Aug. 27 (Bloomberg) -- Landesbank Baden-Wuerttemberg, the largest German state-owned bank, agreed to buy Landesbank Sachsen Girozentrale following a 17.3 billion-euro ($23.7 billion) credit bailout because of investments in U.S. subprime debt.

LBBW will pay at least 300 million euros for the bank and immediately provide 250 million euros in cash for SachsenLB, whose finance affiliates have struggled to sell commercial paper amid a global credit crunch. A final purchase price will be set by the end of the year, LBBW said yesterday in Stuttgart.

SachsenLB got emergency funding from fellow state-owned banks on Aug. 17 to pay debt owed by a unit that invested in asset- backed securities, including subprime loans. Rising defaults on U.S. housing loans to borrowers with patchy credit histories have curbed demand for bonds backed by mortgages, spawning a financial contagion that's spread as far as Germany and China.

``The first big step was the bailout and the takeover is about making sure it doesn't happen again,'' said Konrad Becker, a Munich-based banking analyst at Merck Finck & Co. ``SachsenLB was too small to survive alone and now it's in stronger hands.''

SachsenLB, based in Leipzig, has about 3 billion euros in investments linked to subprime, according to a person with knowledge of the matter. The highest default rate in a decade on such loans has spilled into credit markets and prompted central banks around the world to inject more than $350 billion into the financial system to smooth lending between banks.

Opt-Out Clause

``Someone had to act because the bank faced a shortage of liquidity,'' LBBW Chief Executive Officer Siegfried Jaschinski said at a press conference yesterday, adding that the takeover will stabilize SachsenLB. ``With a bigger partner we don't expect the lender to need any more liquidity.''

The purchase agreement includes an opt-out clause that would allow LBBW to abandon the deal if it discovers unforeseen risks. SachsenLB may be worth between 300 million euros and 800 million euros, Baden-Wuerttemberg state Prime Minister Guenther Oettinger said. The state owns 36 percent of LBBW.

The owners of SachsenLB, the state of Saxony and the Sachsen- Finanzgruppe, made up mostly of regional savings banks, will transfer their stakes to LBBW in return for cash and shares in the parent company. SachsenLB will officially become a subsidiary on Jan. 1. For now it will be held on a trust basis.

LBBW is gaining eastern Germany's last independent state- owned Landesbank, with assets of 68 billion euros. Jaschinski said he plans to focus SachsenLB's business on corporate customers, lending to regional savings banks and business in eastern Europe. The state of Saxony borders Poland and the Czech Republic.

`Strongest Partner'

The Stuttgart-based lender is also holding takeover talks with WestLB AG, whose own plans to buy a stake in SachsenLB were derailed by trading losses and investigations into possible trading irregularities.

``LBBW is making progress in its goal of being an active consolidator among the state banks,'' said Thomas von Luepke, head of German banking at Fitch Ratings in Frankfurt. ``From a credit point of view, LBBW is the strongest partner among the state banks,'' he said.

LBBW has an A+ rating from Fitch. The rating is B/C when the assumed backing of the state is removed. SachsenLB's rating is C/D on negative watch when state support is excluded. The purchase shouldn't affect LBBW's rating, the bank said.

Oettinger said he was ``confident'' that SachsenLB's ``problems can be solved soon and that the financial strength of LBBW won't be hurt'' with the transaction.

Open to Talks

The state premier said he remains open to talks with WestLB about a merger. It's now up to the owners of the Dusseldorf-based bank to make the next move, he added.

``At the moment we have enough homework with the integration of SachsenLB,'' Oettinger said. ``There's no time pressure'' for discussions with WestLB.

LBBW has 428 billion euros in assets. A combination of LBBW, SachsenLB and WestLB, which has 285 billion euros in assets, would create Germany's second-biggest bank after Deutsche Bank AG. LBBW bought Landesbank Rheinland-Pfalz for an undisclosed sum in January 2005.

SachsenLB joined Germany's IKB Deutsche Industriebank AG in getting emergency funding after the credit crunch prevented finance units from selling commercial paper, debt due in 270 days or less. Bank of China Ltd., that country's second-biggest lender, said last week it holds almost $9.7 billion of securities backed by U.S. subprime loans, the most of any Asian company.

The German bank's Dublin-based SachsenLB Europe unit manages financial affiliates including Ormond Quay and Georges Quay, which invest in asset-backed bonds. The division had pretax consolidated income of 54 million euros last year, making it ``one of the most profitable companies and strongest earnings drivers of the group,'' SachsenLB said in its 2006 annual report.

Beyond Lending

Ormond Quay ``hasn't had any losses yet,'' LBBW Chief Jaschinski said. He expects to reduce SachsenLB's activities in Dublin, he said.

Germany's state-owned banks have expanded beyond lending to boost profits since government loan guarantees, which allowed the banks to raise money at lower costs than publicly traded competitors, expired in 2005 under European Union orders.

SachsenLB was created in 1992, a few years after the fall of the Berlin Wall and reunification of Germany. The predecessor of LBBW was one of the country's first-ever savings banks, created in 1818 in southwestern Germany.

IKB and SachsenLB are among German public and private banks with asset-backed commercial paper specialists known as conduits, which sell short-term debt and put the proceeds in investments such as mortgage-backed bonds and collateralized debt obligations. Conduits typically have guarantees from banks, which promise to lend them extra money when it's needed.

To contact the reporters on this story: Jann Bettinga in Frankfurt at jbettinga@bloomberg.net; Aaron Kirchfeld in Frankfurt at akirchfeld@bloomberg.net

Last Updated: August 27, 2007 10:37 EDT