Summary

• A relatively low-profile entity in Austria – Pfandbriefbank Oesterreich AG (Pfandbriefbank) – is becoming the next critical chapter in the Austrian banking system story.
• This all started with the capital shortfall disclosure by Heta Asset Resolution AG (Heta), which prompted the Austrian Financial Market Authority (FMA) to announce on 1 March 2015 a moratorium on Heta’s debt securities, including €10.2bn of senior unsecured bonds guaranteed by the State of Carinthia. Carinthia has indicated that it does not have either the resources or will to honour these guarantees, which should be activated upon the bail-in or insolvency of Heta. This has sparked investor uncertainty about the broader guarantee framework in Austria.
• Given Pfandbriefbank’s exposure to Heta, that moratorium has a direct effect on Pfandbriefbank’s standalone ability to repay nearly €600mn of bonds due in June 2015. As things currently stand, these can only be repaid if Pfandbriefbank’s own guarantees are invoked. If they are not, that will further undermine guarantee mechanisms in Austria, and possibly beyond.
• The Austrian regional mortgage banks have publicly announced their commitment on 4 March 2015 to adhere to these guarantees, although the current trading level of senior unsecured bonds (PFBKOS 2.875 07/17) does not imply investor confidence in these assurances.
• Nevertheless, the PFBKOS 2.875 07/17 bond is currently quoted at around 95 (z-spread of 583bps), a significant discount from the 108 (z-spread of 2bps) level seen prior to the announcement of the Heta moratorium, reflecting investors’ increasing doubts about Austria’s guarantee mechanisms.
• The reaction from the rating agencies to the Heta moratorium has been more sanguine, suggesting that they believe that Pfandbriefbank’s own guarantees will be honoured. S&P sees no immediate effect of the recent events on the two related Austrian entities it rates, while Moody’s placed Pfandbriefbank’s A2 rating on review earlier in March, but did not downgrade it.
• We are inclined to agree with the rating agencies that these guarantees will ultimately be honoured.

DetailPfandbriefbank is an issuing vehicle for its member banks (including Heta – the wind up entity for Hypo Alpe Adria Bank), with total assets of €5.6bn as of end-FY14, and very limited equity, given its business profile. The funds raised by the entity are channeled to its members and therefore Pfandbriefbank relies on the payment of these claims to service its own liabilities.

This reliance is strengthened by the Pfandbriefstelle-Act and Article 92 of the Austrian Banking Act, according to which members of Pfandbriefbank and their respective liable public authorities (Gewährsträger) are jointly and severally liable for all obligations of Pfandbriefbank. In an event of default, recourse against any or all of the member institutes and their respective liable public authorities is possible.

The members include: Hypo Noe Gruppe Bank AG (-/A/-, by Moody’s/S&P/Fitch), Hypo NOE Landesbank AG (-/A/-), Vorarlberger Landes- und Hypothekenbank AG (A2 RuRd/-/-), Hypo Tirol Bank AG (Baa2 RuRd/-/-), Landes-Hypothekenbank Steiermark AG (-/-/-), Salzburger Landes-Hypothekenbank AG (-/-/-), Hypo-Bank Burgenland AG (-/-/-), Austrian Anadi-Bank AG (-/-/-), and Heta Asset Resolution AG (Ca/-/-).

Pfandbriefbank has funded its activities via the wholesale markets, although it has not issued any bonds since 2007.

Pfandbriefbank’s bonds came into focus at the beginning of March following the announcement of the moratorium on Heta’s liabilities, whereby the Austrian Financial Market Authority suspended the interest or principal payments on some of Heta’s liabilities until 31 May 2016, with a view to drawing up a resolution strategy by then. The moratorium included €10.2bn of senior unsecured bonds guaranteed by the Province of Carinthia. Carinthia has indicated that it does not have either the resources or will to honour these guarantees.

Pfandbriefbank carries €1.24bn of exposure to Heta, of which nearly €600mn will come due in June 2015. By this date, the guaranteeing member states will need to agree and extend liquidity support to Pfandbriefbank AG or €5.6bn of its liabilities could come due immediately.

The Austrian regional mortgage banks have publicly announced their commitment on 4 March 2015 to adhere to these guarantees, although the current trading level of senior unsecured bonds (PFBKOS 2.875 07/17) does not imply investor confidence in these assurances.

In recently published research, Moody’s stated that “honouring of the guarantee obligations for Pfandbriefbank has limited impact on the federal states' risk-bearing capacity”. This suggests that what is in doubt is the willingness of the guarantors to act in line with their statement of 4 March, rather than the financial capacity of the guarantors to honour their commitments.

To our mind, therefore, there is a fundamental difference between the case of Heta, where Carinthia’s guarantee obligations threatened to sink the state financially, and Pfandbriefbank, where the guarantee obligations for the states are much less onerous.

Given this, and the potential contagion impact on trust in other guarantee structures if these obligations were also reneged on, it would appear more likely than not that that the guarantees provided to Pfandbriefbank will indeed be honoured. The current price of Pfandbriefbank’s bonds does not reflect that.