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Cablegate: German Banks See Light at End of Subprime Tunnel, but Few

VZCZCXRO9664
OO RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFT #1581/01 1421303
ZNR UUUUU ZZH
O 211303Z MAY 08
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6533
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCNMEM/EU MEMBER STATES IMMEDIATE
RUCNFRG/FRG COLLECTIVE IMMEDIATE

UNCLAS SECTION 01 OF 02 FRANKFURT 001581

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

SIPDIS

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

SUBJECT: German Banks See Light at End of Subprime Tunnel, but Few
Mergers Ahead

Ref: Berlin 0469, Berlin 0112, Frankfurt 1001

ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET
DISTRIBUTION

1. Summary: Following first quarter reports showing further
write-downs, major German banks are beginning to see signs of
recovery in the financial sector, as the real economy exceeds
expectations in both growth and employment. Industry insiders see
challenges ahead in finding new, profitable business models, but
find little cause for worry about the soundness of Germany's banking
structure even though profits are down sharply. If the industry
recovers and profits return, calls for further mergers in the state
banking sector or for the state to privatize Postbank may diminish.

Banking Industry Resilient through Turmoil
------------------------------------------

2. First quarter 2008 earning reports revealed losses in most major
German banks, reflecting ongoing turmoil in the financial sector.
Deutsche Bank reported its first negative quarter in five years,
with a write-down of 2.7 billion euros ($4.19 billion), while rival
Commerzbank announced a write-down of 1.4 billion euros ($2.17
billion). Dresdner Bank, a subsidiary of Allianz, appears to be in
worse shape, with losses of 0.9 billion euros ($1.4 billion), as
rumors circulate that it will be broken up and sold off. In the
state banking sector, where quarterly reporting is voluntary, the
greatest write-downs were announced by BayernLB (2.0 billion euros
or $3.1 billion) with smaller ones also reported by Landesbank
Baden-Wuerttemberg (LBBW), Helaba, NordLB and HSH Nordbank.
Financial authorities also froze assets of Weserbank as it
approached insolvency, while a group of banks bailed out
Duesseldorfer Hypothekenbank, which faced a liquidity crunch.

3. Despite the bad news, financial experts see signs that the worst
is over. A senior economist at Deutsche Bank told Econ Off that
high corporate profitability, good employment data and better than
expected growth in Germany all point to the relative health of the
real economy. Meanwhile, Deutsche Bank's business model remains
sound, with strong returns in equity issuances and asset management
in Asia. A Commerzbank executive also saw reason for optimism,
saying that his bank saw an opportunity to invest in distressed
assets where others were afraid to act. He did, however, admit that
Germany's small- and middle-sized enterprises had been slow to
adjust to the higher price of capital and were still reluctant to
resume normal levels of borrowing. The write-downs of the last year
also mean that expected profits were greatly diminished, which has
altered banks' planning.

4. Some state banks such as Helaba and LBBW saw the recent turmoil
as a vindication of Germany's dispersed financial sector and their
business model. A senior LBBW executive told Frankfurt Consul
General that his bank was less affected by the turmoil since it is
structured like a universal bank and has steady retail income.
Executives at Helaba told Econ Off that their business model, which
is focused on conservative retail and wholesale banking, has only
suffered losses because of changes in spreads in lending markets.
Several sources argued that heavy losses at WestLB, BayernLB and
Weserbank were due to flawed strategies, which focused on riskier
capital markets, and not systemic weaknesses. Meanwhile, the
relative success of traditional retail banking among the savings
banks and banks like Helaba has only served to confirm the viability
of traditional banking.

5. Most sources ascribed the slowdown in profits to a short-term
readjustment in the financial sector and a downward overshooting in
the accounting valuations of assets. While asset markets find their
floor, volumes of leveraged buy-outs, corporate bond issuances,
home-mortgage lending and other sources of traditional bank income
are all down in the current cautious market. Meanwhile, lending
spreads have increased, raising transaction costs for banks. The
implementation of Basel II at the start of the year has also
required banks to raise capital holdings, creating a need to hold
capital.

Prospects for Mergers Low
-------------------------

6. Few experts saw reason to believe that Germany's dispersed
financial system would consolidate further, especially if greater
stability returns to the sector.
Sources at Deutsche Bank and Commerzbank expressed doubt that the
government would privatize Germany's largest retail bank, Postbank,
since that would result in many lost jobs. Although both banks
might be interested in purchasing Postbank and benefiting from
steady retail banking income, the Commerzbank executive said his

FRANKFURT 00001581 002 OF 002


bank saw better opportunities elsewhere (his bank was currently
conducting due diligences on two eastern European banks).
Representatives of both banks agreed that Allianz would be foolish
to break up and sell off pieces, if not all, of troubled Dresdner
Bank at a time when its price would be at an all-time low. However,
both Deutsche Bank and Commerzbank are allegedly stock-piling cash
for mergers, either at home or abroad.

7. Despite LBBW's successful acquisition of SachsenLB, executives
in the state bank sector see little reason to believe that there
will be more consolidation. Referring to rumors that LBBW would
acquire WestLB or BayernLB, the senior LBBW executive told Frankfurt
Consul General that state banks should merge only if they are
profit-making enterprises. Executives at Helaba told Econ Off that
both the savings banks (who partially own the state banks) and the
federal Ministry of Finance would push for more consolidation among
state banks, but this would continue to be opposed by state-level
minister presidents intent on protecting local interests. They did,
however, express some confidence that LBBW would take over BayernLB
in the next twelve to eighteen months.

8. Comment. Despite a bad first quarter, German bankers remain
optimistic that the worst of the subprime turmoil is behind them and
blame bad business models in certain banks as well as an adjustment
to new conditions for most of the trouble. If economic fundamentals
such as employment and growth remain strong in Germany, there is
reason to believe that an overall downturn will be avoided and the
financial sector will rebound. However, the turmoil has resulted in
lower than expected real profits for banks and forced many
institutions to change plans and strategies. If the sector does
bounce back, pressure to consolidate may also diminish even though
many experts feel the industry has too many players. End Comment.

9. This cable was coordinated with Embassy Berlin.
POWELL

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