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Back To European Sov Exposure: Moody's Will Downgrade Austria's Erste Over Attempt To Hide Billions In Sovereign CDS

Tyler Durden's picture


Before MF Global went bankrupt due to European sovereign exposure, the smart money was that Austria's Erste would be "it." After all, recall from our October 10 post "that Erste disclosed some major losses on its €5.2 billion CDS portfolio, consisting of "EUR 2.4 billion related to financial institution exposures, and EUR 2.8 billion related sovereign exposures". Why is this a surprise? UK-based financial advisory Autonomous explains: "The fact that Erste had a sovereign CDS portfolio which was not marked-to-market has left many investors scratching their heads. As a reminder the EBA stress test data showed Erste to have zero sovereign CDS exposure within its sovereign mix compared to the €2.8bn it now appears to have ‘fessed up’ to (taking a cumulative €460m hit). They also have €2.4bn exposure to banks via writing of CDS. The bulk is non-PIIGS but banks spreads have moved in the same manner as sovereigns (albeit wider and more volatile)." And there you have it: the bogeyman that everyone has been warning about, yet nobody has seen, CDS written (as in sold) in bulk against other sovereigns and other banks which up until now were only mythical, as they, to quote the EBA (which had Dexia as its safest bank) simply did not exist. Oh, they exist all right, and what they do is create a toxic spiral of accentuating losses whenever the risk situation deteriorates, creating positive feedback loops of ever increasing losses until the next Dexia appears... and then the next... and the next. Expect the market to latch on to this dramatic revelation like a rabid pitbull once the hopium high from today's EURUSD short covering squeeze wears off." Of course, the market ignored this loud warning bell, and next hting you know MF was under. This time it won't be so easy, especially since Moody's just announced it is about to downgrade Erste precisely for this reason. This move also explains why the market is suddenly rife with rumors of a broad Austria downgrade.

From Moody's

Frankfurt am Main, November 04, 2011 -- Moody's Investors Service has today placed on review for downgrade Erste Group Bank AG's (Erste) standalone bank financial strength rating (BFSR) of C- (mapping to Baa1 on the long-term scale) and the A1 long-term debt and deposit ratings. Consequently, several subordinated and junior subordinated debt ratings were placed on review for downgrade. The P-1 short-term rating was affirmed. A full list of affected ratings is listed at the end of this press release.

The review for downgrade on the BFSR follows the bank's report of a major loss that partly stems from previously undisclosed credit default swap (CDS) exposures. Accordingly, the review will focus on Erste's risk management, internal controls and financial transparency as well as the risk-adjusted profit generating capacity of its business model. The review for downgrade of the A1 long-term ratings follows the review on the BFSR.

As part of the re-assessment of the C- BFSR, a lower mapping of the standalone credit strength to Baa2 from Baa1 is likely, while a move of the BFSR below the C- range cannot be ruled out entirely. Consequently, the rating agency notes that a one-notch downgrade of the long-term debt and deposit ratings is the most likely outcome of the rating review.



The decision to review Erste's C- BFSR for downgrade was prompted by Moody's concerns about the bank's risk appetite as well as its related risk-management policies, internal controls and financial transparency following an announcement on 10 October 2011 of extraordinary charges leading to a net loss of EUR1.5 billion in Q3 2011. Particularly relevant is the disclosure of a EUR5.2 billion net CDS portfolio (protection sold), which appears to be unrelated to Erste's core business operations and had previously been recognised at cost, rather than at fair value. Erste also announced the harmonisation of IT tools requiring the restatement of certain income-recognition accounting, raising questions about the uniform application of appropriate risk-management tools as well as financial transparency on a group-wide basis.

Both changes may mean that earlier qualitative assumptions that Moody's had assumed are no longer consistent with the C- BFSR and the Baa1 standalone credit assessment.

At the same time, Moody's acknowledges the bank's announcement -- during its Q3 2011 earnings call -- that it has reduced its net CDS exposure to EUR300 million as of 27 October 2011 through various measures such as novation, close-outs and -- to a much lesser extent -- hedges. It is Moody's understanding that these actions have effectively reduced the contingent liability relating to these derivatives contracts and related earnings volatility. However, the restatement of the CDS exposures had a negative impact of approximately EUR460 million after tax. This, combined with the other extraordinary charges (predominantly goodwill write-offs for its Hungarian and Romanian businesses), required the bank to postpone the planned repayment of EUR1.2 billion in government-provided participation capital. This could limit the bank's strategic and financial flexibility for a longer period than Moody's previously expected. In the absence of previously anticipated meaningful profit generation for the full-year 2011, Erste's 7.4% core Tier 1 capital ratio (excluding government participation capital) as per 30 September 2011 is weak compared with other banks' capital ratios rated at the C- BFSR level. In Moody's view, the comparative weakness increases the pressure on Erste to make a rapid return to its earlier earnings-generation capacity to bolster its regulatory capital levels.

