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Cablegate: German Banks Weathering Sub-Prime Mortgage

VZCZCXRO0921
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #2094/01 3241035
ZNR UUUUU ZZH
P 201035Z NOV 07
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 9836
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 BERLIN 002094

SIPDIS

SENSITIVE BUT UNCLASSIFIED

SIPDIS

TREASURY PASS TO FEDERAL RESERVE
USEU FOR B. MATTHEWS, J. NUTTER

E.O. 12356: N/A
TAGS: EFIN PREL PGOV GM
SUBJECT: GERMAN BANKS WEATHERING SUB-PRIME MORTGAGE
CRISIS FOR NOW; LONGER TERM OUTLOOK STILL UNCERTAIN

REF: A. BERLIN 1746, B. FRANKFURT 4944

SENSITIVE BUT UNCLASSIFIED; NOT FOR INTERNET
DISTRIBUTION

1. (SBU) SUMMARY: Third quarter reports show that
most German banks appear to have weathered the
turbulences in the international financial markets.
Large private banks such as Deutsche Bank and
Commerzbank reported losses in their investment
portfolios, balanced by gains in other sectors,
resulting in overall third quarter profits. While
this has not had much effect yet on the liquidity
crisis, the Association of German Banks believes if
fourth quarter 2007 reports continue in a positive
trend, interbank lending should resume on a more
normal basis by the first quarter of 2008. While the
full extent of losses is still unclear, analysts
cautiously predict that the German banking sector has
survived the worst of the crisis. Both government and
industry lauded the concerted effort to prevent
further contagion to the banking sector in Germany.
The Finance Ministry has resisted hastily instituting
new procedures in reaction to the crisis. Although
fears over further contagion were expected to increase
consolidation pressures in the balkanized German
financial market at first, the impetus seems to have
waned in the face of resistance on the part of the
federal states. END SUMMARY.

Liquidity Still a Problem
-------------------------
2. (SBU) On November 16, Managing Director of the
Association of German Banks Bernd Brabaender told Econ
Counselor that since no one knows the full extent of
German banking losses all banks are trying to be as
transparent as possible with their statements.
Brabaender added that, while third quarter reports are
a positive sign, the industry knows the real test will
be in the 2007 yearly statements. If the trend of
overall profits continues, this should have a positive
impact on the sector's image and ease the liquidity
crunch. The real problem now is that trust in the
banking sector, even among major financial
institutions, is weak. Brabaender pointed to the lack
of interbank three-month loans as evidence of this.
The lack of liquidity has increased the cost of
banking, but interbank lending should resume on a more
normal basis if the positive trends continue.
Brabaender believes this could happen in February or
March, depending on the outcome of overall 2007
results.

Sub-Prime Crisis Impact
-----------------------
3. (U) The third quarter reports of all major German
banks show positive overall performance despite
turbulence on international financial markets. The
top three German banks, Deutsche Bank, Commerzbank and
Dresdner Bank, all reported either third quarter
profits or small losses. This is a striking contrast
to Switzerland's UBS or CitiBank, which reported sub-
prime losses in the tens of billions of dollars for
the third quarter.

4. (U) Deutsche Bank, the largest German bank,
appears to have weathered the sub-prime mortgage
crisis reasonably well. CEO Josef Ackermann warned of
sub-prime related losses for the third quarter early
on. While Deutsche Bank wrote off losses of 2.16
billion euros ($3.17 billion), overall Deutsche Bank
figures show an increase in profits for the period of
almost 30 percent, or 1.6 billion euros ($2.35
billion). Sub-prime related losses were more than
compensated by other portfolios, especially in the
German retail banking and Asian sectors.

5. (U) Commerzbank, Germany's second largest bank,
reported 291 million euros ($425 million) in sub-prime
related losses. Commerzbank CEO Klaus-Peter Mueller
has been guarded about the long term impact of the
crisis on the German banking sector, repeatedly noting
the full extent of the losses are as yet undetermined.
Despite this, the company surpassed its overall 2007
target of 1.5 billion euros ($2.205 billion) in the

BERLIN 00002094 002 OF 003


first nine months with profits of 1.72 billion ($2.53
billion) euros. Commerzbank CFO Eric Strutz hopes
these profits will be enough to cover any further
losses.

