Bloomberg News

Erste’s ‘Risk Appetite’ Questioned by Moody’s After CDS Loss

November 05, 2011

(Adds more Moody’s quotes in third paragraph, capital gap in seventh.)

Nov. 4 (Bloomberg) -- Erste Group Bank AG’s A1 debt rating may be cut one level by Moody’s Investors Service after the Austrian lender’s surprise disclosure of credit-default swap losses caused concerns about its “risk appetite.”

Moody’s said it’s reviewing the rating because it’s concerned about risk management at Erste, which is eastern Europe’s second-biggest lender, as well as about its ability to generate earnings needed to increase capital ratios. A cut to A2 is the most likely outcome, it said in a statement today.

The review “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,” Moody’s analysts Swen Metzler and Carola Schuler said in the statement. The review will also focus on “the risk-adjusted profit generating capacity of its business model,” they said.

Erste said on Oct. 10 that it would swing to a loss of as much as 800 million euros ($1.1 billion) this year, partly caused by writedowns on 5.2 billion euros of credit-default swaps that it hadn’t revealed before. The national financial supervisor, FMA, is already examining whether Erste broke banking laws by accounting for the swaps off its balance sheet.

The CDS disclosure is “particularly relevant” for Moody’s because it “appears to be unrelated to Erste’s core business,” the analysts said. That may mean “earlier qualitative assumptions that Moody’s had assumed are no longer consistent with” the current ratings, Moody’s said.

‘Limit Flexibility’

Erste has said the CDS accounting was consistent with past rules, and the losses were triggered by new requirements from the International Accounting Standards Board. It said Oct. 28 that it has unwound most of the swaps at no additional loss and would close the book entirely “in the coming days.”

Analysts at JPMorgan Chase & Co. led by Paul Formanko have said Erste should have marked its CDS to market prices “years earlier.” Erste Chief Executive Officer Andreas Treichl last week said he knew that “a lot of investors were just mind- boggled” about how Erste accounted for the CDS.

Treichl and his management board colleagues are returning 35 percent of their bonus for 2010 because the CDS were rebooked at market prices, which resulted in a retroactive reduction of last year’s net income by 12 percent to 988 million euros.

The writedowns and charges, which Erste booked in the third quarter, made the bank postpone a previous plan to repay 1.2 billion euros in state aid this year. “This could limit the bank’s strategic and financial flexibility for a longer period than Moody’s previously expected,” the analysts said in the statement.

Capital Hole

The writedowns and charges -- mostly related to bad loans at its Hungarian and Romanian units -- tore open a 750 million- euro capital hole at Erste, which has to meet the minimum capital ratio of 9 percent of risk-weighted assets the European Union requires from its biggest lenders. The lender aims to fill the gap with retained earnings and will take no further state aid, it said Oct. 28.

Its comparative capital weakness “increases the pressure on Erste to make a rapid return to its earlier earnings- generation capacity to bolster its regulatory capital levels,” Moody’s said.

Erste rose 1.1 percent at the 5:30 p.m. close of trading in Vienna, erasing earlier gains of as much as 4.3 percent. That pared its decline this year to 57 percent, almost double that of the 46-member Bloomberg Europe Banks and Financial Services Index.

--Editors: Zoe Schneeweiss, Keith Campbell

To contact the reporter on this story: Boris Groendahl in Vienna at bgroendahl@bloomberg.net

To contact the editor responsible for this story: Angela Cullen at acullen8@bloomberg.net


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