Long undermined by discussions over the future of the state guarantees they enjoy, the spreads of Landesbank debt were this year hit by more bad news, as the Banking Association of the European Union (FBE) issued its strongest attack to date on the privileges of the German public banking sector. And while analysts suggest that fears over grandfathering are being overplayed, they warn that Landesbank paper is set to remain unloved.
Three thousand against three might appear a very uneven contest, but this is the way in which the antagonists appear to be lining up in the latest acrimonious squabble over the support mechanisms of Anstaltslast and Gewährträgerhaftung enjoyed by Germany's Landesbanks. The Banking Federation of the European Union (FBE) says it represents the interests of 3,000 banks in Europe with total assets of more than Eu10tr, so its latest broadside against Westdeutsche Landesbank (WestLB), Stadtsparkasse Köln and Westdeutsche Immobilienbank is clearly backed by an awesome amount of fire power.
There is nothing new about private sector banks, inside Germany and beyond, taking a pop at the triple-A rated institutions that benefit from the Anstaltslast and Gewährträgerhaftung mechanisms. The debate has rolled on for several years and would by now have become intolerably tedious, had it not been for two new developments resulting from an unusually belligerent statement released by the FBE towards the end of June.
The first of these, says one banker, was that the statement raised the stakes in the battle against the Landesbanks by arguing that the support mechanisms that they all enjoy are illegal in the context of EU law. That marks something of a departure from a belief previously held by some commentators that only the "new" Landesbanks that received state aid after the signing of the Treaty of Rome are illegal.
Given that this may now be a matter that will be presented to a court of law, it has once again raised the issue of whether or not the existing obligations of Landesbanks will be "grandfathered". Conventional wisdom among issuers as well as investors in recent years has been that all Landesbanks' existing bonds will be grandfathered, which in turn has made the whole debate about the durability of Anstaltslast and Gewährträgerhaftung something of a red herring, as far as capital markets participants are concerned. Some bankers now think, however, that the most recent challenge laid down by the FBE may make the issue of grandfathering less of a foregone conclusion than most people choose to believe.
"What the legal deposition has done," says one analyst, "is to say that because of the ways in which the Landesbanks have changed their statutes, their spheres of activity or their ownership structures, they are all technically illegal. And in a worst case scenario, what does that mean? I'm no lawyer, but the thought that crossed my mind when I read through the deposition was: can you grandfather something that is currently illegal? And I think the answer to that is probably no."
The second new development that arose as a result of the FBE's recent broadside is that for the first time the net was widened to include a leading savings bank as well as Landesbanks. "The status of the savings banks was something that had always been hovering in the background," says one analyst, "but to the best of my knowledge this was the first time that one of the Sparkassen had been explicitly named as a target by those who want to see an end to Anstaltslast and Gewährträgerhaftung. From a business perspective that makes perfect sense, because the private sector banks would much rather get their hands on the Sparkasse franchise than on the Landesbanks' business, which as everybody knows is only marginally profitable. But with their huge client base and distribution capabilities, the Sparkasse represent the Holy Grail for private banks."
This is a valid point, because while in international investment banking circles the likes of Deutsche, Dresdner and Commerzbank are all perceived to be the leading lights of German banking, at a domestic retail level none of these can challenge the savings banks. According to an analysis of the German banking system published last year by Credit Suisse First Boston (CSFB), while 65% of retail customers have an account with a savings bank, only 7.4% have one with Deutsche Bank, while for Dresdner and Commerzbank the figures are even lower, 4.7% and 3.4% respectively. That breakdown has very clear implications for the share of lucrative franchises, such as the distribution of investment funds, available to the parties involved in the dispute.
It is not just the domestic banks that would jump at the chance of grabbing a slice of the savings bank cake - so too would non-German institutions. The FBE hinted at this in its July statement, noting that "the savings bank organisation is akin to a group of affiliated companies. The cumulative advantages lead to a partition of the market which makes it very difficult for foreign banks to enter the German market. While the share of the German market accounted for by foreign banks has been stagnating for years at about 5%, in the UK foreign banks already have a share of over 50%."
Where all this leaves the outlook for Landesbank bonds is as clear as mud. A recent report published by Fitch certainly suggests that the gauntlet thrown down to the sector in June is probably the most challenging it has encountered in the last few years. "The dispute between the EC and the German authorities over the future of the guarantees given to the German Landesbanks is hotting up again," warn Fitch analysts in the report, "and this time it looks as though something of consequence may actually happen."
Conceivably, this "something of consequence" could be a very nasty surprise to investors, such as a lack of grandfathering clauses for existing bonds and a wholesale downgrade of Landesbanks from triple-A to single-A, which is how Fitch says it would rate the banks if they were stripped of their guarantees. "Legal consensus is that Anstaltslast cannot technically be grandfathered," note Fitch analysts. "Thus, creditors will probably have to rely on the wording of the Gewährträgerhaftung clauses in the laws governing the Landesbanks for assurance that debt will be paid. Fitch has an opinion from a reputable German law firm that the current wording of Gewährträgerhaftung clauses does not guarantee timely repayment. This, of course, contradicts the legal opinions presented on behalf of the Landesbanks to date."
If bondholders are thinking that this sounds serious, Fitch goes on to suggest that in spite of the legal objections to the guarantees, the chances of Landesbank issues not being grandfathered are extremely remote. At Dresdner Kleinwort Benson in London, senior financial institutions analyst Gerry Rawcliffe agrees, saying that the latest legal deposition has changed the risk from one that was previously non-existent to one that is now very small. "The important point is that not having a grandfathering clause would be in nobody's interest," he says. "Of course it would not be in the interest of investors, but nor would it be in the interests of the private sector banks that are big holders of Landesbank bonds and important underwriters of their issues.
"Our view is that grandfathering will be made effective, but the legal deposition has sowed a seed of doubt and for that reason alone investors should certainly be cautious," he advises. "The gradual trend among Landesbanks is one of spread widening and every piece of news that comes out seems to push the spreads gently wider, and there is no reason to imagine they will creep back in. So, while the downside risk may be very small, it is clear that there is no upside potential with the Landesbanks." *