Dominoes falling from the East


by David Malone{jcomments on}

Chapter one – The Debt train.
Today the Irish will to hear what further humiliations their political and financial classes are going to heap upon them. So naturally everyone is looking at the line of dominoes in Western Europe. Ireland, knocking confidence in Portugal, knocking on to the big kahuna of ‘too big to save’, Spain. But there is a line of dominoes in Eastern Europe that we should not forget.

Hungary was yesterday downgraded by Moodys. The reason was that Hungary is quite obviously NOT going to hit its IMF/EU mandated ‘austerity’ targets. Which will mean its debt will grow, its banks will face higher borrowing costs and the country may not get any more help from the IMF or the EU. Until it is about to fall over when help will forced on them Irish-style.

Not only that, but it is equally obvious that the Hungarian economy which was this year officially limping along at about 0.6% growth will now certainly contract as the global slow down starts to loom clearly out of the fog of denial. Bulgaria will also contract. Bulgaria’s banks saw delinquency rates double this year from 6% last year to 12% of all loans now. The situation is similar in Romania where the economy is set to contract 2% and the value of assets underpinning loans is declining rapidly.

In short, there is another train load of banking losses being loaded in the East. The question is where is the train headed to dump/deliver the debts? Well, sadly, a third of Bulgaria’s banks are owned by Greek banks! They also own about 12% of Rumania’s banks. So as the Balkans default, their losses will fall upon Greek banks who will not be able to contain them. They will give the Greek banks the final push and they will fall over in their turn.

So first stop for the debt train is Athens. Where some of the Balkan debt will be dumped and will trigger a new crisis of Greek bank insovency and debt. The combined debt will then be loaded together onto a new Greek debt train to continue west. That train, now loaded with a toxic brew of Balkan and Greek debt, will make two main stops. Paris, where, eventually, it will unload about €100 billion of exposure to Balkan debt into French banks, and Frankfurt where it will unload a further €80 billion into German banks.

But we should return to the original Balkan train still loaded with debt, because it has further deliveries itself. While the Greek train heads to Paris and Frankfurt, the original Balkan train will now head to Austria. There it will have two main stops, Erste Group of Vienna and Bank Austria, the largest bank in Austria, which prided itself on being the largest western bank in Eastern Europe.

Bank Austria, is, I estimate, in a world of trouble. It has loans throughout Eastern Europe from Poland to Bulgaria and as the downturn intensifies in Eastern Europe, so will its losses. Austria has kept out of the spotlight, but I think its moment approaches. I think Austria, to mix my metaphors in an unforgivable manner, is the next domino to watch in the east. But it is not the last.

Austria and its German neighbor Bavaria have a history of financial troubles, bankruptcies, write downs, dark allegations of political/financial corruption and exposure to bad loans, which are emerging into the light. I think we will see bad debt exposure accumulating in Austria next year.

Now the Erste consignment will have to be dealt with in Austria. But the Bank Austria, the larger part of the problem will not. It will head onward to Italy and to Italy’s largest bank, Unicredit where it will deisgorge its freight of debt. Because Bank Austria, Austria’s largest bank, is in fact, owned by Unicredit, Italy’s largest bank. How and why the pride and jewel of Austria is owned by the pride of Italy, and why it will be Italy that has to deal with a trainload of Balkan debt is the next chapter of the story.

Chapter Two – Too Big to Mention.

In this global debt crisis we have heard several new notions: Too Big to Fail (AIG) and Too Big to Bail (Spain) and now I would like to add one more – Too Big to Mention. And to that category I would like to assign Unicredit as its founder member.

Unicredit is an institution that never gets mentioned because it is SO big relative to its parent nation that their fates are one. Whatever happens to Unicredit happens to Italy. Thus whatever problems Unicredit may or may not have, no one mentions them because everyone knows Unicredit has the 100% backing of the Italian State and Treasury. You mess with Unicredit, you mess with Italy.

So…caution meet wind and here goes.

How Unicredit came to own Bank Austria is a story worth taking a minute to tell. It shows how interwoven East and West actually are. And why I think the Balkan debt train will eventaully disgorge its cargo in Milan, endangering the stability of one of Europe’s largest banks and the nation it sits in.

The story starts in Bavaria with its two largest banks, Beyerische Hypotheken-und Wecshel Bank and Beyerische Vereins-bank. Beyerische was a huge lender in East Germany. Back in 1998 Hypotheken and Vereins had a shot gun wedding. An unusual one because both bride and groom were holding shotguns. The reason, both had large losses to write down. Hypo blew up first. Not hard to imagine that the losses came from its exposure to East Germany.

The marriage was hardly consummated when the joint bank (now called Hypo Veriens Bank HVB) had to write down €3.5 billion inherited from the Hypo half. The Vereins half held on for 7 more years before it too puked up its dowry losses. So this was a bank, that though large, was obviously not overly well run.

Nevertheless only two years later the combined bank, HVB, bought the largest bank in Austria. A German banker who was willing to talk to me on condition of annonymity, who had knowledge of the acquisition, said, it was rumoured at the time that HVB’s purchase was extremely aggressive and unwelcome. What was it HVB wanted to get their hands on? Bank Austria were and I think still are, the largest western presence in Eastern Europe and the Balkans of any Western bank. As such it was seen as the avenue to new markets, new money, Russian money, and the bubbling Eastern European property markets in places like Poland.