Rescue Mechanism Worked
------------------------
6. (SBU) The third quarter results are especially
welcome in light of the concern for the entire sector
sparked by the near-insolvency of IKB and Saxony LB at
the beginning of the sub-prime mortgage crisis.
Experts view this as a major achievement by private
and public banks, as well as Finance Minister Peer
Steinbrueck, to limit the damage early on. The ECB
also stepped in on several occasions to inject
liquidity in the market in order to stave off a
worsening of the crisis. At an October 25 banking
conference, the Chairman of the Association of German
Savings Banks, Heinrich Haasis, lauded Steinbrueck for
his initiative to get both public and private players
to the table to develop a rescue plan for IKB. At the
same event, banking representatives confirmed that
this rescue operation, repeated for Saxony LB a few
weeks later, helped the German financial market stay
calm. "When we look at what happened in Britain with
Northern Rock, we know what we prevented by our
action," a banking representative told the Embassy.

7. (SBU) All major German financial players have
refrained from calling for knee-jerk changes to the
international financial system to prevent future
crises. Both bankers and officials appear to be
waiting to analyze overall 2007 results before
adopting any new regulations. Banking officials are
concerned that any deepening of the crisis may lead to
further regulatory burdens on the industry.
Finance Ministry officials told us that it would be
well into 2008 before the Ministry would make any
concrete suggestions for changes to the existing
regime, and then only after an exhaustive review of
the situation. Finance Minister Steinbrueck had
publicly called for greater transparency of certain
financial products even before the crisis broke.
Steinbrueck repeated that call but recently added, in
language strikingly similar to the U.S. Treasury, that
he prefers a "code of conduct" developed by the
industry itself.

8. (SBU) Deutsche Bank's Ackermann, in his capacity
as Chair of the Institute of International Finance
(IIF), said his organization would create such a
mechanism by spring 2008. The code of conduct would
address improvements in risk management, transparency
of banking transactions and seek to avoid liquidity
shortages. (Note: The IIF represents 370 private banks
worldwide.) Haasis meanwhile admitted that some
financial products have become so complex that banks
have lost control over their impact on the financial
markets.

Banking Sector Consolidation: A Long and Winding Road
--------------------------------------------- --------

9. (SBU) The "early victims" of the sub-prime crisis
in Germany, notably IKB (reftel A), renewed the debate
over a necessary consolidation of the German banking
sector. The business model of the larger public state
banks (LB), such as Saxony LB, came under attack.
Many experts believed the lifting of the state
guarantees for these banks in 2005 should have been
coupled with consolidation. The Association of German
Banks and others have argued that slim profit margins
in the domestic market forced state banks to take on
too much risk in markets they didn't understand, such
as U.S. sub-prime mortgages. Consolidation is
considered by most experts to be the inevitable
solution.

10. (SBU) There are currently 11 such state banks
which are intended to serve as the extended arm of
local savings banks, providing services for German
SMEs investing abroad. The Finance Ministry and the
savings banks advocate a merger of the state banks
into two major entities. When the troubled Saxony LB
was saved by the Baden-Wuertemberg LB (LBBW)--

BERLIN 00002094 003 OF 003


effectively LBBW bought Saxony LB -- there were hopes
that other state banks would merge. So far though,
state politicians have prevented consolidation of this
sector. This is especially evident in the case of the
Westdeutsche Landesbank (WestLB). On November 14, the
state government of North-Rhine Westphalia, the
largest single owner of WestLB, stated its intention
to block the bank's sale. Given WestLB's 2007 losses
of more than 100 million euros ($147 million), the
state government argued it would be the wrong time to
sell or merge the bank. A spokesperson for the
federal agency for banking oversight (Bafin) told us
that banking sector consolidation in Germany would
remain "an incremental process, one that has been
going on since the 1960s but one should not expect any
dramatic progress."

TIMKEN, JR

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