The rules have changed for the German landesbanks. For years, they have enjoyed the backing of their state owners and coveted top grade triple-A ratings. But on July 18 of last year, the European Commission (EC) decreed that it would be scrapping the landesbanks' state guarantees. Six months on and the repercussions of the ruling are already being felt across the Euro-MTN market and beyond. Although it was known that the guarantee issue was under discussion, the final pronouncement came to the surprise of many. Mizuho placed more landesbank trades in 2001 than any other house, yet even it was shocked at the loose nature of the ruling. A spokesman at Mizuho says: "The general reaction was bewilderment at the sweeping nature of the document. In particular, that it did not address market considerations, especially in respect of transactions that had been traded but not yet settled by the day of the ruling and how they would be treated. Additionally, there was no mention of derivatives. Despite assurances from individual lander and the Association of German Public Banks, the position has still not been officially resolved. The landesbank issue was expected to be discussed but such a definitive announcement at that time was unexpected. It caught the market, and the landesbanks themselves, by surprise." Expected or not, the ruling of July 18 2001 has nearly halved the landesbanks Euro-MTN issuance. From January 1 to July 18 2001, the 12 landesbanks closed $44.82 billion off 633 deals, according to MTNWare. From July 19 to December 31, issuance fell to $26.11 billion off 251 trades. Manfred Steyer, head of new issues and syndicate at Landesbank Rheinland-Pfalz (LRP), has noticed the knock-on effects on the number and type of issues being done. He says: "Since the agreement in July, we have seen a slowdown in MTN issuance, particularly as Japanese investors have had a more cautious stance towards the landesbank sector. The agreement has also had a direct effect on the issuance of longer-dated bonds. We currently only issue bonds with a maturity no later than December 31 2015." The spokesman at Mizuho has also noticed these trends. He says: "Issuance with maturities beyond 2015 has dried up for yen issues. Until the ratings issue is resolved for longer maturities then this area of the curve will not be accessible." Marcel Kullman, head of international funding at Landesbank Baden-Wurttemburg (LBBW), also says that it is currently not issuing anything past the 2015 deadline. What he has noticed most is the increasing competition among the landesbanks due to the more limited trading opportunities. He says: "The current climate is very competitive. We generally are one of at least four landesbanks being asked to bid on any given MTN transaction. Competition has increased considerably for MTN funding as domestic-Pfandbriefe, schuldscheine and jumbo-Pfandbriefe issuance has dropped." After years of political wrangling the EC finally reached a compromise with the German government last summer that anstaltslast (maintenance guarantee) and gewahrtragerhaftung (statutory guarantee) on the landesbanks will be maintained, but only until July 1 2005. As part of the deal, all obligations incurred until July 28 2005 and new obligations incurred during the transition period - provided that their maturity is not after December 31 2015 - will continue to be guaranteed until maturity. The explicit state guarantees have been of great comfort to investors in the past. And it is with their investor bases where the landesbanks have had to work the hardest to explain the complexities of the German legal system. Kullman believes that the fact that some kind of decision has at last been made will help enormously in getting investors back and interested in landesbank paper. He says: "Most importantly, we were glad about the ruling because it meant that a compromise had finally been reached, which allowed a long enough period of time for the sector to restructure in an orderly fashion. Most of the landesbanks were very involved in the ongoing discussions, so the ruling was what we were expecting." Although the ruling was not quite what the landesbanks wanted to hear, it had been a long-time coming, as Steyer, at LRP, explains. He says: "A complaint was lodged in 1999 by the European Private Bank Association with the European Commission concerning the question of state support for German public sector banks. The pursuant discussion over the future of the state guarantees for the landesbanks intensified and, therefore, the overall ruling was expected." But there are many uncertainties surrounding the ruling. Still under discussion is whether landesbank bonds will benefit from a timely guarantee or from a deficiency guarantee. A deficiency guarantee does not oblige the guarantor to honour its obligations as they become due. Instead, the guarantor can choose to wait until the bank is liquidated and then pay the amount that could not be paid from the proceeds realized during the liquidation process. The most recent meetings on this issue were due to take place at the time of writing. On a positive note, in their battle to keep and expand their investor base, the new ruling does allow for a four-year transition period during which the landesbanks can restructure in a bid to ensure the highest ratings possible. One option would be to accelerate moves towards closer co-operation or mergers among landesbanks or between landesbanks and savings banks. On January 1 1999, Landesbank Baden-Wurttemburg (LBBW) was established through a merger of three public sector banks, including, for the first time, a savings bank and a landesbank. In light of the recent EC rulings, this structure has been viewed as a model for the restructuring process of the sector. LBBW is the only landesbank that analysts predict will achieve a double-A rating following the removal of its guarantee. Another option is that the landesbanks could compensate their owners by paying for their guarantees with a fee. To keep the body of Japanese investors, it would be necessary to maintain some element of the state support. But Kullmann, at LBBW, says this is an unlikely option. He says: "Compensating state owners for a guarantee has been an option that has been touted, but I believe it could bring more problems than it solves. There are so many questions that would need answering. What would be a fair price? What exactly are you paying for? How much are you paying for? And then, it would be an issue that would have to be ruled on again by the EC." Until any such restructuring does occur it is unclear how low the landesbanks' ratings will fall for deals done outside the new parameters. But Michael Zlotnik, an analyst for German bank ratings at Standard & Poor's, can explain how the new ratings will be decided. He says: "Future ratings will mainly depend on the banks' risk profile, franchise, profitability and capital strength, but could also positively be influenced by their ownership. Thus, given the strategic repositioning of all the landesbanks, it is too premature to assess how ratings will look for debt obligations issued post 2005. But it is extremely unlikely that any rating would fall as low as C."
January 11, 2002
