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No. 6: If you don’t give it to me you’ll only lend it to someone else and look where that got us
Abigail Hofman:

Abigail Hofman:

Champagne was plentiful but canapés were scarce

March 2002

Landesbanken look to a new life


After years of complaints from regulators and private-sector rivals that Germany’s state banks are taking unfair advantage of public guarantees, the issue is in sight of being resolved. The EC has decreed that the Landesbanken will have to do without this subsidy within three years. Most state bank officials are confident that they can find new ways to compete but others are not so sure.




"The Landesbank issue is a bit like the undead," the analyst sighs. "It seems to stay with us for ever." In July 2001, the European Commission ended years of complaints and evasions by ordering Germany to remove public guarantees from state banks. Created to do public finance business for their local governments, the states of the German federation, the Landesbanken have antagonized Europe's privately owned banks by using their funding advantage to move into commercial lines such as asset management, investment banking and derivatives, undercutting rivals to get market share. Now their funding advantage has to disappear within three years. And no-one is sure how the Landesbanken will compete without it.
All over bar the detail
The issue is still unsettled. Germany is in talks with the EC to settle important details. In a typical European bureaucratic tangle, the text, when translated into German, is unclear on whether the grandfathering arrangement that will continue to guarantee bonds issued by the Landesbanken before the ruling will also ensure timeliness of repayment. It's a real problem as far as rating agencies are concerned.
       
Gerry Rawcliffe
Nobody seriously expects major changes at this stage but the squabbling continues anyway, delaying still more the point when the banks will finally need to face up to change. The Landesbanken have three years to get ready for real competition. They need to overcome their chronic unprofitability and consolidate. But business will be tough, and mergers fraught with political difficulties.
The problem is twofold. Although the efforts of the Landesbanken to move into commercial business were what prompted the ruling, they have been historically unprofitable, specializing in low-yielding public-sector loans. They have only been able to lend this cheaply because of their funding advantage. And because these loans are zero risk-weighted, the banks have needed only tiny capital reserves.
Ian Centis, banking analyst at BNP Paribas, explains that the banks will have to start funding at more expensive levels when their ratings fall. This will mean moving away from reliance on public-sector lending towards higher-yielding assets. But, he points out: "This will mean that their assets are no longer mostly zero risk weighted. So they will either have to shrink their balance sheets or find a lot more capital quickly. Their state owners could inject more capital but it is unclear whether Brussels would demand that this yield a market return. The EU kicked up a fuss five years ago about Banco di Napoli in Italy - it is likely to insist that any additional capital now carry market remuneration. Also, it is open to question whether all states would be able to afford a recapitalization."
Brussels might allow a capital injection. But the amounts involved would be too large for some state budgets. Many state authorities, such as financially troubled Berlin, are as heavily indebted as their banks. The Landesbanken will have to raise substantial amounts of new capital. Indeed, observers at other German banks say they are likely to end up effectively privatized. One Landesbank, LB Kiel, recently surprised the market by getting an A3 Moody's rating for a tier-one issue - at the top end of the range most analysts expected. This is a hopeful sign but is no guarantee of favourable treatment in the long term.
So fast action is needed. Guido Versondert, European financial credit analyst at Barclays Capital, says: "My impression is that the rating agencies are taking a fairly relaxed view of the sector for the moment. But the challenge remains the same - the Landesbanken and savings banks start from a fairly comfortable position, and lots of things speak in their favour. But that will involve overcoming local and regional political forces, and there are numerous management teams and local representatives who will not want to give up their status and power, so that there is a real danger the market could remain fragmented." If this happens, if the banks bury their heads in the sand, he adds, they will eventually find their franchises being eroded by privately owned rivals.
       
Guido Versondert
One way forward could be horizontal consolidation. Already the Landesbanken have intricate alliances and cross-shareholdings - at the start of 2002, for example, Bayerische LB increased its stake in the smaller Saar LB from 25.1% to 75.1%, and is strengthening its cooperation with LB Hessen-Thüringen. But Gerry Rawcliffe, head of investment-grade credit research at Dresdner Kleinwort Wasserstein, says this consolidation is easier to talk about than to achieve: "It would be politically sensitive. None of them would want to lose its regional identity but on the other hand it is hard to see a rationale for an owner to maintain five distinct Landesbank subsidiaries. In the UK, we often fail to appreciate the strength of regional allegiances in Germany - it is a genuinely decentralized federal state. The Landesbanken and the politicians who support them want to keep it that way. There have been grand schemes before to unite all of them into some kind of super-Landesbank, and all of them have failed because of political resistance."
Landesbanken have traditionally been there to serve their states; changing to a wider role would be traumatic. Even deciding where to put a merged bank's headquarters could cause bitter arguments. In any case, not everyone is convinced that merging several large, unprofitable banks will create anything except an even bigger unprofitable bank.
Another possible solution would be vertical integration with the Sparkassen - the network of local savings banks that Landesbanken service and in many cases own stakes in. Analysts cite the example of LB Baden-Württemburg, which embarked on its own restructuring at the end of 1998, merging with a local Sparkasse and with the old L-Bank and hiving off the latter's development business into a new, guaranteed L-Bank. Rawcliffe at DrKW says: "LBW has already consolidated by merging with Landesgirokasse, the very strong regional savings bank. Rather than a pure wholesale bank, you get a more diversified business, which in the current rather difficult environment is a major ratings stabilizer. It's almost the only Landesbank with a sizeable retail franchise, and is the strongest financially."
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