Germany 2005 - A disappearing breed?
As the deadline approaches for the loss of the Landesbanks’ State guarantee, a number of concerns continue to plague the sector. Restructuring challenges linger and nagging doubts remain as to whether Landesbanks will retain a place in the German banking system. Are they just obsolete institutions destined to ultimately disappear? Helene Durand investigates.
The basic point is not generally challenged, namely that “all the Landesbanks are going to suffer when their guarantee is removed,” as summarised by Paul Fenner-Leitao, European bank analyst at Barclays Capital.
“These institutions, which were never really competitive, are entering a market that's already not profitable. Also, if the German banking system was to be rebuilt now, Landesbanks would probably not exist in their current form," he added.
The topic is not new, and market participants have been examining the challenges faced by the Landesbanks since the European Commission’s ruling on July 17 2001 that the public sector support mechanisms (Anstaltslast and Gewahrtraegerhaftung) were to be removed.
Since then, Landesbanks have been under scrutiny, and while some steps have been taken towards implementing changes for survival, the consensus seems to be that there will be some contraction of the 10 existing institutions.
“Landesbanks are lagging behind in the development of a fee-based business. At the moment, their margins are very thin and there are just too many of them around. A consolidation process is already in progress and a number of combinations already exist. We will see more of this, and down the line there may be just three to four Landesbanks left,” said Otto Dichtl, analyst at BNP Paribas.
“It's a bit of a conundrum, and it is difficult to guess how many Landesbanks there will be left. There will be some horizontal integration going forward, possibly with private sector banks. Ultimately, they need to increase efficiency, cut costs and find a niche,” said Barclays’ Fenner-Leitao.
Within the rationalisation process currently underway, some Landesbanks have already found their niche. HSH Nordbank – which is the merger of Landesbank Schleswig-Holstein and Hamburgische Landesbank – has a significant position in shipping financing in Scandinavia and the Baltic region.
In the case of Bayerische Landesbank, the bank reduced its foreign activities and exposure while it merged its subsidiaries in Luxembourg and Switzerland with Landesbank Hessen-Thuringen in order to generate greater cost efficiencies.
The approach for Landesbank NRW was slightly different. The bank was reorganised into the development bank for the state of NRW in March 2004. As a result of its mission, the bank benefits from the state guarantee.
Meanwhile, the case of Landesbank Berlin, which is 100% owned by Bankgesellschaft Berlin, is slightly different, as the State of Berlin will be selling its stake in the bank in 2007.
“What will happen to us in 2007 is still open. It is clear that the bank has to be privatised, but there will be no advantage to any group,” said Arnd Muehle, head of long-term funding at Landesbank Berlin.
In other cases, there is a clear attempt from the Landesbanks to get closer to the Sparkassen, Germany's savings banks. Westdeutsche Landesbank has been seen as the most aggressive in its restructuring. While it aims to be profitable on a European basis, it hopes to form a close partnership with the savings banks of NRW and Brandenburg.
“WestLB might be the biggest – with the most to lose – but it is selling some of its non-core businesses and has tried to set up a legal framework allowing it to work with the savings banks. This will clearly help the bank,” noted Fenner-Leitao.
Norddeutsche Landesbank has also made it a main pillar of its strategy to concentrate on the core regions of Lower Saxony, Saxony Anhalt, Mecklenburg-Western Pomerania and North-eastern Europe, and to co-operate with savings banks in order to survive.
Landesbank Baden-Wuerttemberg, has a mix of wholesale and retail customers and carries the highest credit rating as a result. Finally, Landesbank Hessen-Thuringen formed a banking group integrating the region's saving banks. The concept, named S-Verbund or Verbundkonzept, is favoured by analysts.
However, doubts remain as to whether the Sparkassen in general will favour a closer relationship with Landesbanks. "Landesbanks are making some progress in the direction of commercial or formal relationships, but it is a slow progress. This is not least because there has sometimes been a perception that the Landesbanks have looked down on the savings banks and are now only looking for co-operation to serve their own needs, rather than those of the savings banks," explained Nigel Myer, financial/banks analyst at DrKW.
