Loose cannons at Vestia multiplied Interest Rate Swap problems in 2011

During the last week I wrote two articles on the building cooperative Vestia and its investment in interest rate swaps gone awry:

·         Building cooperative Vestia, based in Rotterdam, The Netherlands plays ‘hedgefund’ with the banks

·         ABN AMRO and Deutsche Bank are the largest parties involved in the Vestia Interest Rate Swap deal gone awry.

With a possible loss of €2.5 bln already, the financial situation seems quite hopeless for the building cooperative. Not only Vestia itself has €1 bln at stake, but the government-sponsored Social Fund for Housing (SFW) and five other building cooperatives have respectively €1 bln and €500 mln on the line.

If this situation will remain the same or even deteriorate, then the chances that the tenants and tax-payers have to jump into the financial void are almost 100%. As I explained in the first article (first link here), there is a big chance that the EU and the US, just like Japan, will remain in a situation of near-zero interest for the next 10 to 20 years. Am I a bear? Definitely! But am I wrong? I suspect not!

Today, the Dutch financial newspaper Het Financieele Dagblad (www.fd.nl) has found out that the loose cannons at Vestia have multiplied their problems during 2011, by increasing their over-the-counter  (OTC) interest rate swap exposure to €20 bln from €10 bln.

Here are the pertinent snips of this continuing story that proves that there is no limit to financial stupidity.

Vestia doubled its problem

Building cooperative Vestia doubled its derivative position since the end of 2010, thus largely increasing its vulnerability for interest drops.

It has become clear now that the derivative portfolio of Vestia soared during 2011 to € 20 bln from €10 bln at the end of 2010. This is stated by sources around Vestia.

Recently the news was spread that Vestia had to pay a few billions of euro’s to cover its derivative positions. Vestia hedged a possible interest increase using derivatives, but the contracts – so called interest rate swaps – caused that the cooperative has to pay extra when interest drops further. And that is exactly what happened last year.

Vestia extended its exposure by purchasing a lot of extra derivatives just before the interest dropped one more time. This was disclosed to this newspaper.by various sources. ´Possibly Vestia bought extra swaps, due to the low interest rate’, according to a source. In other words: Vestia found that the interest was so exceptionally low, that it also entered into interest rate contracts for the distant future. Presumably the cooperative didn’t reckon with further interest decreases. The extension of derivative positions explains why Vestia had to deposit an amount of multiple billions of euro’s at the bank.

This deposit amount of €2.5 could hardly be combined with a derivative position of only €10 bln.

Last week two interim-managers entered at Vestia. Their task is to diminish the derivatives exposure of Vestia with the help of the Dutch Finance Ministry and the Dutch national bank De Nederlandsche Bank (DNB).

Insiders state that derivatives with underlying loans will be exchanged for loans with a higher interest rate, as a premium for the unilateral ending of the contracts.

Further Vestia is looking to projects that can be delayed or even scrapped. On top of that the Rotterdam-based building cooperative wants to sell 22,000 – 30,000 houses from their portfolio.

And that is that for financial lunacy to the third degree.

These are the probable consequences of this financial lunacy:

• Those interim-managers will have to purchase new loans at the bank at an interest rate that would even make the worst loan-shark feel ashamed. Just as a premium...
• One-fourth to one-third of the tenants of Vestia will get ‘an offer they can’t refuse' to buy their home, or else… 
• The market in and close to Rotterdam will be flooded with at least 20,000 rental houses being for sale suddenly. And that in possibly the worst housing market ever in The Netherlands. 
• And of the €2.5 bln that is now at stake, at least €1.5 bln will have vanished without a trace, is my prediction. 
• The tax-payer will again be footing the bill for the missing billions.

 And what about the banks and Vestia?

If Vestia survives this event, it might be a matter of a few years until the next opaque trade begins, unless the leading figures are penalized heavily with gigantic fines and imprisonment.

And the banks? They never really changed their attitude after the credit crisis; they only kept a very low profile for a few years.