Erste Group Reveals Stunner: Reports Billions In Previously Undisclosed Underwater Sovereign CDS; Who Is Next? And How Much More Is Out There?

Tyler Durden's picture

Anyone looking at a heatmap of European markets today will see a sea of green punctuated by a very red island in the middle. The culprit: Austrian mega bank Erste, which issued an ad hoc and very unexpected press release, in which it warned that losses in its Hungarian and Romanian books would lead to a 14% hit, or €1.1 billion, to tangible book value, something that in itself is not a surprise to anyone (except the stress test). After all, since early 2010, most have known that due to Swiss Franc-based mortgage exposure, Hungary is next to follow in the PIIGS footsteps, and its collapse has so far been delayed due to lower overall public and private sector leverage. What was, however not only a surprise, but a shock, was 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.

Still, this does not answer the question how Erste managed to squeeze this information by its auditors and the regulators, without having broken most public company, not to mention bank, laws. The answer is simple: the accountants let them do it.

Autonomous with more:

Note the EBA only required banks to declare CDS exposures in its trading book (Erste was not trading these but rather holding them as “credit surrogates”) so they could argue their exposures were strictly speaking correctly disclosed to the EBA. It seems Erste has changed their classification following an IASB paper from July. There is a link to the  paper below where the relevant paragraphs appear to be 59-63 - Erste believed previously they were ‘financial guarantees’. With reference to paragraph 62 specifically, our in house accounting expert, notes that CDS do not meet the criteria for designation as a guarantee (as a guarantee must apply to a specific referenced asset held by the buyer rather than simply a referenced name). This isn't something there should expect confusion over - the starting point for all derivatives accounting is FVTPL, with any hedge accounting simply changing where the movements are recorded. Thus the decision to treat these positions as ‘guarantees’ should be considered a very “aggressive” approach.

And, logically, the two immediate follow up questions are 1) who else and 2) how much:

It also raises two broader questions - the scale of protection that has been sold by other banks across Europe and how many other banks have deployed Erste’s accounting approach (and will now be forced to move to mark-to market)? On the latter we have calls in with all the banks we cover cross Europe (more later). On the former I remind you the disclosure on sovereign CDS was a major disappointment in the EBA stress test in July. Despite investor hopes / market pressure at the time, the EBA presented the data in a way which rendered the information almost meaningless. It showed the net of positive market values and negative market values with no data on the notional value of positions.  Market values of PIIGS derivatives exposures according to the EBA data ranged between €1.5bn for BNP Paribas and (€800mn) for LBBW.

As we identified in our note at the time (see page 15 - link below) the problem is that the net market value can change very quickly and unfortunately we remain totally in the dark on who has written what. The BIS data is equally as unhelpful - in its latest Quarterly Review (link below), the BIS explained how complicated the data is and how impossible it is to unravel who has written what. This is an obviou

So while Erste group is getting pummeled for being the first to be truthful, granted under duress, with its book exposure, this is merely the first of hundreds, if not thousands, of banks that it will be revealed in the coming weeks and months wrote hundreds of billions of CDS on sovereigns that have since soared to stratospheric levels. While on one hand ISDA may show up and once again make it clear that it only works for bank interests, reconfirming it would never declare a sovereign credit event (for more on the traditional CDS triggers see table below), the truth is that Erste, and soon many other banks' counterparties will demand a pound of flesh in daily variation margin, for even the tiniest amount of CDS exposure, which in turn will lead to a sudden and very dramatic liquidity crunch as unlike quarterly reporting where banks can fudge numbers and data all they want, when it comes to counterparty exposure, other banks know better than anyone just how bad the bank on the other side of the phone is. And will act accordingly.

Expect many more risk flaring episodes in the weeks ahead once this revelation is properly digested.

And as noted above, while probably very much irrelevant now that IDSA has made it clear in the aftermath of Greece it is merely a figurehead for various banking interests, and will never pronounce a sovereign EOD, here is what in theory, should trigger credit events for various types of CDS.

