Germany has been the surprise
victim of the US subprime mortgage crisis, with a significant
number of the country’s institutions – including seemingly
conservative state-sponsored ones – becoming entangled in risky
collateralised debt instruments and other investments. Jessica
Skelly reports from Berlin
Problems in the US subprime mortgage market continue to rock
financial institutions, particularly so in Germany, where many
banks, even state-sponsored institutions famous for their low
profitability, have shown a remarkable appetite for risk. In late
July, the IKB Deutsche Industriebank (IKB) – a small German lender
to the Mittelstand (SME) business sector – made headlines
when it announced losses as a result of its investments in US
subprime debt.
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IKB’s major shareholder, state-owned bank Kreditanstalt für
Wiederaufbau, immediately announced a massive rescue effort,
providing €8 billion ($10.8 billion) of liquidity and covering €1
billion of €3.5 billion risk-exposed positions on IKB’s balance
sheet. IKB had built up a €12 billion portfolio of asset-backed
securities over the past few years, many of which were bundled into
collateralised debt instruments.
While the European Commission is set to scrutinise this significant
government-backed bailout, German regulators are looking into IKB’s
offshore entity, Rhineland Funding, which held the portfolio.
According to IKB, some 70 percent of its assets are rated double-A
or above, with only 10 percent of assets below investment grade.
These investment vehicles, popular with many banks, are mostly kept
off balance sheets and funded in the asset-backed commercial-paper
market.
When market fears deepened in July, Rhineland Funding found that it
was no longer able to secure new short-term funding. Consequently,
it was forced to call on a €12 billion line of credit promised by
IKB and several other German banks. For its part, Deutsche Bank, a
critic of the over-extended US subprime market, then exercised its
option to cancel its commitment, thereby alerting the Financial
Supervisory Authority (BaFin), the German financial watchdog, that
a possible meltdown was under way.
Deutsche Postbank, the largest retail bank in Germany, reported in
mid-August that its exposure as a result of its investment in IKB’s
Rhineland Funding was about €600 million. “The question is not
really which banks will be hit next, but rather to what degree
Germany’s financial institutions are involved in the subprime debt
market,” said Christian Schmidt, an analyst with local investment
bank Helaba.
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By GlobalDataIKB now seems likely to be sold off, and is looked upon as an
attractive asset because of its strong client relationship with
small- and medium-sized companies. Private banking house Sal.
Oppenheim increased its stake in IKB in mid-August to over 5
percent. “The IKB is an interesting asset for any bank that is
engaged with SMEs,” said Michael Dawson-Kropf, an analyst with
ratings agency DBRS.
Hot water
Germany’s Landesbanken, which act as clearing houses for
transactions by savings banks in their regions and help to fund
public works, could also find themselves in hot water. WestLB looks
the most forlorn. It owns about one-half of the €35 billion assets
invested in Brightwater Capital, a special offshore vehicle like
Rhineland, and may have up to $300 million in mark-to-market
losses. The BaFin is also investigating SachsenLB, which has €17
billion invested in a similar type of portfolio.
WestLB’s subprime exposure comes on the heels of the July exit of
CEO Thomas Fischer, who was forced to resign following a damning
report from the BaFin into alleged illegal trading activities
totalling €250 million. Fischer, a former Deutsche Bank risk
expert, was hired in 2004 to clean up WestLB after years of
disastrous lending.
“It looks like WestLB under Fischer did not change much after all,”
said an analyst in Frankfurt. “The bank simply swapped one type of
punting for another, but the results have been the same.”
Because the trading scandal embroiled the board for months, WestLB
was forced to sit out the bidding process in June for Landesbank
Berlin and its retail subsidiary, Berliner Sparksasse. The
Deutscher Sparkassen- und Giroverband (DSGV), the savings banks
association, won the bidding with its €4.6 billion offer (see
RBI 575).
The fallout for WestLB is that it may well now either be sold or
fused with another Landesbank, most likely Landesbank
Baden-Württemburg (LBBW), the biggest regional bank. The DSGV,
which has a 51 percent stake in WestLB, favours a tie-up with LBBW,
while the regional finance ministry in the state of North
Rhine-Westphalia is inclined to press for a private investor in
order to stave off job losses. A decision is expected by
September.
“The most efficient way of providing capital market services for
the savings banks and the Landesbanks’ domestic corporate
clients would be to combine WestLB with one of Germany’s
private-sector banks, which are far stronger in these areas but
weaker in their domestic markets,” said an analyst with Metzler
Bank, who added that there is little rationale for more than a
couple of Landesbanken rather than the current nine. “But
don’t expect that to happen, as mergers between public sector and
private banks still remain absolute taboo in German political
circles.”
Market commentators in Germany are saying private investors will
continue to lose confidence, which will hit banks hard. “Investors
are spooked by potential losses that may be hidden in the banks’
books or rolled into off-balance sheet vehicles,” said banking
expert Isabel Schnabel from the University of Mainz. “There is
still not enough information about the balance sheets of most
financial institutions so we can expect to hear calls for much
greater transparency.”
Little the central bank can do
Experts say there is little the European Central Bank can do
because central bankers as well as regulatory agencies do not
control the securitisation market which packages mortgages into
securities that are then sold off in pieces to investors around the
world. Banks, insurance companies, large hedge funds and pension
funds are all in the same game.
“The most critical issue for the market now is the deteriorating
position of the credit market, which itself has evolved in recent
years in very complex ways,” said Ulrich Hocker, head of the
Deutsche Schutzverein für Wertpapierbesitz, the country’s largest
association for private investors. “New financial tools such as
credit-default swaps slice and dice these loans into pieces sold
around the world, and now investors are waking up to the complexity
of these new tools.”
