Slow progress

IFR Germany 2010
10 min read

The story of the rebuilding and the eventual consolidation of the German Landesbank sector has run throughout the financial crisis, and progress has been painfully slow. Given the bureaucracy involved, that is hardly surprising. But signs are emerging that the next year could finally see significant developments, with WestLB likely to set the template for others to follow. Mark Baker reports.

Since the financial crisis began, the German Landesbank sector has undergone a radical upheaval. Institutions that were once seen as bastions of safe regionally-based lending were shown to have succumbed to the same unhealthy divergence from their core mission as much of the rest of the banking sector. Huge bets were taken on high yielding but highly rated tranches of mortgage-backed securities that were too good to be true.

That what were supposed to be ultra-traditional local firms were complicit in this crisis shook the trust that Germans had in their banking system. It has led to the establishment also of a federal bailout fund, the Soffin.

Berlin, understandably, has sought in return to grab more control of the wayward Landesbanks away from the regional governments and local savings banks associations that have owned the firms. And the EU has weighed into the state aid debate, imposing conditions on firms that have received help and calling for a timetable for consolidation of the Landesbank sector.

WestLB is the key

But the long-term picture for the Landesbanks has moved remarkably little over the last year. It will surely involve the mergers of some banks and possibly the privatisation of others. In part, there has been a degree of watching to see what happens at WestLB.

The bank suffered badly in the crisis and turned to the government and its regional shareholders – the savings bank associations of Rhineland and Westphalia-Lippe, together with the state of North Rhine-Westphalia – for assistance. It has established a bad bank that may be a template for others to follow and which will formally go live at the end of April 2010. That move, which involves the transfer of €77bn nominal of non-core assets – not all of which are by any means toxic – is crucial to the future of WestLB. It will leave a healthy “core” bank that will seek to be a lynchpin for the rebuilding of the Landesbank sector.

In return for providing federal funds and helping recapitalise the healthy core bank of WestLB, the federal government has taken a “silent participation”. The EU has imposed conditions including the reduction of the bank’s balance sheet and the sale of various businesses.

These include the profitable real estate arm WestImmo, for which about 10 bids had been received at the time of writing, when the bidding period was about to expire. There are expected to be some German banks and a number of private equity names among the bidders.

WestLB’s supervisory board will review the bids for WestImmo at the end of April, but the direction in which this sale goes could be a significant indicator of how the overall process of reorganising the Landesbank sector will take shape. What observers will be looking for in particular is any sign that a German solution is being sought, such as the selection of a German bank as winner of WestImmo.

The EU’s conditions also called for a change of ownership at WestLB, but the timetable for this process is very fluid. Europe has said that the sale process for WestLB should begin in summer 2010, but has also said that if nothing has happened by 2011, then the timetable would be simply extended.

Delicate political landscape

The political landscape is particularly delicately poised at the moment, ahead of local elections in Germany scheduled for May 9. The result of these elections, say bankers at the Landesbanks, will prove to have an importance influence on what happens in terms of the strategic future of the banks. Whatever political landscape emerges from the polls, the regional governments will remain the largest shareholders in the Landesbanks and will therefore have the same preoccupations over preserving local employment – WestLB employs 5,000 staff in the state of North-Rhine Westphalia – and securing the best price for any assets they choose to sell.

The recent crisis involving the state of Greece’s finances – and the country’s dependence on the co-operation of Germany in any European bailout scheme – has added a potent new ingredient to the mix, say those at the Landesbanks. This is particularly true since German chancellor Angela Merkel has shown a marked reluctance to provide wholehearted public support for a Greek bailout.

“There has been a rather elaborate game of bluff and double bluff being played,” said one source. “The Greeks have a pretty strong card. They can point out that it might not be very useful to Merkel’s coalition if they ask for the money in the week before the elections, for instance.”

The other related factor is that there has clearly been a change of attitude among German political circles in the last few months, moving away from a cross-border EU approach to financial stability and to much more of a pro-German stance.

The combination of these factors has important implications for the long-term strategy for the Landesbanks. If it is the case that the domestic financial stability of Germany is the most important factor for Berlin, then that ought to translate into a broader commitment to bail out the banks and also to pressure them to return to their origins – supplying capital to German industry. Consolidation of the sector within the country’s borders would also help with this, by increasing balance sheets.

Domestic focus

All of which points to a series of domestic mergers as the most likely future for the Landesbank sector. Insiders say that the EU would prefer a cross-border and/or private equity solution, but concede that it will have to be realistic when faced with the importance of Germany for broader European financial stability. EU bodies, including the European Commission, will also have to face up to the fact that Germany is increasingly adopting a direct approach to discussions. Merkel is bypassing the Commission and new European Council president Herman Van Rumpuy in favour of one-on-one talks with the likes of French president Nicolas Sarkozy.

That domestic focus is unsurprisingly being seen in the strategies of individual banks. WestLB has been trimming its activities overseas dramatically – pulling out of cities including Buenos Aires, Johannesburg, Kiev, Mumbai and Beijing. It has even closed branches within Germany, in Dortmund, Bielefeld and Muenster, and will be closing Cologne this year. LBBW is selling its New York based subsidiary.

According to ratings agency DBRS, WestLB’s full-year 2009 results, released in March, demonstrated “the strength of the bank’s core franchise and the significant progress achieved towards rebuilding the earnings generation ability of the core bank”. WestLB posted group losses of €503m in 2009, but the core bank’s adjusted profit was €292m.

The likelihood is that it will continue to be developments at WestLB that set the scene for the rest of the sector. The regional savings banks that own the bank held a meeting in April at which it was decided that the preferred future for the bank was consolidation within the Landesbank sector. Nevertheless, they also refused to rule out a sale to a foreign private equity firm if that was the only solution.

With Berlin now holding a stake in WestLB, the federal government has a strong influence on events – more so than at firms where its offers of aid have been rebuffed. Bavaria’s BayernLB has, for example, consistently rejected any involvement with Soffin in spite of the huge losses that it suffered in particular from its majority-owned subsidiary Hypo Group Alpe Adria. The bank did accept assistance from the Austrian government, however, as well as from the Carinthia region and other shareholders. The European Commission in December 2009 approved the aid on condition that the bank undertook a restructuring plan.

Ultimately, though, the German federal government is seen as likely to end up taking silent participations in most or all of the seven Landesbanks. Behind the scenes that participation is expected to be not so silent. Consolidation could see a first stage of regrouping into perhaps three firms, with an eventual target of just one that serves German small and mid-cap industries – although that programme is at this stage purely speculative and would take years to realise.

That the federal government can still call the shots in disputes with the Landesbank shareholders was shown dramatically in November 2009. The savings bank owners of WestLB briefly looked to be on the point of triggering a new banking crisis by indicating that they were not prepared to give the firm any more support. The move triggered a sudden blow-out in spreads until the federal government forced the savings banks to back down and agree to pour in significant amounts of aid alongside Berlin’s participation.