And from the Erste press release, here are the long-overdue details on its CDS exposure:

Background on the CDS portfolio (protection sold)


In the years up to 2008 Erste Group built up a diversified portfolio of off-balance sheet sovereign and bank risk positions (CDS sold), which – as credit surrogates (financial guarantees) – were held at amortised cost. As at 30 September 2011 the total volume amounted to EUR 5.2 billion (at amortised cost):

  • EUR 2.4 billion related to financial institution exposures, and
  • EUR 2.8 billion related sovereign exposures
  • About 14% or EUR 0.7 billion of the total volume is related to banks and the sovereign in Greece, Portugal, Spain, Ireland and Italy

Following an interpretation issued in a staff paper of the IASB dated 28 July 2011 concerning the classification of CDS as derivatives versus financial guarantees, the management board of Erste Group decided to reclassify the aforementioned portfolio as of 30 September 2011, resulting in a mark-to-market valuation of the entire portfolio. Historical accounts will be adjusted as follows: the cumulative effect of EUR -149 million for the business years prior to 2010 will be booked against equity at the start of 2010; in the business years subsequent to 2009 the valuation result of this portfolio is included in the line item "Net Trading Result”. The overall impact from the reclassification amounts to EUR -176 million pre-tax (EUR -132 million post-tax) in 2010. In 1-9 2011 the negative impact from valuations and from losses on disposal amounted to about EUR -234 million (about EUR -180 million post-tax).


With a view to minimise income statement volatility, Erste Group plans to sell these assets in an accelerated manner, taking advantage of windows of opportunity as and when they arise. As a substantial part of these assets are sovereign exposures, the disposal will have a correspondingly lower impact on risk-weighted assets.


Erste Group has also significantly reduced – mainly as a result of asset disposals – its net exposure (sovereign, bank, corporate and retail) to Greece, Portugal, Ireland, Spain and Italy from EUR 5.1 billion at year-end 2010 to EUR 3.6 billion at 30 September 2011; 81% of this exposure is related to Spain and Italy. Sovereign exposure to Greece, Portugal, Ireland, Spain and Italy was reduced from EUR 1.9 billion to EUR 0.6 billion, while bank exposure declined from EUR 2.3 billion to EUR 2.0 billion; corporate and retail exposure remained unchanged at about EUR 0.9 billion (mainly Spain and Italy). As of 30 September 2011 95% of Erste Group’s sovereign exposure to Greece, Portugal, Spain, Ireland and Italy is carried at market value.

PS: You know the drill: Austria-Erste CDS compression trade...

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Deadpool's picture

cockroach theory. Where there is one there is always many many more.

Ya know, "hundreds of billions of CDS on sovereigns that have since soared to stratospheric levels." is not a European invention. This is a Wall Street (read Goldman Sachs) invention. they really did steal the world.

Cassandra Syndrome's picture

Do you not think you are being unfair on Cockroaches using them in this analogy?!

GetZeeGold's picture



In other announcements.....the new spokesman for the EU is Gomer Pyle.




DoChenRollingBearing's picture

Beat me to it!


Also, @ fuu,

Yum, may I have dozen please?  "Para llevar a la casa."

unclebill's picture

hmmmm. I should have been a bankster...and make millions

GeneMarchbanks's picture

We already know that all Euro banks have tons of off-balance sheet horseshit. The timing of their 'announcements' is the only wildcard. It's always an accidental discovery.

I hope these motherfuckers burn along with all fiat.

dracos_ghost's picture

In all seriousness, is there a possibility that these banks are burning the red-headed step children off their books before Basel III really starts to impact them.

vocational tainee's picture

That is why, we should make tabula rasa..

criticaster's picture

Someone obviously got spilt up from the Occupy Wall Street demo...

Goldman did not invent CDSs. They were first offered up by bankers in trust and subsequently by JP Morgan. Originally they were intended as big-ticket risk control for multinational corporates and were supposed to come with the same due dilligence as any insurance policy. JP Morgan and later Citi, were particularly instrumental in deploying them for more general puposes including mortgage securitisation. Of course, by the time CDSs blew the financial system up 'everybody was at it', but it was not Goldmann that invented them.

Lets at least try to get our facts straight.


papaswamp's picture

Loads of 'Come to Jesus' moments bitchez as banksters now run to get bailed by the sheeple.

GeneMarchbanks's picture

Were you the dude who called this earlier today? Somebody came out earlier and said watch Austria and Eastern Europe. Whoever it was, kudos.

papaswamp's picture

In relation to Bulgaria I think I said something....which makes me wonder if something in Bulgaria has gone pop. Was a day or 2 ago though wasn't it? Too much vino and I forget.

GeneMarchbanks's picture

'Dick Darlington

Vote up!

Vote down!


Austrian "jewel" Erste Group Bank Ag (EBS AV on bbg) getting hammered today after announcing losses in it's Eastern Europe operations and markdowns of it's PIIGS holdings'

Congrats Dick Darlington, call of the week.

GetZeeGold's picture



I'll give you a green for that Dick.



