Aug. 21 (Bloomberg) -- Landesbank Sachsen Girozentrale, the German state-owned bank getting emergency funding, has about 3 billion euros ($4 billion) in investments linked to U.S. subprime mortgages, according to a person with knowledge of the matter.

The bank's Ormond Quay finance unit holds the securities among its AAA rated asset-backed bonds, according to the person, who declined to be identified because the holding has not been made public. Ormond Quay invests in securities backed by residential mortgages, commercial property and credit cards.

The Leipzig-based lender is the second German bank after IKB Deutsche Industriebank AG to get funding after a credit crunch prevented finance units from selling commercial paper, debt due in 270 days or less. SachsenLB obtained 17.3 billion euros in credit on Aug. 17 from German state-owned banks to repay debt from Ormond Quay.

``I would have never thought that IKB or SachsenLB would get into so much trouble,'' said Wolfgang Gerke, president of the Bavarian Finance Center and a former professor of banking and finance. The events will accelerate consolidation among state- owned lenders, he said.

Saxony's Finance Minister Horst Metz in an e-mailed statement yesterday dismissed as ``speculation'' that SachsenLB faced losses of 500 million euros linked to Ormond Quay. The company declined to comment. Ormond Quay was founded in 2004 and is managed by SachsenLB's Dublin-based Sachsen LB Europe unit.

Emergency Funds

The highest default rate in a decade on U.S. subprime mortgages has spilled into credit markets and prompted central banks around the world to inject more than $350 billion of emergency funds into the financial system to smooth lending between banks. Investors have fled even money market funds, considered among the safest instruments, in case they have invested in debt backed by mortgages to the riskiest borrowers.

European Union regulators will examine whether the credit line included state aid. EU Competition Commissioner Neelie Kroes's department asked the German government for information to determine ``whether there are elements of state aid or not,'' European Commission spokeswoman Amelia Torres told reporters in Brussels yesterday.

The commission, which vets whether government grants harm competition, could force Germany to recover any illegal subsidies. The EU probe follows at least five years of investigations into German grants to state-owned savings banks, which make up half the country's banking market.

``We will answer of course all the questions once we receive them,'' German Finance Ministry spokeswoman Ulrike Abratis said in an interview. The EU examination ``isn't unusual,'' she said.

Profit Impact

SachsenLB said Aug. 17 the rescue package will ``negatively impact'' profit. A week earlier, it said it had ``sufficient liquidity'' and didn't expect a default by units such as Ormond Quay that invested in AAA rated asset-backed securities.

Standard & Poor's yesterday cut its assessment of SachsenLB's debt to BBB+, the eighth-highest of 10 possible investment-grade credit ratings, from A-. SachsenLB ``needs to restore investor confidence,'' the rating company said.

``Investors' appetite for SachsenLB's complex structured products is likely to remain subdued, which could reduce the group's medium-term growth prospects,'' the rating company said. It may cut the rating again if more problems emerge, S&P said.

Moody's Investors Service and Fitch Ratings placed SachsenLB's debt on review for a possible downgrade last week, partly because of obligations to Ormond Quay. Fitch affirmed its A+ long-term rating and F1+ short-term issuer default ratings today, saying SachsenLB ``is extremely likely to meet all its liabilities in a timely manner.''

Contagion Concern

State banks Norddeutsche Landesbank Girozentrale, also known as NordLB, the Bayerische Landesbank and Landesbank Baden- Wuerttemberg have each reported an interest in merging with SachsenLB, Saxony's MDR Radio station reported on its Web site yesterday, without saying where it got the information.

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 EU orders. SachsenLB's bailout raised concern that other Landesbanks may also suffer losses from investments in asset-backed securities.

``The German authorities need to address this issue quickly otherwise the lack of confidence could impact the other Landesbanks,'' said Ben Ashby, an analyst at JPMorgan Chase & Co. in London. ``Liquidity is one of those things that if the market believes it is an issue for an institution, it very quickly can become a reality.''

No Funding Needs

WestLB AG's new Chief Executive Officer Alexander Stuhlmann, who replaced Thomas Fischer in July after the bank suffered 243 million euros in first-half trading losses, told reporters yesterday the lender ``won't be the next SachsenLB or IKB because it has high liquidity and minimal subprime exposure.'' The Dusseldorf-based bank said Aug. 11 it had 1.25 billion euros in securities linked to the U.S. subprime market.

Bayerische Landesbank, Germany's second-biggest state-owned bank, said on Aug. 17 its U.S.-based finance units holding subprime-linked investments don't need emergency funding. Giro Balanced Funding Corp. and Giro Funding U.S. Corp., which together borrowed about $15 billion in the U.S. commercial paper market at the end of March, haven't tapped liquidity guarantees from Munich-based BayernLB, spokesman Peter Kulmburg said.

Investor confidence in Germany, Europe's largest economy, fell more than economists forecast to an eight-month low in August. The ZEW Center for European Economic Research in Mannheim today said its index of investor and analyst expectations dropped to minus 6.9 from 10.4 in July.

Asset-backed commercial paper conduits are units of finance companies that sell notes with short maturities. They invest the proceeds in assets such as mortgage loans, car loans and credit cards. Buyers include pension funds and mutual funds.

Conduits in Europe, the Middle East and Africa had more than $500 billion of debt and owned as much as $205 billion of collateralized-debt obligations and home loans at the end of May, according to Moody's.

To contact the reporter on this story: Aaron Kirchfeld in Frankfurt at akirchfeld@bloomberg.net.

Last Updated: August 21, 2007 14:38 EDT