Peripheral problems drive lenders to turn inwards

Germany’s banks are set for an inward turn in the months ahead, as they refocus on domestic business, target new capital requirements and grapple with the legacy of state support. Katie Llanos-Small surveys the changes ahead for the structure of Germany’s banking system.

  • 23 Nov 2011
Email a colleague
Request a PDF

Few would have envied Eric Strutz on November 4. That was the day the Commerzbank CFO had to deliver grim news: the core bank of the German lender had posted a third quarter loss, its first since 2009.

The message was clear. Hefty impairments on the bank’s holdings of sovereign debt from peripheral Europe had driven the numbers into a loss. Looking ahead, the bank would shift its focus squarely inward, with a moratorium on lending outside Germany and Poland to the end of the year.

The refocus on domestic business is not unusual in Germany. In fact, Commerz’s move to put the brake on international lending reflects a shift for many German banks. The Landesbanks stand out the most in this respect: still licking their wounds from the 2008-2009 crisis, they have been restructuring their operations to focus squarely on local business under European state aid rules.

Many challenges facing German banks are shared by their counterparts across Europe. Lenders are going through a period of introspection as they plan how to meet a muddle of new capital requirements and deal with a steadily increasing sovereign debt crisis.

In some jurisdictions, banks are cutting lending altogether — leaving corporate borrowers to tread their own path to the bond market — in a bid to squeeze risk weighted assets and thereby boosting capital. German banks are following a different path.

The country represents an exception to a trend in other parts of Europe towards disintermediation, says Andrew Sheets, head of credit strategy at Morgan Stanley in London. "In Germany there is such a savings glut, and it is such an overbanked market, that a lot of banks are looking to remain relevant," he says.

"The glut of savings used to be deployed overseas in structured assets, but now the focus is internal. A lot of banks are willing to lend to domestic companies at tighter spreads than the market might, and that’s a natural result of having them wanting to remain relevant."

On the list

That is not to suggest Germany’s banks have retreated from the global stage. On the contrary. Commerzbank and Deutsche Bank made the cut for global regulators’ first list of the world’s 29 biggest institutions. Their size, interconnectedness and global reach meant the national champions were classified as global systemically important financial institutions (G-SIFIs) by the Financial Stability Board in early November.

Being labelled as a G-SIFI is a dubious badge of honour, however. Those on this list must draw up resolution plans — commonly dubbed living wills — to smooth the way should they fail. The group will be reassessed each year, and those still on it in 2014 will have to bring in capital buffers.

Regulators did not indicate what size they expect each bank’s buffer to be, beyond a generic 1%-2.5% indication. But market expectations put Deutsche at the higher end of that range, and Commerz at the lower.

The G-SIFI capital buffers are just one more aspect of a rapidly changing regulatory environment for the banks to deal with. As the European sovereign debt crisis has steadily escalated, the banks have been drawn in with it. They now face complying with a jumble of regulations and bar-raisings when markets are at their worst — or, one hopes, close to it.

European regulators are desperately grappling with a multitude of problems: the threat of sovereign default, tanking markets and a bank funding crisis. As they attempt to come up with a solution to the multi-headed problem the picture of what capital banks need, and by when, has become increasingly muddled.

While the G-SIFI buffers are still over four years away, Basel III is nearing, and Basel 2.5 takes effect in January 2012. But the most immediate focus for many banks is how to meet the European Banking Authority’s temporary 9% capital requirement by the June deadline.

The new requirement, imposed after stressed European leaders pulled an all-nighter to try to construct a package to quell heaving markets, was unexpected. But for many, it may not be too difficult to meet.

The 13 German banks caught by the new requirements have to find around €5.2bn, according to early calculations. Commerzbank accounted for the bulk of that, with Nord LB estimated to need around €660m and LBBW, around €360m.

The ways in which banks meet the new requirements will be different for each institution and jurisdiction. Disintermediation will be a big theme in some countries. For many of Germany’s lenders, though, the result will be a turn inwards to refocus on domestic operations and core business areas.

One FIG credit analyst at a German bank, who did not want to be quoted, says the country’s institutions would use a range of methods to meet the target. "The banks will look at retaining earnings, and cutting bonuses or dividends, as well as selling RWAs — although at the moment everyone wants to sell but no-one wants to buy," said the analyst. "Based on the current information, for all the German banks that I cover that’s doable and I would expect them to reach this capital without asking for state aid."

When the EBA target was announced, NordLB had already unveiled plans to retain profits, divest assets and convert silent participations to meet Basel III. It said it could meet the 9% requirement without state aid or tapping its owners for capital, while LBBW said it does not need fresh money to reach the target.

Adjusting business models

Such changes are nothing new for the Landesbanks. Ever since they began restructuring following losses from the 2008-2009 crisis sparked by US subprime lending, they have been told to keep their eyes squarely on the home market. After the financial market stabilisation fund, SoFFin, stepped in and bought chunks of ailing banks during the crisis, the European Commission’s state aid rules have forced much of this domestic refocusing, in some cases ordering lenders to ditch extravagant international businesses.