Erste's A1 long-term ratings currently benefit from the very high support assumptions as a systemically relevant bank in Austria which results in three notches of uplift from the bank's Baa1 standalone credit strength. Accordingly, the long-term rating is expected to move in tandem with Erste's standalone risk assessment.


There is currently no upward rating pressure as expressed by the review for downgrade.

In addition to the factors described above, the bank's BFSR could come under downward rating pressure due to (1) a stalled economic recovery in Eastern Europe resulting in additional substantial credit charges, beyond levels anticipated by Moody's, (2) an extended period of weak earnings and hence lower internal capital generation, and (3) weakened capitalisation levels as a result of strong asset growth in Eastern Europe.

The bank's long-term ratings could come under downward pressure in case of a weakening in its intrinsic financial strength, as well as adverse changes in the systemic support assumptions currently factored into Erste's ratings. However, Moody's does not consider this likely at present.



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Fri, 11/04/2011 - 10:16 | 1844976 GeneMarchbanks
GeneMarchbanks's picture

Erste is junk.

All who believe they are hedged should be getting itchy by now.

Fri, 11/04/2011 - 10:13 | 1844977 paarsons
Fri, 11/04/2011 - 18:48 | 1846860 Buck Johnson
Buck Johnson's picture

Along with the US also, we all are. 

Fri, 11/04/2011 - 10:15 | 1844983 snowball777
snowball777's picture

Like the first person from the key party to turn up with the clap!

For anyone who thought that the ISDA playing "blind monkey" would avoid repercussions...

Fri, 11/04/2011 - 10:15 | 1844987 qussl3
qussl3's picture

Everybody waiting for a hail mary from the G20.

No shorts into the weekend.

Dont hold you breath.

Fri, 11/04/2011 - 10:17 | 1844988 RobotTrader
RobotTrader's picture

-1138 TICK

46 days in a row at -1000 or worse

New NYSE record in number of consecutive days of "panic selling" intraday.$TICK&p=D&yr=0&mn=6&dy=0&id=p37322057532


Fri, 11/04/2011 - 10:25 | 1845040 qussl3
qussl3's picture


"Sold to you sucka!"

Fri, 11/04/2011 - 10:59 | 1845206 disabledvet
disabledvet's picture

apparently someone didn't get their Groupon allotment this morning...

Fri, 11/04/2011 - 10:16 | 1844989 nyse
nyse's picture

Oops! (It is starting...)

Fri, 11/04/2011 - 10:17 | 1844990 Karl Tashjian
Karl Tashjian's picture

|||||||\\\\\_ _ _ _ _


Get it?

Fri, 11/04/2011 - 10:20 | 1845000 Tsar Pointless
Tsar Pointless's picture


Fri, 11/04/2011 - 10:21 | 1845006 Dapper Dan
Dapper Dan's picture

Is it?

dominus domino

Fri, 11/04/2011 - 10:31 | 1845073 GeneMarchbanks
GeneMarchbanks's picture

Only for those who read right to left.

Fri, 11/04/2011 - 10:55 | 1845179 Miss Expectations
Miss Expectations's picture

See, if you're going to set up a huge line of dominoes, you need to leave spaces so that if you accidentally knock one over, you don't take down the whole project.  Then, when all your dominoes are set up and you are ready to take down the whole project, you carefully fill in the spaces and let the whole thing go.  All the G20 keeps trying to do is stop the first domino from falling, because they KNOW there are no spaces to stop this thing if it starts tumbllng down.  The spaces could have been created by taking out the too big to fail, but there was no f'ing way they would step away from the game.

Fri, 11/04/2011 - 11:35 | 1845317 SwingForce
SwingForce's picture

V Domino scene Like This?:

Fri, 11/04/2011 - 10:19 | 1844997 Jay_Son
Jay_Son's picture

Check out the Italian 2 year - now over 5.5%.  10 year over 6.35%.  Where's the cavalry?

Fri, 11/04/2011 - 10:20 | 1844998 Vergeltung
Vergeltung's picture

this ties in with several other points made this week. this has been a rich week at ZH for us readers.

