* Audit shows bad bank overvalued by nearly half
* Worst-case assumptions were grossly overoptimistic
* No sign that balance sheet was falsified - regulator
* Finance minister relieved "dramatic" facts are now in the open
By Michael Shields
VIENNA, March 3 (Reuters) - Among the "bad banks" that have emerged since the global crisis, Austria's Heta Asset Resolution stands out as a spectacular failure, brought down by setbacks ranging from the demands of accounting rules to ailing Balkan economies and a Swiss decision to let the franc surge.
Questions are swirling over how things could have gone so wrong so quickly at Heta, carved out just last year from the lender Hypo Alpe Adria whose demise has already caused Austria's worst post-war financial scandal.
Now Heta has revealed a capital hole of 7.6 billion euros ($8.5 billion), making supervisors take control this week and suspend its debt payments.
Other bad banks, notably in Ireland, have taken over assets from troubled lenders based on worst-case scenarios and sold many off at higher prices. But with Heta, which holds the assets of just one lender rather than a range as in Ireland or Spain, worst-case assumptions have proved grossly overoptimistic.
Austrian taxpayers have already coughed up 5.5 billion euros in aid for Hypo Alpe Adria. But news that an audit found Heta's balance sheet was overvalued by nearly half has still shocked the nation, although this time investors will foot the bill.
After years of kicking the can down the road, Austria finally hit the eject button from a fatally flawed bank that had gorged on debt guarantees from its home province of Carinthia, the base of right-wing firebrand Joerg Haider who died in a car crash just at the global crisis was erupting in late 2008.
The opposition Neos party wants prosecutors to investigate the debacle but supervisors play down the possibility that Hypo fiddled its books to hide losses.
"We have no indications at the moment that the balance sheet was falsified. If we did we would investigate this accordingly," Klaus Kumpfmueller, co-head of the Financial Market Authority (FMA) watchdog, told reporters.
Kumpfmueller acknowledged that the FMA too had been surprised by the size of the adjustments, which went far beyond the worst-case assumptions a year ago that wind-down costs would not exceed 4 billion euros.
He attributed the markdowns to the accounting switch triggered by reclassification of the business as no longer a going concern, and a significantly worse outlook for economies in the Balkans where the bank was active.
On top of this was the jump in the franc's value after the Swiss National Bank ceased to cap the currency early this year, delivering a hit worth hundreds of millions of euros, he said.
From the 1990s, home buyers across eastern Europe and Austria took out franc mortgages due to their lower interest rates. However, the Swiss currency is now 12 percent higher against the euro than in mid-January, forcing lenders such as Hypo to increase provisions as many borrowers struggle to keep up their payments.
Hypo/Heta auditors Ernst & Young declined to comment, citing customer confidentiality.
Since Hans Joerg Schelling became finance minister last year, Austria has finally begun tackling Hypo's legacy that has swollen state debt and deficits, prompted a parliamentary investigation and soured ties with the neighbouring German state of Bavaria, which owned the bank until 2009.
Schelling declined to label Hypo's bookkeeping as unprofessional.
"For me as new finance minister it was a matter of getting clarity and having facts and figures on the table that were as clean as possible to be able to make decisions," he said.
"Now they are there and even if the number is dramatic I am happy that facts and figures are on the table and no one is trying to get back into the fog zone," he told ORF radio.
The fog zone seems like home to Hypo, whose bold expansion in Austria and the Balkans pushed it to the brink of insolvency before the government in Vienna bought it from publicly owned Bavarian lender BayernLB.
Founded in 1896 as the Province of Carinthia Mortgage Bank, Hypo was a sleepy lender until Haider, the Freedom Party leader who governed the province, built it into a regional powerhouse.
Taking advantage of Carinthian state guarantees that cut Hypo's borrowing costs, the bank pumped up its balance sheet from 5.4 billion euros in 2000 to 43.3 billion in 2008. The expansion continued after BayernLB took over in 2007.
Hypo lent money to an airline that went broke and helped Haider's government finance a grand lakefront stage in the provincial capital of Klagenfurt, while growing briskly in the Balkans.
Former Chief Executive Wolfgang Kulterer and other senior managers have been convicted of misusing bank funds by financing the ill-fated airline, lending money to investors for a share sale and covering up swap losses.
Management blunders help to explain how Hypo ended up with close to 1.7 billion euros in writedowns and loan losses that threatened its survival at the time of the 2009 rescue.
It had yachts as collateral but had no idea which loans they were backing. It financed a Belgrade office building used as security, then discovered when the loan went bad that the developer still had rights to all its access roads, making the property inaccessible, one banker close to Hypo has said.
It booked 1.66 billion euros in risk provisions and writedowns in 2013, when it lost 1.9 billion. It lost another 1.67 billion in the first half of 2014 after 1.44 billion euros in provisions. Its balance sheet shrank to 25 billion.
Kumpfmueller said he could not rule out prospects that Hypo accounts had got a positive gloss in the past, and a person familiar with the situation described a culture of trying to avoid big writedowns that would annoy its state owner.
A panel of experts said in December that Austria bungled its handling of the lender. Supervisors and auditors either turned a blind eye or did not act decisively to head off disaster.
Austria's parliament launched an investigation last month into the Hypo affair, seeking to assign blame for the scandal. ($1 = 0.8950 euros) (Additional reporting by Angelika Gruber; editing by David Stamp)