* 890 mln euros in state-backed subordinated debt affected
* Austria seeks 800 mln euro contribution from BayernLB
* Federal guarantee on Hypo debt unaffected
(Adds comments from government officials, bankers, market
By Michael Shields and Angelika Gruber
VIENNA, June 11 Austria broke new ground for
debt markets on Wednesday by deciding to annul 890 million euros
($1.21 billion) of subordinated Hypo Alpe Adria debt guaranteed
by the bank's home province of Carinthia.
The move aims to ensure that investors - not just taxpayers
who have pumped more than 5 billion euros into Hypo so far -
share wind-down costs for the stricken lender, officials said.
"Bailing in" junior bondholders in ailing banks in Europe is
not new, but imposing losses on holders of debt with an official
guarantee has credit rating agencies and investors worried about
the reliability of state backing for debt in Austria.
Standard & Poor's put seven Austrian banks on CreditWatch
negative on Tuesday because of the government's plan, following
Moody's downgrades of Hypo debt on similar concerns.
"There will be a massive loss of confidence. To what extent
this will spread to Austria as a place to do business and to the
Vienna stock exchange is the big question and big worry," one
Austrian institutional investor said on condition of anonymity.
But the blue-chip ATX market index was down only 1.2
percent by 1215 GMT, while 10-year government bond spreads
widened slightly to around 31 basis points over German Bunds.
Finance Minister Michael Spindelegger said the move should
be no surprise as the government had flagged in March when it
ruled out letting Hypo go bust that subordinated Hypo creditors
would take a hit.
"What was promised then is being fulfilled now," he told
reporters after the cabinet signed off on the draft law, which
could take effect by August once parliament approves it in July.
He stressed that the federal government would honour its 1
billion euro guarantee on Hypo junior debt.
The draft legislation means Hypo would also not repay 800
million out of 2.3 billion euros in cash contributed by German
regional bank BayernLB when Austria had to
nationalise it in 2009 to save it from collapse. BayernLB had no
Hypo has refused to repay the 2.3 billion, saying it should
be treated as equity rather than debt until it is back on its
Hitting Hypo creditors is a risk that the coalition
government is willing to take to avoid deepening a public furore
over its handling of the country's worst-ever financial crisis.
In fact, Austria sees the case as a chance to change
assumptions of implicit federal backing for all guarantees from
the provinces, forcing investors to look more closely at the
credit quality of each region.
Austria's legislation, drawn up by the finance and justice
ministries and outside experts, is based on a 2001 European
Commission directive on reorganising and liquidating banks, so
it should be solid ground to counter expected lawsuits by
investors, government officials said.
It does not touch the state guarantees, but simply
eliminates the underlying Hypo liability, the officials said.
Austrian constitutional law experts have questioned whether
expropriating investors outside of a formal insolvency procedure
will stand up in court.
Insurer Uniqa, which faces a 34 million euro hit on Hypo
debt, said it was considering a lawsuit. Vienna Insurance Group
could take a 50 million euro hit.
In London, market participants were divided on whether
Austria's move would affect the broader market. There was a
muted reaction in credit spreads and credit default swaps.
"While it won't be good for the bonds in question, I
struggle to see the applicability to the broader market unless
you have banks in similar situations, which is not the case,"
said a senior debt capital markets banker.
"This is not a systemic issue. What it says though it that
there is less and less appetite for taxpayers to be exposed to
losses in these institutions," he added.
A bond syndicate banker was less sanguine.
"Changing the law like they did in Ireland or Holland is one
thing. Changing the law to get out of a guarantee is completely
different. A guarantee is a guarantee and you have to ask what
it's worth if governments can turn around and just revoke them,"
Austria is also going after holders of non-voting capital in
the bank and wants a 500 million-euro contribution from
Carinthia as well, which the local government is resisting.
Austria's draft law also sets up a "bad bank" to wind down
assets at Hypo, whose breakneck expansion at home and in the
Balkans pushed it to the brink of insolvency.
It is selling off its Balkans network and will put its
Italian banking unit - which is barred from doing new business
under an EU-approved bailout plan - into a new holding company.
($1 = 0.7345 euros)
(Aditional reporting by Helene Durand in London and Andreas
Kroener in Frankfurt; editing by Tom Pfeiffer)