There is no doubt that Landesbanks would hugely benefit from accessing a ready-made retail network. The Sparkassen clearly have a strong market share and pools of liquidity. The general consensus, however, is that for the time being, this is politically difficult.
Fritz Engelhard, European covered bond strategist at Barclays Capital, said that this politically-charged question meant that he expected integration to be more horizontal than vertical.
The funding question
While some Landesbanks are still lagging behind in terms of restructuring, their funding programmes are well under control.
“The Landesbanks have a lot of liquidity and I do not anticipate that they would have huge needs in 2005–06 – and 2007 in some cases. They will also likely increase their use of the pfandbrief market to keep funding costs down,” said BNP Paribas’ Dichtl.
“The process will be slow, Landesbanks are not growing, their balance sheets are actually shrinking. They have less risk-weighted assets, therefore less capital,” said Fenner-Leitao.
Landesbank Berlin’s Muelhe confirmed this, but did add that Landesbank Berlin could come to market after the removal of the guarantee – more as a marketing exercise than a funding one.
It is clear, however, that Landesbank spreads in the senior unsecured market will widen. In the non-guaranteed CDS market, Landesbank spreads are close to those of large commercial banks in Germany in the Single A bracket.
“The CDS market gives a proxy for where unsecured – unguaranteed – Landesbank debt would price. At the moment, their average cost of funding is flat to Euribor, but I suspect that 10bp–15bp over Euribor in the current environment is what they will be looking at for a five-year deal,” estimated Fenner-Leitao.
Muehle said he expected Landesbanks to use the same type of products as they use today – including their MTN programmes, use of the domestic market and of the benchmark market. He noted, however, that benchmark sizes would decrease from the current €1bn to €500m.
In order to keep their funding costs down, Landesbanks are expected to increasingly turn to the pfandbrief market. However, changes in the pfandbrief law (to come into effect on July 19 2005) mean Landesbanks are more likely to move away from the public sector-backed pfandbriefe and toward the mortgage-backed version.
Under the new legislation, new loans to Landesbanks and savings banks will no longer be guaranteed and therefore used as collateral for public sector pfandbriefe. Furthermore, Landesbanks will have to fulfil a list of criteria to issue pfandbriefe.
Using the mortgage pfandbrief route could be facilitated as upcoming changes in insolvency legislation mean that assets that were previously not bankruptcy-remote will become so. Thus, as long as the Landesbank which acquired the mortgages can access them – even, in the case of bankruptcy, from the banks from which they acquired the mortgages – the assets can be put into the cover pool.
Alternatively, they could move to other covered bond markets such as Luxembourg, where unguaranteed Landesbank and savings bank paper will be eligible as collateral.
“Landesbanks will have to adjust to the new legal framework. They will have to evaluate mortgages under the mortgage lending value principle, something that they are not doing now. Technically, this is not difficult, but it will be costly and have to be done in a timely fashion,” said Barclays’ Engelhard.
Funding costs will be dependent on how strong investors and rating agencies believe the link is with the Laender (German states). At the moment there is a strong assumption that all the Landesbanks will benefit from an implicit guarantee from the Laender going forward. Both S&P and Fitch ratings range from A+ to BBB+ while Moody's adopts a Double A to high Single A range.
However, Nigel Myers from DrKW said there could be delays to capital injections from owners in cases where “they incur losses on international operations, at a time when the local economic and fiscal situations are poor and objections are raised about protecting the interests of foreign investors over those of the region.”
In the meantime the recapitalisation issue remains. A number of Landesbanks have paid back state aid with interest but are now waiting for a capital injection from their owners.
The EC is still deliberating whether it will allow this to be done quickly. If not, the Landesbanks could be facing even more problems. Analysts and Landesbanks are confident, however, that the situation will be resolved quickly, and a straight capital injection allowed.
“Disputes with the EC rumble on, not least about the repayment of implicit subsidies and terms of recapitalisation. But as long as the states and the savings banks' associations continue to be able to convince the rating agencies they are committed to their respective Landesbanks, then the support will likely be the main factor behind spread levels of bonds,” concluded DrKW’s Myers.