(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
By Neil Unmack
LONDON, March 13 (Reuters Breakingviews) - It seems not everyone was ready for a Greek default. Although most investors have been braced for a hit for well over a year, Austrian lender KA Finanz announced on March 9 that it will write down up to 1 billion euros of Greek exposure, partly because of losses on credit default swaps. The loss is largely due to accounting. But it's a setback for those hoping an orderly payout would show credit derivatives in a good light.
At first glance, the episode confirms the fears of policymakers who warned that triggering Greece's CDS could reap chaos. KA Finanz, a "bad bank" carved out of Austrian lender Kommunalkredit, will take a 423 million euro charge because it hadn't previously recognised losses on its 522 million euros of Greek credit derivative exposure.
KA Finanz's approach appears to be mainly a quirk of accounting regulations. International standards typically require banks to reflect movements in derivative prices in their profit and loss statements. That's what KA Finanz did after Kommunalkredit was nationalised in 2008. From 2010, however, the bank stopped reporting results under international accounting rules. Though it recorded the fair value of the CDS in its accounts, it did not have to recognise mark-to-market losses in its earnings. KA Finanz isn't the first Austrian bank to take a hit on its Greek CDS; last October, Erste Bank marked down five billion euros of CDS previously booked as financial guarantees.
However, this is a far cry from a derivative timebomb like AIG, the U.S. insurer which spread chaos in 2008. Unlike AIG, KA Finanz posted collateral against its CDS exposures, giving counterparties protection if it failed to pay. The bank recorded the fair value of the derivatives in its annual accounts. And as a bad bank which is in rundown, KA Finanz can hardly be accused of recklessly loading up on risk.
Nevertheless, the CDS surprises may not be limited to Austria. During the boom years, banks and insurers entered into complex deals that allowed them to take on CDS exposure without recognising market fluctuations in their earnings. The structures, which often used sovereign CDS, were also sold in Germany and Italy, according to one derivatives banker. Triggering the Greek CDS event may well prove a perfect showcase for an orderly credit event. But there is always the potential for further upsets.
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-- KA Finanz AG, the bad bank spun off from Kommunalkredit Austria, the nationalised lender, said on March 9 it would need to take a provision of about one billion euros on its Greek exposure following the country's private sector bond swap.
-- KA Finanz owns Greek bonds and government-guaranteed bonds, and was also exposed to Greece through credit default swaps.
-- A triggering of the credit default swaps would require a charge of 423.6 million euros, according to KA Finanz's statement. The bank said it had 522.8 million euros of "CDS and CDS-type contracts".
-- ISDA, the trade body of the derivatives industry, declared on March 9 that the Greek PSI had triggered a credit event on the country's credit-default swaps.
-- KA Finanz statement: www.kafinanz.at/EN/Adhoc%20%20Press%20Releases/Adhoc++Press+Releases.aspx
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