Fri, 11/04/2011 - 10:26 | 1845044 Sockeye
Sockeye's picture

A rich week indeed. Proving once again that the cynical and skeptical viewpoint is usually right when it comes to understanding the wizardry of bankers and high finance.

Fri, 11/04/2011 - 10:21 | 1845010 pendragon
pendragon's picture

france is clearly deep in recession witness the pmis...when can we expect the sovereign downgrade?

Fri, 11/04/2011 - 10:22 | 1845012 Tsar Pointless
Tsar Pointless's picture

This is shocking news. Banks lie about stuff.

I need a hug. Then a drink. Then a nap. Then a nice blowjob. Then another drink. Then another nap.

Fri, 11/04/2011 - 10:22 | 1845022 Ancona
Ancona's picture

Cue up the slow motion death spiral. As long as they fall one at a time, and there is a lag between explosions, the PTB will try to contain this, but when they start to pop all at once, it's lights out.

Fri, 11/04/2011 - 10:24 | 1845026 Zola
Zola's picture

Can we move to GS and JPM already ? These appetizers are leaving me unsatisfied. I m really looking forward to the MAIN COURSE !

Fri, 11/04/2011 - 11:02 | 1845224 disabledvet
disabledvet's picture

If it's any consolation the man picked to replace Treasury Secretary Tim Geithner has just abandoned SS MFGlobal just as it had hit the iceberg. "Good luck boys!" was heard off in the distance from what turned out to be the only life boat.

Fri, 11/04/2011 - 10:25 | 1845038 midgetrannyporn
midgetrannyporn's picture

Both Moody's Investors Service and Standard & Poor's Ratings Service placed their once-revered triple-A ratings on the Abacus deal...


Moody's and S&P are worthless.

Fri, 11/04/2011 - 10:26 | 1845047 sabra1
sabra1's picture

"the hills are alive, with the sound of mucas!" (everyone, sing with me!) 

Fri, 11/04/2011 - 11:00 | 1845184 Zero Govt
Zero Govt's picture

i knew nothing of Erste until yesterday catching their tv ad' on "growing CEE" (the economic zone of Slovakia, Czech, Hungary etc ...bascialy as my girlfriend ruthlessly commented, "every country with no money!")  

a simple Google search came up with enough headlines on write-offs, write-downs and remarkable contrasts to Erstes own website of sugar coated PR to wonder which story was nearer the truth: Glossy up-beat Erste or the crumbling down-beat debt

Fri, 11/04/2011 - 10:55 | 1845188 citrine
citrine's picture

In other news, Intesa halted in Milan.

Fri, 11/04/2011 - 10:56 | 1845193 youngman
youngman's picture

the G 20 meeting is going in Bank boardrooms across the world can hear a pin drop....

But remember..its only paper many calls are being made to Geitner and Bernanke right now......on the red phone..and what is China doing other than laughing their asses off..


But gold and silver are

Fri, 11/04/2011 - 11:04 | 1845239 disabledvet
disabledvet's picture

Brie, Champagne...a special meal called "Grapes of Wrath"...what could possibly be wrong with that?

Fri, 11/04/2011 - 11:21 | 1845263 slewie the pi-rat
slewie the pi-rat's picture

L0L!!!  "...a toxic spiral of accentuating losses whenever the risk situation deteriorates..."

can i get that cone dipped in butterscotch, please?

Fri, 11/04/2011 - 11:34 | 1845315 Iwanttoknow
Iwanttoknow's picture

Is this the new Kredit Anstaldt?

Fri, 11/04/2011 - 11:43 | 1845350 SwingForce
SwingForce's picture

You guys are sofa king FUNNY today!

Fri, 11/04/2011 - 11:54 | 1845376 M.B. Drapier
M.B. Drapier's picture

Yes, Austria's long been a dark horse in the race to European bankruptcy, hasn't it?

Fri, 11/04/2011 - 14:36 | 1846166 tony bonn
tony bonn's picture

"...which was not marked-to-market has left many investors scratching their heads..."

mark to market? they should be scratching their asses because that antiquated device for valuing assets is passe and decaying from mold thanks to fasb and the us congress....

and what brilliant wunderkind decided to hide the cds? more of the smarmy low rent iq b-school graudates no doubt - the kind who can't make it without cheating, "team work", or a prosthesis....

fuck you bankster crooks

Fri, 11/04/2011 - 15:53 | 1846386 larynx
larynx's picture

Thats what the austrian main population informer is reporting:

Just ignore the wording as its the usual cool aid - but i would really like to know whos that guy in the pyjama.

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