German City Needing Aid Shows Debt-Crisis Tentacles: Euro Credit

Offenbach, a city of about 120,000 people neighboring Germany’s financial capital Frankfurt, is so mired in debt it had to ask the state of Hesse for a 211 million-euro ($277 million) bailout in June.

In so doing, it became one of the largest of 102 municipalities to tap 3.2 billion euros of aid Hesse is making available as the first of Germany’s 16 federal states to introduce a formal rescue fund for struggling towns and cities.

Offenbach, in Frankfurt’s shadow as the financial center rose to prominence during the past two decades, has lost its place as an industrial hub as household goods maker Rowenta Werke GmbH and printing-press maker Manroland AG cut production at their factories. As Germany, the biggest national contributor to euro-area bailouts, pressures indebted European countries to cut down on spending, its own cities are buckling in the absence of a mature municipal bond market and as public-finance lending shrinks in the wake of Europe’s sovereign debt crisis.

“The financial situation of Offenbach is not sustainable,” said Michael Beseler, who was the city’s treasurer until Sept. 6. “The rescue package by the federal state of Hesse is not enough and is only a step in the right direction.”

The debt crisis is prompting banks to take a more prudent view of default risks, Michael Kemmer, the general manager of the BdB Association of German banks, said in an e-mail in June. “In addition, the new regulatory framework has consequences for loan commitments.”

Increasing Pressure

New Basel capital and liquidity rules for commercial banks and institutions specializing in covered bonds that come into force in January are increasing the pressure on over-indebted German municipalities.

The overhaul, known as Basel III, was designed to prevent a re-run of the crisis that cascaded across financial markets after the collapse of Lehman Brothers Holdings Inc. in 2008. “With the advent of Basel III, banks tried to push interest rates up for our loans,” said Offenbach’s Beseler. “We rely 100% on bank loans.”

A second bailout for Greece that involved private investors writing down the value of sovereign bond holdings has altered lenders’ perceptions of what had previously been deemed risk- free assets.

“The new normal is that banks have begun to look at municipalities through a different lens, with a greater emphasis on risk,” Martin Junkernheinrich, a professor of applied environmental research and public economics at the University of Kaiserslautern, said in a phone interview. “The Greek debt crisis shows that states and, of course, cities can go bust.”

Running Deficits

One-third of all German cities spend more than they earn, and there is no reversal of this trend in sight, according to an April survey by state development bank KfW Group, which is based in Frankfurt.

“Those cities that face financial problems expect the situation to worsen,” KfW said in its annual survey of cities. “Above all, big towns with more than 50,000 inhabitants are affected.” In that group, the proportion of municipalities running deficits reaches two-thirds, the study showed.

The state of Hesse, home to affluent cities including Frankfurt and the capital Wiesbaden as well as Germany’s single- biggest employment location at Frankfurt Airport, is leading the charge on municipal bailouts.

Under the proposed debt restructuring, municipalities can receive aid equal to as much of 46 percent of their debts from Jan. 1, 2013, delivering on an election promise by Hesse’s Prime Minister Volker Bouffier two years ago. A total of 106, or 25 percent, of Hessian municipalities qualify for the assistance and 102 have applied, according to a July 4 statement by the finance ministry.

Rescue Mechanism

“Hesse has acknowledged that there are many municipalities which cannot solve their financial problems on their own,” Stefan Loewer, a finance ministry spokesman, said. “The rescue mechanism aims to facilitate a partial debt restructuring and will help the cities to stand on their own feet financially in years to come.”

Until the 1950s, Offenbach was the center of Germany’s leather industry with more than 10,000 workers, according to city records. Frankfurt’s neighbor was also a manufacturing hub, counting on companies such as Rowenta, owned by French SEB Group since 1988, and Manroland for tax revenue.

“The first recession after the second World War in the late 1960s, followed by the oil crisis in the 1970s, prompted the decline of many industrial and leather companies,” Juergen Eichenauer, the head of Offenbach’s city museum, said. “The demise of all these companies has laid the foundations for the city’s debt burden as high unemployment pushed up social costs.”

Crisis Outbreak

Since the outbreak of the 2008 financial crisis, Offenbach has lost 20 percent, or 13 million euros, in corporation tax revenue. Manroland, which once employed more than 5,000 people in the city, filed for insolvency protection last year. Chemical makers Invista Resins & Fibres and Allessa closed their last production sites in 2009 and 2010, respectively, the city said.

Offenbach’s unemployment rate was 10.6 percent in August 2012. That compares with an average 5.7 percent for the state of Hesse, according to the German labor office. Without 438 million euros of short-term loans, almost four times what it borrowed in 2000, this one-time stronghold of German manufacturing can’t pay its bills.

Tightening Bottleneck

Some of the biggest providers of public finance are ceasing operations in the wake of the debt crisis, tightening the bottleneck further for municipalities.

Franco-Belgian lender Dexia SA (DEXB), once the world’s biggest municipal lender, is being broken up after Europe’s debt crisis reduced its ability to obtain funding. Depfa Bank Plc, the Irish unit of bailed out German lender Hypo Real Estate and once one of the biggest lenders to German municipalities, halted new business after a July 2011 ruling of the European Commission.

Commerzbank AG announced on March 30 that it will wind down all public-finance activities to comply with European Union regulations for its Eurohypo unit, which provided 256 billion euros in annual real-estate and public financing at its peak in 2008, according to spokesman Heinrich Froemsdorf.

Banks will increasingly differentiate on the basis of municipalities’ risk profiles, the Association of Covered Bond Banks spokesman Christian Walburg said on Aug. 27. The volume of German public covered bonds, which banks use to finance their loans to public creditors, may drop to a more than 20-year low of 326 billion euros in 2012, according to the group.

German Pfandbriefe

The volume of covered bonds backed by public funds declined 39 percent to 356 billion euros from 2008 to 2011. The volume of covered bonds backed by real estate loans rose 3 percent in the same period, according to the association.

While Spanish 10-year bond yields reached a euro-era high on July 24 climbing to 7.62 percent, German Pfandbriefe, which are backed by mortgages or public-sector loans and are guaranteed by the borrowers, touched a record low of 1.81 percent on Aug. 30 as Europe’s debt crisis prompted investors to shun peripheral euro-area sovereign debt.

Benchmark 10-year German bund yields slid to a record 1.167 percent July 20, while two-year securities dropped to negative yield July 11.

Deutsche Bank AG, Germany’s biggest lender, on the other hand, is sticking with municipal lending, albeit under more stringent criteria. For the past 10 years, the bank has implemented internal credit ratings on municipalities.

“The creditworthiness assessment gives the municipalities the opportunity to figure out their weak spots,” Frank Hartmann, a spokesman for Deutsche Bank, said in an e-mail. “Municipalities can figure out, based on the assessment, how they can become more attractive for potential external investors such as insurance companies or pension funds.”

To contact the reporter on this story: Annette Weisbach in Frankfurt at aweisbach1@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net

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