Wednesday, April 29, 2009

Derivatives Hit Austrian Railroad With Record Loss

Posted on Bloomberg by Zoe Schneeweiss:

OeBB-Holding AG, Austria’s state- owned railroad company, reported a record 966 million-euro ($1.3 billion) loss after writing down the value of derivatives that went awry.

OeBB’s 2008 loss compared with a profit of 42.4 million euros a year earlier after the company wrote down the entire 613 million-euro notional value of synthetic collateralized debt obligations. The Vienna-based company, which bought the contracts from Deutsche Bank AG in 2005 and 2006, is appealing a February court ruling dismissing a claim that the lender didn’t disclose the risks associated with the derivatives.

State-owned companies and local authorities from Germany to Italy reported more than 1.13 billion euros of losses on derivatives that allow buyers to speculate or protect against risk, leaving taxpayers to pick up the tab.

“There was a climate that pressured publicly owned companies to look for creative ways to finance themselves,” said Thomas Hofer, the Vienna-based owner of H&P Public Affairs, which advises political campaigns. “They were given the feeling of being financially negligent if they didn’t invest in derivatives.”

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in interest rates or weather. CDOs, which package other bonds and loans into notes of varying risk and yields, are losing money as their holdings get downgraded.

‘Didn’t Fully Disclose’

“Deutsche Bank didn’t fully disclose all the risks attached to the CDOs,” Bettina Gusenbauer, an OeBB spokeswoman, said in a phone interview from Vienna.

The derivatives and the risks were fully reviewed with OeBB, a Deutsche Bank spokesman, who declined to be identified, said in an e-mail. OeBB initiated the transaction, not Deutsche Bank, the e-mail said.

Taxpayers shouldn’t “have to pick up the bill for speculative investments,” said Susanne Enk, a spokeswoman for Austria’s Federal Ministry of Transport, when asked about OeBB’s investment.

OeBB’s CDOs package credit-default swaps tied to debt including asset-backed securities and company bonds and expire between 2013 and 2015, the company said. OeBB made provisions on the securities of 420 million euros in 2008, and 157 million euros the year before, it said today.

‘Precautionary Measure’

The provisions are a “precautionary measure,” OeBB Chief Financial Officer Josef Halbmayr said at a press briefing in Vienna today. “We’ve taken all relevant measures to ensure that deals of this kind won’t take place again,” he said.

Credit-default swaps are derivatives used to protect against debt losses or speculate on credit quality, and pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to meet its obligations.

Municipal authorities across Europe are reporting losses from derivatives since credit markets unraveled in the slump triggered by the collapse of the U.S. subprime mortgage market in August 2007.

Milan’s financial police seized 476 million euros of assets from UBS AG, Deutsche Bank, JPMorgan and Depfa Bank Plc this week in an investigation into alleged fraud linked to the sale of interest-rate swaps, which are designed to protect buyers against losses caused by fluctuations in borrowing costs.

The city is suing the banks after losses on derivatives purchased in 2005, and alleges the lenders misled municipal officials on the advantages of the securities. Officials at the banks declined to comment, as did a spokesman for Milan’s city council.

Interest-Rate Swaps

In Germany, the Wuerzburg Regional Court ordered Deutsche Bank in March 2008 to cover a third of the 2.6 million euros city utilities lost in interest-rate swaps bought from the lender. A court reduced a loss claim against Frankfurt-based Deutsche Bank in July by the city of Hagen, Germany, to 1 million euros, from 47 million euros. Both decisions are being appealed.

A Deutsche Bank spokesman said the bank disclosed all risks and informed the municipalities “comprehensively” when selling derivatives in Germany.

“Swaps are like anything else where there’s a sophisticated seller and a simple-minded client,” said Anthony Neuberger, Professor of Finance at Warwick Business School in Warwick, England. “Anything complex can have effects that are different from those anticipated.”

French local authorities are susceptible to buying derivatives because the country’s rules are lax, according to a July report by Fitch.

French Rules

“The French rules, which do not limit the risk taken by local authorities using structured debt, favored the growth” of derivatives, the ratings company said.

About 25 percent of the 132 billion euros of debt owed by local public administrations in France was tied to derivatives as of January, according to Christophe Parisot, a Fitch analyst in Paris.

French Budget Minister Eric Woerth said in February that structured finance holdings don’t pose “a systemic financial and budgetary threat.”

“Structured credits are proposed only to certain clients with significant borrowings and with teams capable of following them,” Dexia SA, which received a 6.4 billion-euro bailout last year by France, Belgium and Luxembourg and which is the biggest lender to local governments, said in a January report to clients.

Derivatives Banned

Losses on derivatives led some European governments to ban local authorities or state-owned companies from investing in derivatives.

The U.K. High Court ruled that about 3.2 billion pounds ($4.7 billion) of swap contracts entered into by Hammersmith and Fulham Council were unenforceable in the 1980s. The 1997 Local Government (Contracts) Act banned investment in the derivatives, according to a spokeswoman at the Department for Communities and Local Government.

Polish municipalities can’t use derivatives, according to local-government Web site, which cites the Finance Ministry’s May 2008 interpretation of the Law on Public Finances.

In Finland, “city fathers learned it the hard way -- there’s no speculation” in the derivatives market because, “in the previous recession, some municipalities speculated on currencies” and lost, said Reijo Vuorento, planning manager at the Association of Finnish Local and Regional Authorities.

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