HVB continued to grow. Eastern money and eastern loans, thanks to HVB, now flooded as far as Bavaria. HVB became the largest real estate financier in Europe and Germany’s second or third largest bank by number of customers. However, all did not go well. By 2003, according to a second very senior banker who was also willing to speak, and who claims personal knowledge, HVB had accumulated a vast pile of less than wonderful and non-performing assets. He quoted a figure of 57 billion euros worth. I have not been able to verify this figure of course. So let’s say somewhere in excess of 40 billion euros of not-so-super loans, just to err on conservative side. Either way it’s a lot. HVB, he told me, wanted rid of this new bolus of bad debt.

Chapter Three – The Irish Connection
How to get rid of it became the question. 2003 was also, and not coincidentally, the year Hypo Real Estate (HRE) was born. The infamous Hypo Real Estate which had to be bailed out first by the German taxpayer and, now indirectly, also by the Irish Tax payer.

HRE (Hypo Real Estate) was spun out of HVB (Hypo Veriens bank) in 2003, at the moment HVB wanted rid of its non-performing loans. In the event HVB decided to spin out all its non German residential business which, my source claims, included the very large majority of those pesky non- performing loans HVB wanted to get rid of. So, HRE was the solution to the problem. HVB spun out this non German business and the non-performing loans but sweetened it with a large, very large, amount of cash. Another source has told me that the deal was also done to allow Georg Funke to have his own bank. He really, really wanted one of his own but couldn’t have HVB, so they created HRE and gave that to him instead. Again, I can’t verify the story but yet another banker (I know, I know, I need to get out more and meet other people) did say this sort of ego driven thing was “definitely part of modern banking.” Make of it what you will.

Hypo Real Estate (HRE), was housed in Dublin by the simple expedient of giving it the banking license of HVB Ireland. Same license, same bankers, new bank. HVB Ireland became HRE. Magic. Over night Hypo Real Estate became Ireland’s largest bank. It was Irish registered, Irish ‘regulated’, was bigger than any other Irish bank, including AIB, but was listed not on the Irish exchange but, via a holding company, on the Frankfurt stock exchange. It was that holding company based in Munich that controlled Hypo Real Estate and that is why the bail out when it came properly fell on Germany not Ireland. It was not a case of Germany bailing out an Irish bank. Germany bailed out a German bank which had been squatting in Ireland to take advantage of low taxes.

But I am getting ahead of myself.

At the moment we are still in 03 and are just about to enter THE property and debt boom. This means that HRE, although it was born deformed, with non-performing assets, probably saw them recover as the boom years floated all boats. The rest of HVB (from which HRE was spun out remember) also continued to grow and lend.

But by 2005 yet more bad banking was taking its toll. This was the year the Vereins side wrote down €2.5 billion. I hope you are beginning to get the feeling that bad banking is an almost constant feature of this saga. According to the snappily entitled “Strategic planning for accountants: methods, tools and case studies.” by Dimitris N. Chorfas, by 2005, “Analysts and investors,…, wondered how, with all these assets HVB was in danger of going under? Also, why did HVB’s exposure skyrocket?” (p. 556). The author goes on to list “mounting losses”, “Tumbling credit ratings” and “A share price less than half of what it was a year earlier” as symptoms of the rotten and parlous state of HVB. My question, is what sort of bankers manage to make one enormous lot of losses after another and never learn?

Stay with me now. We’re nearly there.

Chapter Four – Last stop, Milan
In 2005 Unicredit enters our story. As a German banker said to me last week, “There is no way the Bavarians would give the Italians the keys to the vault, unless the alternative was death.” HVB was near death. But this was not a simply rescue of a sick bank by a healthy one. Unicredit had to offer 5 shares in Unicredit for every one of HVB. And after the marriage, who should emerge as Chairman of the new, vaster Unicredit but a Dieter Rampl, CEO of HVB – A German/Bavarian banker. The Italian nationalist element in Unicredit were, I am told, very unhappy.

The share swaps and Rampl’s ascendancy together, tell me Unicredit had some of its own weaknesses. To which it had now added a sick, bad-debt riddled HVB. What it had also got however, was now a huge presence in Germany AND, via Bank Austria, – the largest banking presence in Eastern Europe and the Balkans.

Fast forward to today, and we can now see why the debt freight train is headed for Milan. Unicredit owns HVB and its losses and Bank Austria and its Balkan losses. My question is – is Unicredit robust enough contain its own losses plus those of HVB, and Balkan losses out of Bank Austria?

To which we need to add one more detail. In the boom years, Unicredit also bought Pioneer Asset Management in the USA. Through Pioneer Unicredit also bought Vanderbilt Capital Advisers. Vanderbilt were in the CDO business. In fact they were up there with Bear Stearns in terms of how many CDOs they managed. And not all of them fared well. A coinsiderable number of those they managed collapsed, and some were the object of law suits. A recent estimate put Vanderbilt’s expected losses on its CDOs at about 4 billion dollars. And now Unicredit is trying to sell Pioneer. Wonder why?

Oh, and Pioneer were and may still be one of the bond holders of Anglo Irish Bank. See the bond holder list I posted previously. That they used to buy up Irish Bonds was also confirmed for me by a former insider.

So… what this very long journey has been about is to say there is a line of dominoes in the Eastern ‘periphery’ waiting to start falling towards those falling from the West. When they do we should look for the first signs of real trouble in Austria and if we see it, we should then turn to Italy which is the joker in the pack.



This article is reproduced with thanks to David Malone. He is the author of the book Debt Generation. You can read and listen to excerpts from his book here: