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Many people hoped that Germany's Landesbanken would simply wither away when they lost their state guarantee next year. That always looked like wishful thinking.
Now the country's biggest regional wholesale lender has kicked off its survival strategy in earnest. WestLB, one of the most troubled Landesbanken, last month announced plans to raise e1.5 billion to prepare for the post-guarantee world. So much for withering away.
WestLB matters not only because of its size. It is also a role model for the whole sector. It recently hired Thomas Fischer (pictured), one of Germany's best-known and most talented bankers, to turn it around.
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Thomas Fischer
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Fischer's challenge has been to find a role for a bank that has eked out a living in the past by exploiting the funding arbitrage provided by the state guarantee to do everything from straight lending to local Mittelstand companies to sophisticated international private equity. Because WestLB, like other Landesbanken, was able to fund itself more cheaply than rivals in the private sector, it was able to undercut them. This is one reason why private-sector banks such as HVB and Commerzbank have found it hard to make money.
Fischer might manage to inject more market discipline into WestLB. After all, it has been sloppily run in the past. But more radical reform is likely to be stymied by the bank's owners.
True, it was never on the cards that Fischer could close WestLB – which would arguably have been the best solution for the banking sector. Putting the bank into run-off might have led to a massive loss of value for its investors. The same logic also precluded other moves, such as selling WestLB to a private-sector institution.
Merger pitfalls
But there was another, more realistic option – to merge it with other Landesbanken. This would have made sense in terms of cutting costs and might have avoided an immediate capital write-off. But it might have also meant that politicians in WestLB's home state of North Rhine Westphalia would have lost control. That remains a no-no.
Instead, the bank is likely to merge with the local savings banks that are its shareholders. This has one advantage in that it should reduce its dependence on wholesale funding. But it is unlikely to deliver any industrial benefits. There are few cost savings to be wrung from putting a Landesbank together with savings banks.
In the longer term, WestLB might merge with contiguous Landesbanken but there is no immediate intention to do so. As to listing on the stock market, that remains a distant dream.
So where does this leave the shareholders who are sticking in e1.5 billion? Well, they should end up with a more secure investment. WestLB's tier one capital ratio is thought to have fallen to below 5% by the end of last year – too close for comfort to the 4% regulatory minimum. Following the capital injection, it should be near 7%.
But investors won't stand to earn much of a return on their money. Although WestLB has been partly restructured, it remains marginally profitable. This year, for instance, its core business isn't likely to make any money.
Moreover, it would need to lift revenue by more than a third, without any increase in costs, just to cover its cost of equity. Given the sluggish state of the German economy, and a highly competitive banking market, that looks a tall order. It might take the bank more than half a decade just to stop destroying value.
The shareholders do not seem to have been deterred by such slim pickings. The savings bank associations, which own 34%, have already voiced support for the rights issue. The regional government, though strapped for cash, is likely to follow suit.
One reason for this is that the owners do not look upon their investment in purely economic terms. To the government, WestLB remains a source of local power and influence. To the banks it is a provider of cheap wholesale and investment banking products.
Fischer might have long-term plans to turn WestLB into a lean and mean private-sector institution that could raise money from the stock market. But in the short to medium term, whatever his preference, he is going to have to dance to his owners' tune.
Many private-sector banks have set great store by the withdrawal of the state guarantee next year. They argue that this will restore sanity to German banking. It is true that the discipline of market pricing will ultimately force the Landesbanken to change their ways. Reality cannot be suspended indefinitely. But while owners of Landesbanken persist in investing for non-economic reasons, the loss of the guarantee is unlikely to be a fast-acting panacea.
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