Austria's AAA Rating Under Attack From East and West

Austria's triple-A credit rating hangs in the balance, and analysts are divided as to whether the country is more at risk from its banks’ heavy exposure to ex-Communist Eastern Europe or from Western Europe.

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The country seems to be torn between the riskiness of emerging markets on one hand, and the problems of the euro zone on the other.

Of the three major credit rating agencies, only Fitch Ratings still rates Austria triple-A with stable outlook. Moody’s Investors Service put Austria’s top notch rating on negative watch in February, while Standard & Poor’s downgraded the country to double-A plus with negative outlook in January.

“The major concern regarding the Austrian financial sector is its exposure to Central, Eastern and South Eastern Europe [CESEE]. While the region is heterogeneous in terms of its economic fundamentals, as illustrated by the dispersion of Fitch’s sovereign ratings ranging from A+ for the Czech Republic, Estonia and Slovakia to BB- for Serbia, from a global perspective it is a small region within emerging markets,” Fitch analysts’ Gergely Kiss and Kit Ling Yeung wrote in the agency’s latest rating report on Austria.

“As many CESEE countries have accumulated large external debt, typically through the banking sector, foreign funding of local subsidiaries will remain a key vulnerability for a long time as domestic adjustment is a slow, gradual process,” they wrote.

Austrian banks’ net exposure to CESEE is around 30 percent of Austria’s gross domestic product [explain this], or 110 billion euros ($136 billion), taking into account local funding, according to Fitch. This includes 50 billion euros of direct lending to private companies in the region, 44 billion euros to fund subsidiaries in the region and 18 billion euros to fund subsidiaries’ equity.

This has led to hefty writedowns of their exposure to countries like Hungary, Romania and Ukraine. The government has taken part in a number of small-scale bailouts of the sector, including an injection of 1.2 billion into KA Finanz, the bad bank of Kommunal-kredit, and 1 billion euros to rescue Österreichische Volksbanken.

In comparison, Austrian banks' exposure to Western Europe is limited.

“Austrian banks do not have much lending exposure to Western Europe, with the exception of Austria itself,” said Christian Kuendig, senior director of financial institutions at Fitch Ratings.

“They have no major banking subsidiaries in other Western European countries; they are all concentrated in Austria and Eastern Europe. If they have euro zone exposure, it is interbank exposure and bond exposure, and minor exposure through international corporate banking.”

Kuendig pointed out that while euro zone sovereign downgrades may be at the forefront of the markets' attention, CESEE countries are still, on average, lower rated.

Based on ratings by Fitch, 17 percent of Austrian banks’ lending in emerging Europe is to countries with non-investment grade or “junk” sovereign ratings, while 30 percent is to countries rated triple-B negative, the lowest investment grade.

“Central European markets are generally higher risk than core European countries like Germany, UK, Holland or France. CESEE ratings are also lower on average than most of peripheral Europe [explain this], with the exception of Greece and to a lesser degree Portugal. Rating-wise, countries like Spain still compare well with most CESEE markets,” said Kuendig.

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Others argue that the euro zone debt crisis may still pose greater dangers for Austria.

“The exposure to Emerging Europe is bigger, but the effects from the euro zone could be more serious. For instance, Austria is relatively exposed to Italyand given the size of Italy, if there was a default, as seen in Greece, that would be pretty devastating,” Jennifer McKeown, senior European economist at research firm Capital Economics, said.

And exposure to higher-growth developing economies might ultimately be positive for the country's banks, according to some.

Douglas Renwick, senior director in Fitch Ratings’ sovereigns group, added: “We do not expect Eastern Europe to experience an economic stress large enough to require large-scale sovereign intervention in the Austrian parent banks. This partly explains why the Austrian sovereign rating is on stable outlook.”

— By's Katy Barnato