German Banks Take State-Level Bailouts over Federal Funds

					  UNCLAS SECTION 01 OF 02 FRANKFURT 003553 
 
STATE FOR EEB(NELSON),EEB/OMA(SAKAUE, WHITTINGTON), DRL/ILCSR AND 
EUR/AGS 
TREASURY FOR ICN(KOHLER),IMB(MURDEN,MONROE,CARNES),OASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON GM
 
SUBJECT: German Banks Take State-Level Bailouts over Federal Funds 
 
ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR INTERNET 
DISTRIBUTION 
 
					

1. SUMMARY: Both Landesbank Baden-Wuerttemberg (LBBW) and BayernLB
(BLB) have come to terms with their state governments and other
owners on capital injections of billions of euros. Putting
state-level taxpayers on the line enabled them to maintain local
control by avoiding federal rescue funds and some of the onerous
requirements that come with them. LBBW will accede to ownership's
demand that it pursue merger talks with the even-more-troubled state
bank, BayernLB, in order to create one of Germany's largest banks,
but BLB may now not be interested because the Bavarian state
government, which is poised to become the majority owner, may want
to maintain local control. The surprise losses which led LBBW to
seek funding have prompted political outrage and calls for
management changes at the bank. END SUMMARY.

State-Level Help Following Global Losses


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2. After an extraordinary meeting between LBBW and its owners on
November 21, Baden-Wuerttemberg Minister President Guenther
Oettinger (CDU) announced that the bank will not seek help from the
federal government's Financial Market Stabilization Fund (FMSF), and
will instead receive a capital injection of 5 million euros ($8.5
billion) from its three owners: the state government, the city of
Stuttgart and the state savings banks. The State of
Baden-Wuerttemberg and the savings banks will come up with 2 billion
euros ($2.54 billion) each, while the City of Stuttgart will
contribute 950 million ($1.2 billion). The funding not only puts
state taxpayers on the hook, but also uses up all of Stuttgart's
reserves. The state and the savings bank will issue bonds to raise
their shares. LBBW may also ask for 15-20 billion euros ($19-25.4
billion) in loan guarantees from either its owners or FMSF.



3. LBBW's Tier One capital ratio had dropped to 6.8% following
unexpected losses stemming from the bankruptcy of Lehman Brothers
and the economic meltdown in Iceland. LBBW now expects losses of up
to 2 billion euros ($2.54 billion) in 2008 despite a rosy prediction
in August from CEO Siegfried Jaschinski that the bank would make a
profit for the year. LBBW's losses stem mostly from investments
made by recently acquired SachsenLB and LB Rheinland-Pfalz, which
has been owned by LBBW since 2005. LBBW maintains that its core
business, lending to small and medium-sized businesses in
Baden-Wuerttemberg, remains stable and profitable.



4. The news that LBBW would ask for funding came as a surprise, as
the bank had fared better in the financial crisis than other state
banks and was seen as a candidate to lead consolidation in the
state-bank sector. Jaschinski has come increasingly under fire as
he has admitted losses piece-meal and rejected suggestions that the
bank would need help. Nils Schmid, a leading Social Democratic
parliamentarian and member of the administrative council of LBBW,
told econ spec that Jaschinski's hesitation had damaged the
reputation of the bank and created outrage in the usually
pro-business CDU-FDP government coalition. Schmid nevertheless
admitted that raising the bank's Tier 1 capital was necessary for it
to remain competitive and to provide the necessary credit to the
real economy in the upcoming recession.

State Funding Creates More Flexibility for Merger, but Bavaria Might
not be Interested


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5. In agreeing to the deal, both LBBW and its owners revealed a
desire to maintain the bank's independence which could have been
jeopardized had it taken funding from the FMSF. As Germany's state
bank sector appears poised for further consolidation, LBBW would
have opened itself up to accepting the federal government's
decisions on potential mergers. LBBW can now pursue merger talks
with BayernLB on its own terms and make its own decisions on any
other mergers; a merger with BLB would create Germany's third
largest bank overall. All political parties in the
Baden-Wuerttemberg state parliament, however, have expressed
reservations about LBBW taking over a troubled entity such as BLB.



6. Furthermore, the State of Bavaria is now set to become a
majority owner of BLB, which means that a merger with LBBW is
becoming more unlikely as BLB would not want to be a junior partner
in such a setup. Bavaria is spending at least 10 billion euros
($12.7 billion) on the bailout of BLB and is also not tapping the
FMSF in order to rule out federal government influence. It is
unlikely that Bavaria would spend money to see important divisions
and jobs transferred to Stuttgart later on.



7. However, financial experts in Munich believe that BLB has a
bleak future as an independent bank, despite the capital injection

FRANKFURT 00003553 002 OF 002


and public guarantees, because its losses are so great and its
business model is outdated. The State of Bavaria will recoup its
money only if the bank generates a 15 billion euro ($19 billion)
profit in the coming years, a tall order considering economic
conditions and the current loss of at least 3 billion euros ($3.8
billion). Experts question the bank's traditional business model
because many of its competitors have taken the medium-sized clients
who were traditionally the bank's main market and to whom the bank
must now return as it divests itself of the more exotic investment
strategies that have brought ruin.

Comment


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8. With the capital injection, the state government and LBBW's other
owners hope to put the bank on stable ground so that it can help the
local economy during the upcoming recession, while Bavaria looks to
rescue its own bank. Both cases once again reveal the close
relationship between Germany's federal states and their state banks,
where the state banks often serve as a tool of the state
governments' political and economic power. Both states have taken
the risk of using taxpayer money in order to ensure that their banks
maintain full flexibility as well as independence from the federal
government.



9. This cable was collaborated on with ConGen Munich and
coordinated with Embassy Berlin.
POWELL