Paralympic Equity's picture

I wrote a comment about it in the post on the Max Bank and the greek bank recap/aid. ATX was beaten up by this, Erste booked a big loss on goodwill writeoffs from eastern Europe, I expect more to come. Austrian banks have 300 bn € exposure to mortgage loans in eastern Europe, and most of them are pegd in EUR or CHF and it is a big pile os steaming shit. I am from a eastern Europe country.

papaswamp's picture

It is interesting that the whole eastern european aspect has been largely ignored....or perhaps by design kept out of the news because things could be substantially worsethan the larger 'realm' is aware? 

Paralympic Equity's picture

Things are a lot worse than it is presented, a lot of mortgage dept is under water, and there is a lot of currency risk even with the big interventions by the SNB. It could became very ugly

stormsailor's picture

yeah, there is a lot of "hidden" nasty out there.  i have gotten burned today already for 5k, but i believe i'll short again -20 /es this time from 1185. 

defn8Dog's picture

Sorry... this story missed the bad-news-cutoff last week and is no longer admissable.  The market has put in its lows for the year.  Better luck with these sad, outlier stories, next summer.  

Smithovsky's picture

didn't you get the memo? humor is only allowed on redES+greenGC days

Smithovsky's picture

so another 5% up tomorrow?  

Manthong's picture

Unless we can just get another 8.5% in the scheduled afternoon melt-up today to equal the stellar performance of Columbus Day 2008 (per previous thread).

papaswamp's picture

Up 2.2% ..then the down sessions will start again...

SheepDog-One's picture

HEY no problem! Europe is engineering a $6 trillion Euro leveraged super-fest....hell just borrow some from them! PLENTY to go around! The world is flush with CASH all is well!

plantigrade's picture

And if $6 trillion is not enough they can still be re-leveraged to 60.

Trees do grow to the sky in the land of unicorns.

kote's picture

The EBA didn't have Dexia listed as the safest bank.  Intesa Sanpaulo listed Dexia as the safest out of the 21 "peers" it selected.

RockyRacoon's picture

Whew!  I can't wait to hear about the others.   Being the leper with the most fingers ain't that high an endorsement.

Dugald's picture

Yuh!.. cheap bearings are always noisy...

kote's picture

ZH got the facts wrong.  It hurts the credibility of the site and the message when that happens.  The message doesn't change whether or not Dexia was ranked at the top, so why give critics ammo with sloppy / false reporting?

Facts are important, especially for a site outside the MSM.

slewie the pi-rat's picture

yeah, but tyler put the Intesa Sanpaulo list over the weekend, so i think he just mis-spoke, altho you seem to be technically correct, imo, kote

like you, i do not consider the ideas to be too damaged or "changed" by the glitch, which i have removed here:

"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 (...[deleted dexia mention]...) 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."

but you are correct, i think, in worrying that someone might "report" what zH & tyler are saying, here, and "push" the glitch, just for the sake of confusing disinfo, to make it look like tyler is trying to pull something or "denigrate the EBA" or whatever

so, thanks; i missed that the first time; and yes, this is an important zH/durden call

rambler6421's picture

I heard on the CNBC today that the blogosphere is spreading all these rumors about I-banks like Morgan Stanley........must be a reference to Zerohedge.


Tyler, don't start all these rumors for all these banks!  CNBS (aka Pravda) won't like it. 

abugarance's picture

totally irrelevant, the bank is already nationalised and besides Merkozy promised, all will be well, hush little one...

PaperBear's picture

Oh look what I just found down the back of the sofa.

This is a completely asinine situation.

SheepDog-One's picture

What did you find, another $1 trillion dollar bill? Hooray, the world is saved once again! 

ouchtouch's picture

I think you mean a $trillion platinum coin.

Caggge's picture

The banking industry needs to give out bonuses to retain their talent. The talent is the best and the brightest in the whole world. Yet, they manage their business this way. Whoops, I found another debt that will  bankrupt our bank if you don't bail us out. It is amazingly stupid to expect the same "talent" to solve the problem that caused the problem.

DoChenRollingBearing's picture

@ SheepDog

No, the trillion dollar bill is NEXT week!

Montecarlo's picture

Hey - this is bullish for metals!

BurningFuld's picture

Erste had previously consulted with Tim Giethner regarding disclosure of the CDS's.

Greater Fool's picture

No, no: It's actually more asinine than that.

The basic content of the press release is, "We just asked around a bit and found out that CDS are derivatives. Sorry, guys. Our bad."