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Commerzbank: wild rumours of |
Sometimes it’s not only what you say that matters but when you say it. When Merrill Lynch analyst Stuart Graham published a research report on the German banks entitled Turning Japanese, his timing was perfect – or disastrous. It depends on your point of view. At a time when so much of the research churned out by investment banks goes straight into the bin, panic-stricken investors picked up on it. Investors say it moved the market.
“A weak banking sector coupled with a weak economy is in itself worrying,” says Graham in the report. “But the more we think about it, the more we see the disturbing parallels with Japan.”
In the light of how the German banks had been performing in the stock market, these sorts of concerns were difficult to shrug off. It’s difficult to separate the impact of the research from the maelstrom of confusion over potential credit problems at the banks.
As one fund manager puts it: “Sentiment was very bad when the note hit our desks. There was a lot of people acting like rabbits in the headlights as we saw the extreme collapse of the stock market, including stocks previously thought immune such as Allianz.”
It didn’t help that just days earlier an email from a credit analyst at Merrill to a rating agency questioning Commerzbank’s creditworthiness was leaked to the press. In it, the US bank sought clarification about potential losses linked to derivatives trading at the German institution. Though senior executives were quick to deny that the email represented Merrill’s official position, these two events together seemed to suggest that it knew something the rest of the market didn’t. Rumours of Commerzbank’s impending collapse swept through the market.
Commerzbank isn’t exactly a stranger to rumours. For the past 20 years it has been a perpetual takeover target and its share price regularly bounces up and down as a result – mostly down these days. Ulrich Ramm, executive vice president at Commerzbank, says the bank is being hit by rumours of insolvency because it is more vulnerable than its peers. “Everyone knew that we don’t have any problems in our loan book – we didn’t lend to Enron or WorldCom for example – so they channelled the rumours to something else,” he says. The derivatives business was a fitting target, Ramm believes, because “it’s very difficult to give immediate proof that we have no problems with our derivatives exposures”.
It’s true that Commerzbank does look to be the weakling among the German banks. Deutsche Bank is by far the strongest of the private institutions and able to shrug off hearsay more easily, Dresdner is sheltered by mother ship Allianz and HVB lies tucked out of harm’s way in Munich. But the wider question is whether the Germany/Japan connection is the right one to make.
According to Graham, there are a number of parallels between the situations in Germany since 1999 and Japan since 1989. Both countries have experienced a stock market and property bubble and both suffer from a weak banking system with a complex series of corporate cross-shareholdings thrown in.
There is a heavy reliance on bank lending in Germany as there is in Japan and the two share social and demographic problems as well as a lax regulatory environment and unwillingness on the part of the government to make tough choices.
Robert Lind, chief European economist at ABN Amro agrees that what’s happening in Germany is “significantly similar to Japan”. In fact, he feels that the macroeconomic environment in Germany means that it is a lot worse off. That’s largely because it’s hamstrung by its membership of the EU. The European Central Bank is focused on setting interest rates for the region as a whole, whereas Germany needs lower interest rates and a fiscal policy designed to stimulate growth and demand. “We would argue that the ECB needs to concentrate on Germany as problems could spill over and have implications for the economies of other EU countries,” says Lind.
Certainly there are some obvious parallels. As in Japan, the loan books of the German banks were built up using the wrong cost of capital. To compensate for the fact that the loans were uneconomic, banks took equity shares in businesses to reduce credit risk and in theory give them a stake in future growth. But that safety measure backfired when the economy turned down and the rest of the capital markets pulled the rug.
The problem today is that the 25 financial institutions in the DAX – Germany’s large-cap index – together own around 50% of the DAX companies. This means that falling equity prices produce a sort of leverage effect.
But the view from Frankfurt is that, despite these similarities, Merrill’s analysis has missed the mark. Frankfurt players point out that Germany has not really undergone a property boom or the sudden dramatic increase in the cost of capital that proved fatal for many of Japan’s real-estate borrowers. On the contrary, house prices are flat or even falling. “Germany could do with a property bubble,” says Alan Saunderson, director of economic and monetary research at Eurozone advisers, based in Frankfurt.
“Germany is not Japan,” states Rainer Sartoris, a treasury research analyst at Trinkhaus & Burkhardt in Düsseldorf. “Market forces are working in Germany, we have seen some bankruptcies and there will be more.”
Other market participants feel that Merrill acted recklessly in making wholesale comparisons between Germany and a financial system that is practically a flat-liner. “The comparison with Japanese banks highlighted by Merrill Lynch is misleading,” says Johannes Reich, head of equities at Metzler. “Obviously the loan portfolios of the German banks have been negatively affected, this is nothing new. But they are not at the brink of an everlasting depression.”
Nonetheless, things are very far from being rosy for Germany’s banks. An interest rate cut by the ECB would go some way towards reducing bankruptcies at least. But at its meeting on October 10 the ECB left rates unchanged at 3.25%. “We have the benefit of having seen the situation in Japan,” says Ulrich Bechmann, Deutsche Bank’s chief economist. “We think the ECB will cut rates.”
In the meantime, as Hypovereinsbank’s dismal results demonstrate, there is much more pain in store for Germany’s banks. Earlier this month, the bank announced loan loss provisions of at least e3.3 billion this year, 32% worse than previous expectations. While German banks may not be turning Japanese, they’re certainly not turning the corner just yet.