While the changes have been in some cases dramatic for the Landesbanks that are restructuring, their efforts will not be in vain, believes Fitch. It says those changes — deleveraging, divesting subsidiaries and refocusing on customer-related activities — will mean the banks benefit from having core businesses anchored in their home regions with strong economies. But it cautioned the profitability in the sector is still weak.

"In 2010 and 2011, most Landesbanks were able to improve their operating profit thanks to reduced impairment charges and positive asset valuation swings," the ratings agency said in a report in November. "However, profitability is still constrained by deleveraging, ongoing IT migration projects, increasing regulatory requirements and higher funding costs as well as the banks’ exposures to peripheral European countries."

 Will systemic support be there next time?  

Attitude towards state support is one of the most curious aspects to the German banking system. On one hand, many Landesbanks benefitted from swathes of state support to stop them from toppling over during the crisis. Yet little more than a year after these rescues, the country pioneered laws in Europe to limit state support in the future.

The German bank restructuring act is designed to protect taxpayers from future bank bail-outs. While it is strict on paper — its introduction pushed spreads on German subordinated debt wider and they never came back in — some doubt whether it will be used.

"Germany was the first country to push ahead with a resolution regime, not to be forced any more to rescue large banks when they fail," said Corinna Droese, financial institutions analyst at DZ Bank. "But so far there’s no chance to let a bank go or restructure it."

State support was huge in Germany: some €30bn of capital support was disbursed under a rescue programme set up in 2008, with the Länder putting up a further €23bn to recapitalise their banks.

The banks are looking at ways to exit state aid programmes. Commerzbank, for example, is keen to shake off state aid and executed an elegant operation in early 2011 to repay much of what it had received. And, nudged by the European Union, the Landesbanks are restructuring to conform with state aid laws.

Yet expectations are that systemic support will continue to prop up the Landesbanks for the foreseeable future. Fitch reckons that as these institutions increase their role in their domestic markets, they will become more important to public sector owners. And then, strategy aside, market conditions are simply not conducive to anything else right now.

"Regarding if or when the states are going to pull back from supporting the Landesbanks, it’s not really clear right now," says Abdoulaye Aboubakar, financial institutions analyst at DZ Bank. "We’ve heard some declarations of politicians pledging to get out of these institutions as soon as possible — but as soon as possible means not right now, because market conditions are not the right ones right now. So we don’t expect to see any change in this respect this year or next year."

The restructuring act has its origins in the rescue of Hypo Real Estate. When the lender ran into trouble in 2009, SoFFin pitched in with €10bn of capital, asset relief to the tune of €20bn, and €145bn of liquidity guarantees, sparking a national debate.

"Rescuing Hypo Real Estate caused very intensive discussions in Germany," said Droese. "Based on this experience they pressed ahead with the restructuring law to not be in a position to have to save a bank. But the situation changed again, with Greece getting worse and worse the banking sector is facing slightly different problems to when Hypo failed. So even if politicians are not willing to rescue banks, they have to because they don’t want the situation to get more disastrous."

The reticence to push forward on these rules echoes sentiment elsewhere in Europe. Denmark introduced laws similar to Germany’s bank restructuring act and, initially, it was unafraid to use them. To much international interest, senior creditors to two small lenders had haircuts imposed after these institutions failed in the early part of 2011. But shortly after, regulators took a step back and reversed the law.

At the European level, a draft directive on crisis management is due, but its release has been pushed further and further back. This legislation, which has a similar purpose to that of Germany’s restructuring act, was due to be unveiled before the summer. As this special publication went to press it was expected in the coming weeks. But some were taking its slow progress as a potential sign that politicians are wary of making market conditions even worse than they already are with such laws.

"In the short term, I don’t really think this law will get used," said a FIG credit analyst at a German bank. "For the banks I have under coverage and that could fall under the restructuring legislation, there’s not really a candidate out there that would fall under it."

But the analyst added that even if there was a bank to which the rules could be applied, market conditions could hamper their use.

"When the market is more turbulent it is more likely they would think about re-establishing 2008 rescue measures — otherwise it would be difficult to re-establish confidence in the markets," said the analyst.

  • 23 Nov 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,761.51 1606 9.02%
2 JPMorgan 380,362.89 1737 8.21%
3 Bank of America Merrill Lynch 364,928.71 1322 7.88%
4 Goldman Sachs 269,252.76 932 5.82%
5 Barclays 267,252.43 1082 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 45,449.36 196 6.56%
2 BNP Paribas 38,734.80 217 5.59%
3 Deutsche Bank 37,615.10 139 5.43%
4 JPMorgan 34,724.19 118 5.01%
5 Bank of America Merrill Lynch 33,835.53 112 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,475.46 105 8.65%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.81%
5 Goldman Sachs 17,333.10 99 6.67%