Commerzbank Announces Third Quarter Write-Offs

UNCLAS SECTION 01 OF 02 FRANKFURT 004944

SIPDIS

DEPARTMENT FOR EUR/AGS
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON GM

SUBJECT: Commerzbank Announces Third Quarter Write-Offs


ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
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REF: a) 07 Frankfurt 4624, b) 07 Berlin 1574, c) 07 Berlin 1746


1. Summary. The release of third quarter earnings reports has shed
further light on the extent of the damage caused by subprime
investments in the German banking industry, with Commerzbank,
Germany's second largest private bank, reporting larger write-offs
than originally anticipated. While Commerzbank and its competitors
continue to generate earnings from traditional sources that more
than offset their write-offs, this wave of losses shows that the
burden of subprime debt will continue to weigh on banks' balance
sheets. As mortgage-backed securities no longer yield high returns,
private banks will have to develop new investment strategies to
replace this once-lucrative vehicle. Meanwhile the European Central
Bank (ECB) announced that it would roll over two supplementary
longer term refinancing operations issued at the height of the
crisis into the new year, as an ongoing part of its efforts to bring
stability to the still fragile interbank lending process. End
Summary.

Third Quarter Reports: It's Not Over
--------------


2. On November 6, Commerzbank AG, Germany's second largest private
bank after Deutsche Bank, released its third quarter earnings report
which revealed a rise in total profits of 56%, based mainly in the
traditional sectors of tax gains and private banking. Despite the
overall positive trend, the report also revealed larger than
expected write downs of 291 million euros ($425 million) in
investments based in U.S. mortgage-backed securities. Commerzbank's
losses were not nearly as high as those of Germany's largest bank,
Deutsche Bank. Deutsche Bank, which invested more aggressively in
subprime vehicles, wrote off losses of 2.16 billion euros ($3.17
billion). Deutsche Bank also reported overall profits in the third
quarter.


3. Commerzbank CEO Klaus-Peter Mueller had braced investors for the
news as early as October 20 admitting to a "further market impact"
from subprime loans and opining that there would be "repercussions"
when banks released third-quarter earnings reports. The reports of
write-offs from Commerzbank and Deutsche Bank showed that the German
banking sector would clearly weather the storm, but the large
private banks days of record-setting profits were in the past in the
near term.

Klaus-Peter Mueller: Voice of Caution
--------------


4. Like many other large banks, Commerzbank stepped in early when
the subprime crisis began in August to stave off insolvencies and
calm panic. On August 22, when reports started coming out that two
small German banks, SachsenLB and Deutsche Industriebank (IKB),were
facing insolvency, Commerzbank made three billion euros ($4.38
billion) available on the interbank market to stabilize the German
banking sector. Joining Deutsche Bank's CEO Josef Ackermann and
others in trying to calm investor fears, Mueller said in a September
5 statement that he saw the market stabilizing, adding "There are
good reasons to believe that the markets will return to calm
waters."


5. Commerzbank initially appeared to be better protected from the
crisis than its competitors. On September 20, Mueller announced the
bank would set aside a relatively small 92 million euros ($128
million) to cover an estimated 80 million euros ($111.2 million) in
subprime losses, although he admitted that Commerzbank had no way of
knowing what a "sufficient" figure to cover the losses would be.
Deutsche Bank announced comparatively larger potential losses of 1.5
billion euros ($2.1 billion) in late September.


6. While Deutsche Bank CEO Josef Ackermann continued to go on the
record to assure investors that the crisis was not a major worry,
Mueller adopted a more cautious stance, saying that Commerzbank was
largely protected but it was not clear where other banks stood. A
Commerzbank executive told EMIN and Congen Econoff on October 11
that, while Commerzbank had over 10 billion euros in conduits, the
conduits were mostly originated by Commerzbank and of good quality
(see reftel a). Mueller remarked privately to Frankfurt Consul
General November 2 that the worst was yet to come, and expressed
dismay that U.S. television was still running advertisements for
cheap mortgages.


7. In a long anticipated move, Mueller also announced October 22
that he will step down as CEO of Commerzbank on May 15, 2008 to
become Chairman of the Executive Board. He will be replaced by
Martin Blessing, a current board member.

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The ECB: A New Kind of Normalcy
--------------


7. The reports of losses have fueled the crisis of confidence in
the German and greater European banking sectors, necessitating
further action by the ECB. On November 8, the ECB announced in a
press release that it would roll over two supplementary longer-term
refinancing operations (LTROs) valued at 40 and 75 billion euros
that were set to mature at the end of November and the beginning of
December. The two LTROs had been issued in late August and early
September at the height of the credit crunch.


8. In another sign of fragile banking conditions, the spread
between unsecured three-month interbank lending and the risk-free
equivalent remains at fifty-one basis points, while it was in single
digits in early August. An ECB executive told Congen Econoff
November 13 that the distrust between banks shown in this disparity
may be "a new kind of normalcy" reflecting a more accurate
assessment of risk and that interbank rates may never return to the
halcyon days of before.


9. Comment. When Blessing succeeds Mueller next year, he will
inherit a bank that, like many banks in Europe, will need to find
new sources of earnings. German banks such as Commerzbank have made
record profits from a combination of high return mortgage-backed
securities and other more traditional sources of income. Where
banks will turn to replace the earnings from mortgage-backed
securities is unknown, but profits in the near future may not be as
high as before the subprime bust and a new type of normalcy where
interbank lending is not as fluid may take hold. End Comment.


10. This cable has been coordinated with Embassy Berlin.
POWELL