Cablegate: Sub Prime Crisis Getting Costly for German

VZCZCXRO8034
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #0469/01 1061531
ZNR UUUUU ZZH
P 151531Z APR 08
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 0903
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 BERLIN 000469

SIPDIS

SIPDIS

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

E.O. 12356: N/A
TAGS: EFIN PREL PGOV GM
SUBJECT: SUB PRIME CRISIS GETTING COSTLY FOR GERMAN
BANKS: THE LATEST VIEW FROM BERLIN

REF: (A) FRANKFURT 1001 (B) BERLIN 112, (C) BERLIN

161

1. SUMMARY: With all major year-end reports of German
banks now in, the impact of the U.S. sub prime crisis
on German banking is beginning to reveal its full
extent of damage. The story emerging is one of a
sector largely intact, but bruised and ripe for
consolidation. Set for a record profit year, German
banks lost much of their margin in the second half of
2007 due to the deepening sub prime impact. Despite
significant write-downs, most German private banks
managed to remain in the black for the year. However,
several German state banks, as well as SME lender bank
IKB, were on the brink of collapse and various rescue
packages needed to be constructed. The federal
government now supports more consolidation in the
industry, which the states (Laender) continue to
resist. Banking and financial authorities are also
calling for more transparency and Finance Minister
Steinbrueck wants more regulation. The banking
industry has countered by proposing a voluntary "code
of conduct" to better prepare the financial markets
for future crises and stave off further regulation.
END SUMMARY.

2007 - Not Bad Until...
-----------------------

2. Eight months into the sub prime mortgage crisis, a
clearer picture of its impact on the German banking
sector is emerging as major banks publish their 2007
reports. According to the Head of the Association of
Private Banks, Klaus-Peter Mueller, the 2007 reports
show that it would have been an "extraordinary year"
if not for the crisis; despite write-downs due to the
U.S. sub prime turmoil, almost all major German banks
posted profits in 2007.

3. This is all the more impressive when the full
extent of exposure of German banks to U.S. sub prime
loans is known. Standard & Poors calculates that
Germany's 16 largest banks face write-downs of more
than 18 billion euros in the second half of 2007
alone. As a result, S&P estimates that German banks'
profits fell by 80 percent between July and December
of 2007 to 3 billion euros.

State Banks and IKB - The System's Achilles Heal
--------------------------------------------- ---

4. While Germany's private banks weathered the crisis
relatively well, a number of state banks
(Landesbanken), jointly owned by one of the German
states and regional savings banks, were severely hit
by the international financial crisis. Three of the
seven state banks that invested heavily in U.S. sub
prime securities -- Sachsen LB, WestLB and BayernLB --
had to be rescued from insolvency with public money.
While SachsenLB escaped bankruptcy by being bought by
Germany's largest state bank, LBBW (Baden-
Wuertemberg), WestLB and BayernLB are still in limbo
with reported losses of 5 billion and 4.3 billion
euros respectively. A Bundestag financial expert told
the Embassy that in the case of WestLB, the federal
government was approached to bail out the bank.
Finance Minister Steinbrueck rejected such calls,
pointing to the responsibility of the German states to
rescue "their" own banks. The Finance Ministry told
us that the government would like to force a merger
among state banks, but feared that the states would
then seek compensation for their attempts to bail the
banks out.

5. The SME lender IKB (Industrie Kreditbank) was the
first bank to be hit by the sub prime crisis in July
2007. Since then, IKB's losses have mounted and
federal government-owned KfW bank (together with the
Association of Private Banks) is now on its third
attempt to keep the bank afloat. The rescue operation
has depleted the 5 billion euro KfW emergency fund and
currently totals eight billion euros, with no end in
sight. "In the end, the federal government will have
to come in directly with taxpayer money; it can't and
won't allow the bank to go under," a representative of
the Association of Savings Banks told the Embassy. On
April 8, KfW's handling of the crisis led to the

BERLIN 00000469 002 OF 003

resignation of KfW Chief Ingrid Matthaeus-Maier, who
was criticized for her handling of the IKB operation.

Consolidation: Much Speculation - Little Action
--------------------------------------------- --

6. Germany's banking industry has long been regarded
as ripe for consolidation. The current crisis is
viewed by many analysts here as the trigger to finally
set the wheels in motion. There is widespread
consensus within the industry and the federal
government that state banks lack a sustainable
business model. Their embrace of risky U.S. sub prime
securities is seen as ample proof that these banks
were forced to take on risk they didn't understand in
order to generate profits to stay afloat. Analysts
favor a merger of all state banks into one institution
that could then aid the savings banks in financing
overseas investments by German SMEs. So far, however,
state governments (mainly those of Bavaria and North
Rhine Westphalia) have blocked any meaningful merger.
As a prominent Budnestag deputy from Bavaria told
Embassy, "the issue is still taboo."

7. Most of the merger dynamic appears to be coming
instead from the stated intention of Deutsche Post to
sell its subsidiary "Post Bank." With more than 10
million customers, Post Bank is one of Germany's
biggest retail banks. Deutsche Bank and Commerzbank,
with their notoriously weak retail business, have both
expressed interest in buying Post Bank. Another
potential buyer is Allianz, which has for years been
unhappy with the performance of its subsidiary
Dresdner Bank. So far though, there is much talk and
little action. Both Deutsche Bank and Commerzbank
have already failed with earlier take-over attempts
and are likely to approach the matter with caution. A
contact at the German Savings Bank Association in
Berlin told us that a merger of Postbank with a
private bank would require a lot of time, money and
energy since two distinctly different business
cultures would have to be combined.

Reactions: Risk Management is Gold, Equity is Key
--------------------------------------------- ----

8. In recent weeks Steinbrueck, German Banking
Supervisory Authority (BaFin) Chief Jochen Sanio, and
Bundesbank President Axel Weber have called separately
for banks to fully disclose their exposure to U.S. sub
prime investments and to list related write-downs.
According to all three, such a step is needed to
restore confidence in financial markets. Bundesbank
President Weber used a Berlin April 7 event of the
Association of Private Banks to stress the importance
of risk and liquidity management by banks. "In the
recent boom years, there was not a great need for
either", Weber said, "but the crisis has shown that
one cannot neglect them without increasing the risk of
being caught off guard when a crisis approaches."

9. Steinbrueck and BaFin Chief Sanio emphasize higher
equity underwriting of risk-prone investments. They
intend to propose changes that would further tighten
Basel II banking regulations which came into force on
January 1, 2008. Bundesbank's Weber and
representatives of private banks reject calls for a
so-called Basel III agreement, arguing that current
rules have not had time to take full effect. In a
possible move to counter mandated government actions,
the IIF (International Institute for Finance) at an
April 9 meeting in Berlin proposed a voluntary "code
of conduct" for banks that incorporates suggestions
made by regulators and government representatives.
Apart from improved risk management by banks, the IIF
also calls for changes in the IFRS accounting system.
The IIF and the Bundesbank regard the IFRS requirement
for frequent evaluations of bank assets as "pro-
cyclical." "Especially in the very volatile
environment we currently have, Weber said, repeated
reports of write-downs make the markets even more
nervous."

Comment
-------

10. The emerging dynamic of a push and pull between

BERLIN 00000469 003 OF 003

the federal and state governments on consolidation and
federal government and the private banks on tighter
regulation can be expected to continue over the next
several months. Where the state banks and regulators
eventually land is a story still in progress. How it
ends will no doubt be largely shaped by the ability of
German banks to recover from their bruises. More bad
news -- always a possibility -- will continue to drive
the momentum for fewer German banks and more
regulation.

TIMKEN, JR

© Scoop Media