Rough Shoals for Banks--and Germany's Economy

With losses piling up, loans for new business are scarce

Like most bankers in Germany, Bernd Fahrholz is not given to panic or exaggeration. So it came as a shock on July 24 when the chief executive of Dresdner Bank, which holds $500 billion in assets, declared that the country's financial institutions are in calamitous straits. "There is a crisis" in the economy, Fahrholz warned an audience of journalists, adding that "it is especially a banking crisis."

The next day, Albrecht Schmidt, CEO of Germany's second-largest bank, Munich-based HypoVereinsbank, chimed in, saying 2002 is turning out to be "one of the most difficult banking years since World War II." Schmidt then unveiled HVB's first-ever quarterly operating loss--the result of plunging revenues and a 36% increase in loan-loss provisions. Even worse, he said there was little hope of things improving before next year.

Germany's banks are reeling. They've seen record corporate bankruptcies that have sent loan losses spiraling and profits tumbling. To regain their equilibrium, they are embarking on a long-overdue round of layoffs, cost-cutting, and asset sales. The crisis could spark a badly needed series of bank mergers. "These are things that should have happened years ago," says Mark Hoge, an analyst with Bank of America in London. "If they had, Fahrholz wouldn't be talking about a crisis."

As the banks go, so goes Europe's biggest economy. At least 40,000 German companies will fail this year, according to Creditreform, which gathers data on insolvencies. That's 25% more than last year, the worst year on record. So the banks are reluctant to make new business loans for fear of not being repaid. That makes it harder for Germany, and the rest of Europe, to emerge from its economic funk of the past two years. In any event, the banks aren't in the best of shape to expand lending: Loan-loss charges will increase by at least 40% this year, analysts predict. Add to that the slumping equity and bond markets that are hammering the banks' investment banking revenues, and it's easy to see why Fahrholz and other bankers are rattled.

Banks elsewhere in Europe are also feeling the pinch. France's BNP Paribas and Spain's Banco Santander Central Hispano just reported sharply reduced first-half profits. But Germany's banks are experiencing the worst squeeze. The German economy is expected to grow just 0.9% this year, less than much of the rest of Europe. And banks in Germany haven't merged and streamlined to the same extent as those elsewhere, which means that their costs have stayed high and their profits low. The three largest listed banks--Deutsche Bank, HVB, and Commerzbank--reported returns on equity of less than 5% last year, vs. an average of just under 15% for all euro zone banks. "German banks' low profitability is partly the result of their own managerial ineptitude and means [that] they are badly placed to weather a crisis," notes Hoge.

No one expects any big German banks to go bust: All are well-enough capitalized to avoid such a fate. But four smaller banks have collapsed or been bailed out in recent months. And in late July, rating agency Standard & Poor's said it may downgrade three of the country's largest local government-dominated banks.

Analysts warn that unless the banks take urgent steps to restructure and improve their performance, they may end up as acquisition targets for foreign predators in two or three years. The biggest banks appear to be doing just that. Commerzbank is looking for buyers for U.S.-based Montgomery Asset Management LLC and Britain-based Jupiter Asset Management Ltd. Dresdner is mulling the sale of Dresdner Kleinwort Wasserstein, its investment-banking unit. HVB and Deutsche Bank are cutting staff. And Frankfurt is buzzing with speculation that Commerzbank will soon merge with one of its bigger rivals or that some of the government-dominated banks will join up. But with no relief in sight on the economic horizon, a quick turnaround in bank profits is unlikely. It's a picture that Fahrholz--and other European business leaders--are right to regard with increasing apprehension.

By David Fairlamb in Frankfurt

    Before it's here, it's on the Bloomberg Terminal.