Stress Tests May Expose German Landesbanken's `Black Hole'

German officials seeking to bolster confidence in the financial system by releasing the results of banking stress tests may heed calls to shine a light into the accounts of Germany’s state-owned lenders.

Banking industry officials, who met with regulators in Frankfurt today, are generally willing to participate in the tests, the Bundesbank said in a statement, so long as the same criteria are used for all European banks.

“Stress tests can’t be credible without the Landesbanken,” said Simon Maughan, a London-based banking analyst at MF Global Securities Ltd. “We need clarity on the listed and unlisted sector to see where the real problems are.”

European Union leaders pledged on June 17 to disclose the results of tests by the end of July showing how individual banks would hold up to economic and market shocks. German Chancellor Angela Merkel said it’s important to have “maximum transparency,” after doubts about Greece’s ability to repay its debts undermined confidence in the region’s banks.

More than a week later, questions remain over which banks will be included. Landesbanken are under scrutiny after booking more than $34 billion in credit losses and writedowns during the global financial crisis, according to data compiled by Bloomberg, forcing state bailouts for Bayerische Landesbank, Landesbank Baden-Wuerttemberg, HSH Nordbank AG and WestLB AG.

Photographer: Andrew Harrer/Bloomberg

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Photographer: Andrew Harrer/Bloomberg

Germany's Chancellor Angela Merkel pose for a photo during the Group of Eight summit in Huntsville, Ontario.

State-owned lenders accounted for 17.5 percent of loans to companies and self-employed people in Germany at the end of last year, compared with 11.9 percent for the country’s largest commercial banks, according to the DSGV association of savings banks. The government will rely on market pressure to compel lenders to publish their stress-test results, the German finance ministry said on June 18.

Bundesbank, BaFin, Banks

The Association of German Public Sector Banks, which represents 62 lenders including the Landesbanken, opposes publishing results for individual lenders, and is open only to the release of aggregate results. Landesbanken are owned by regional governments and groups of savings banks.

“German Landesbanken may harbor a black hole,” said Michael Helsby and Derek De Vries, analysts at Bank of America Merrill Lynch, in a note to clients on June 18. “These are arguably unlikely to pass an unstressed test let alone a stressed one.”

The first round of tests to be published by the Committee of European Banking Supervisors will probably cover about 25 of Europe’s largest banks, three people familiar with the matter said yesterday. Those tests, which evaluate the impact of an economic slump and don’t include risks tied to sovereign debt, were passed by Deutsche Bank AG, Commerzbank AG and Munich-based BayernLB, the people said. The CEBS tests may not be enough to allay investors’ concerns.

‘Biggest Problems’

“We cannot judge how serious the situation is until the results are published,” billionaire investor George Soros said in a speech in Berlin on June 23. “Indeed we shall not be able to judge even then because the report will deal only with the 25 largest banks and the biggest problems are in the smaller banks, notably the cajas in Spain and the Landesbanken in Germany.”

BayernLB, Dusseldorf-based WestLB, Norddeutsche Landesbank Girozentrale in Hanover, Hamburg-based HSH Nordbank, LBBW in Stuttgart, Landesbank Berlin Holding AG and Frankfurt-based Landesbank Hessen-Thueringen Girozentrale declined to comment.

Bundesbank President Axel Weber told German lawmakers on June 25 that tests on European banks may be extended to 100 lenders, according to Hans Michelbach, the deputy finance spokesman in parliament for Merkel’s Christian Democratic bloc.

Weber, who is also an ECB Governing Council member, said on June 17 that future stress tests in the banking industry may include sovereign-debt holdings and signaled that the Landesbanken will be included.

‘Convincing Stress Tests’

“I don’t think that we in Germany can convey a convincing stress test to the market if certain credit institutes that are being discussed are excluded,” said Weber. “In this respect, yes, it’ll be focused on big institutes and Landesbanken will also be among these big institutes.”

Greece’s debt woes focused attention on Spain’s public finances and the costs of buttressing the country’s savings banks, known as “cajas,” that have been hobbled by a surge in bad debts. The Bank of Spain has said it’s performing stress tests on most of the country’s lenders, including commercial and savings banks, and plans to publish results by August.

Europe’s banks had $2.29 trillion at risk in Greece, Italy, Portugal and Spain at the end of 2009, according to figures from the Bank for International Settlements in Basel, Switzerland. German banks accounted for $520 billion.

Banking Risks

BayernLB held 1.6 billion euros ($2 billion) in sovereign debt from Greece, Italy, Portugal and Spain at the end of 2009, the bank said in its annual report. WestLB has said it holds about 1 billion euros of government bonds of the four countries after shifting most of the debt to a bad bank. Other state lenders including LBBW have declined to disclose their exact exposure.

State banks may perform poorly in stress tests because they don’t have large retail-banking operations and rely on corporate client business, which would suffer in the event of an economic slump, Merck Finck & Co. analyst Konrad Becker in Munich said. HSH Nordbank is dependent on economic developments because of its ship-financing unit, he said.

Landesbanken have high costs and lack a “viable” business model, the International Monetary Fund said in a report in March. Some of the state-owned lenders will continue to show a “tendency for excessive risk-taking in search of profits” and more needs to be done to prevent them from being “a continuous drain on the public finances and a source of financial instability for Germany,” the fund said at the time.

Government Bailouts

Landesbanken, which have enjoyed cheaper funding because of state backing, ran into trouble after piling money into structured products including subprime assets to boost profit. Leipzig-based state lender SachsenLB was acquired by LBBW in 2008 to save it from collapse. LBBW needed a 5 billion-euro capital injection a year later from its owners, including the state of Baden-Wuerttemberg.

WestLB was bailed out and set up a bad bank to rid itself of about a third of its assets, including toxic securities. HSH Nordbank, a global shipping financier, tapped regional states for 3 billion euros in capital and 10 billion euros in guarantees to cover potential losses.

Not all state lenders ran into trouble. Landesbank Hessen- Thueringen, known as Helaba, didn’t require state aid and posted a profit last year. Landesbank Berlin was profitable for the past three years.

The eight Landesbanken and DekaBank Deutsche Girozentrale, the fund manager for Germany’s savings banks, had combined assets of about 1.82 trillion euros and more than 54,000 employees at the end of 2009, the DSGV said.

More State Capital

The country’s Soffin bank-rescue fund, set up after the 2008 collapse of Lehman Brothers Holdings Inc., has provided German lenders with about 29 billion euros in capital and about 153 billion euros in guarantees. The fund could be used to inject capital into lenders if the stress tests deem it necessary.

Attempts by Germany’s Landesbanken to merge have mostly failed because of wrangling between regional politicians. Germany may need only two or three state-owned banks, Heinrich Haasis, president of the DSGV, said in February.

Government bailouts have drawn a public backlash across Europe, raising concern about further state support. Germany’s federal and state governments may have no other choice with the Landesbanken after the stress tests, according to analysts.

“My guess is that absolutely nothing will change for the Landesbanken and the German taxpayer will have to stump up again,” said MF Global’s Maughan.

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

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