Bank Austria and was reportedly a factor in CEO Hampel's early departure from BA. Central Bank: Rescue Measures are Working, No Credit Crunch - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - ¶11. The OeNB has said since late March that there is no "credit rg^QQ[;xHwcrunch" in Austria (despite anecdotal evidence that lender scrutiny and terms remain tight -- ref B). A recent OeNB study of financial market indicators concludes that since mid-March, money markets have largely normalized, interest rates are falling, the Vienna Stock Exchange is rallying, and the GoA's bank rescue package has proven itself effective. Austrian central bankers now see the downturn as a demand-side, real-sector phenomenon rather than a financial crisis inhibiting credit supply. ORDWAY