BAYERNLB - SUBPRIME CRISIS HITS BAVARIA

UNCLAS SECTION 01 OF 02 MUNICH 000130 SIPDIS C O R R E C T E D C O P Y //CHGD SIGNATURE LINE TOREAD NELSON VICE GUY// SIPDIS E.O. 12958: N/A TAGS: ECON ETRD GM PGOV PREL SUBJECT: BAYERNLB - SUBPRIME CRISIS HITS BAVARIA MUNICH 00000130 001.2 OF 002 -------------- SUMMARY -------------- ¶1. A BayernLB official told ConGen Munich that the bank,s subprime losses would exceed the embarrassing 1.9 billion euros already declared in February. Both Moody,s and Bavarian Minister-President Beckstein share this view, saying as much as 4 billion euros may be at risk. While the losses don,t appear to threaten the solvency of the bank, they have raised questions about the lack of oversight by bank and state officials, and may potentially provide the catalyst for a merger with Landesbank Baden-Wuerttemberg at some point after Bavaria,s fall elections, creating Germany,s second largest bank. -------------- BAVARIA,S STATE BANK -------------- ¶2. ConGen Munich met with Peter Kulmburg, BayernLB,s head of communications, March 27 to discuss the impact of the financial crisis in the U.S. on BayernLB and the prospects of a merger with its counterpart Landesbank Baden-Wuerttemberg (LBBW). BayernLB is a semi-public bank, owned jointly by the state of Bavaria and the regional savings bank association (Sparkassen). The bank serves as a &house bank8 to the state of Bavaria and as a clearing house for the Sparkassen located in the state. -------------- SUBPRIME LOSSES BUILD -------------- ¶3. As with most of the German banking sector, BayernLB has not been immune to the effects of the U.S. subprime crisis. In February, the bank admitted losses of approximately 1.9 billion euros (USD 3 billion) because of a number of non-performing loans backed by U.S. mortgage securities. The losses were particularly embarrassing given that BayernLB officials had previously maintained that their exposure to the subprime crisis was minor. As a result, CEO Werner Schmidt was forced to step-down and was replaced by Michael Klemmer. The affair also embarrassed Bavarian Finance Minister and Christian Social Union (CSU) chief Erwin Huber, a member of the bank,s supervisory board. ¶4. Kulmburg explained that BayernLB owned a portfolio of asset-backed securities previously valued at 30 billion euros (USD 46.8 billion). For a significant part of the package it was not possible to determine current market prices, he said, as there were currently no buyers. As result, a valuations model had to be accepted by the bank,s auditors to determine the value of the package. The &loss8 of 1.9 billion euros BayernLB reported in February was composed of a write-down of 600 million euros (USD 936.3 million) of subprime related investments and a revaluation of assets resulting in the reduction of their book value by 1.3 billion euros (USD 2 billion). ¶5. Kulmburg pointed out that BayernLB was determined to keep these assets because it expected that a good part of them would perform nonetheless. He explained, however, that the losses would likely exceed the 1.9 billion euros, as problems with U.S. mortgage-backed securities had deepened during the first quarter. This view is shared by ratings agency Moody's Investors Service, which announced March 25 that it had put BayernLB's &C-8 bank financial strength rating on review for possible downgrade. "Moody's decision ... reflects the bank's significant 32 billion euro (USD 49.9 billion) exposure to structured credit products, of which more than 4 billion euros (USD 6.2 billion) is subprime related," said Peter Burbank, lead analyst for BayernLB at Moody's. Kulmburg,s and Moody,s comments appear to also be shared by Bavarian Minister-President Beckstein, who told the press on March 31 that he also expected the bank,s losses could ultimately mount to as much as 4 billion euros. -------------- NOT ALL BAD NEWS -------------- ¶6. Kulmburg explained that even though the crisis was clearly bad news for the bank, it posed no threat to BayernLB,s survival. He added that the bad news related to subprime losses overshadowed the bank,s successes, such as its well-run business loan program which had almost no insolvencies. Another strength was the bank,s growing business in southeastern Europe, which BayernLB was pursuing through its Austrian subsidiary, Hypo Alpe Adria Group. Kulmburg said BayernLB,s overall strategy included a MUNICH 00000130 002.2 OF 002 stronger focus on retail banking, especially in southeastern Europe, loans to small and medium sized firms, and a reduction of its securities trading activities. -------------- MERGER ACTIVIITY? -------------- ¶7. Kulmburg said despite rumors, a merger with another German Landesbank was not immediately forthcoming, especially not before Bavarian state elections in September. He nevertheless expressed the view that a merger of BayernLB with another Landesbank, preferably Landesbank Baden-Wuerttemberg (LBBW),might be in the cards at some point in the future. Kulmburg noted that there had already been merger negotiations last fall, which the Bavarian state government had stalled, arguing that it wanted to maintain BayernLB as an independent entity in order to preserve Bavaria,s importance as a financial center. Despite the Bavarian government,s desire to keep BayernLB independent, the savings banks in Bavaria and Baden-Wuerttemberg, which each own 50 percent of their respective state banks, would have welcomed the merger, arguing that a merged bank would result in better and cheaper services. -------------- COMMENT -------------- ¶8. At this point, BayernLB,s losses represent more of an embarrassment for the bank and the Bavarian government than a threat to the viability of the institution. However, it is an example of the questionable business model of state banks. Even BayernLB's successful operations in southeastern Europe barely conceal the fact that the actual role of state banks -- to provide higher financial volume than regional savings banks could provide -- has vanished. Together with North-Rhine Westphalia's WestLB, BayernLB is a prime case of how (parochial) state government policymaking prevents desirable banking consolidation in Germany. ¶9. It is not yet clear whether frustration on the part of the savings banks and the public (which ultimately will pay for losses with tax money) with the bank,s leadership and apparent lack of government oversight could be the catalyst for a merger between BayernLB and LBBW, the two largest German state banks. A merged institution would become Germany,s second biggest bank after Deutsche Bank, with its business focused on Germany,s most economically dynamic region. However, despite economies of scale, a combined bank would face the challenge of needing to report to two separate state governments interested in securing the greatest number of jobs and other benefits for their states. ¶10. This report has been coordinated with Embassy Berlin. ¶11. Previous reporting from Munich is available on our SIPRNET website at www.state.sgov.gov/p/eur/munich/ . NELSON