[A-List] Germany: banking crisis?

["Michael Keaney" <michael.keaney@xxxxxx>]

German money machine grinds to a halt

Europe's most powerful banking sector is on red alert

Mark Milner and Jill Treanor
Thursday October 31, 2002
The Guardian

Germany's banking system is facing a crisis of confidence. Profits are
evaporating and share prices crumbling, prompting uncomfortable comparisons
with Japan's troubled finance houses.

The latest indication of the German disease comes this morning from
Deutsche, the country's largest and once the world's biggest bank.

There is little doubt that the third quarter figures will make grim reading.
In just three months Deutsche's profits are expected to have fallen to ?129m
(£81.5m) from ?721m, according to analysts at Lehman Brothers.

What is doubly grim is the expectation that they will still be better than
those of its stock market-quoted peers, Commerzbank and HVB.

HVB has already reported a third quarter loss while Commerzbank has hinted
it might finish the year in the red.

Customers whose finances were in this state could expect a pointed missive
from their branch manager. The banks, too, are coming in for a harsh
response - from investors. Deutsche's share price has crashed 30% in the
last three months - although it bounced back by some 7% yesterday - and is
little more than half the level at which it stood in early January.

Commerzbank's fall from favour has been even more precipitous. Its shares
are now changing hands at around ?7, just a third of the figure seen in
November last year. HVB, where chief executive Albrecht Schmidt is to step
down earlier than planned, is down by more than 60% over 12 months.

Deutsche - which, when it bought Bankers Trust in the US four years ago,
claimed a place on the world leader board - now has a market capitalisation
of about £18bn, allowing five British banks to claim they are bigger in
investors' eyes.

As well as HSBC, which is in the global rankings already, HBOS (the merged
Halifax-Bank of Scotland), Royal Bank of Scotland, Barclays and Lloyds TSB
are all bigger than the German powerhouse.

Does it matter? To some in the City of London it means the ambitions of
Barclays and Lloyds TSB in particular to expand in Europe may be thwarted.
John-Paul Crutchley, a banking analyst at Merrill Lynch, says the relative
strengths of the British banks may in fact work to their disadvantage,
because they would appear to be exploiting rivals' weakness.

"In some ways, if they want to be more aggressive it could help [the British
banks]. But these are difficult, political trade-offs. This could actually
prevent rather than incentivise deals," Mr Crutchley warns those expecting
weakness to lead to a flurry of deals.

So what has gone wrong with the German banks? In the short term, the simple
answer is the German economy. It has virtually ground to a halt. Even Jürgen
Stark, the vice-president of the Bundesbank, Germany's central bank,
acknowledged yesterday that the country was on the verge of stagnation,
although he denied it would slide into recession. Next year doesn't look
much better, either.

Empty offices
A struggling economy matters to all banks, but to Germany's it matters more
than most. A huge slice of the economy is accounted for by the Mittelstand,
the small and medium-sized sector. Significantly, and unlike other similar
sectors elsewhere in Europe, these businesses rely far more on borrowing
from the banks than raising equity capital. So when the bad times hit, more
go bust, leaving the banking sector, rather than investors, to suffer.
Corporate insolvencies are expected to reach 35,000 this year and could
approach 45,000 next, according to a Commerzbank estimate.

Real estate has played a part in dragging down returns. Speculative building
in cities such as Berlin and Leipzig have created a surfeit of empty
offices. Voids mean no income, no income means paying the bank loans becomes
a problem.

Slumping stock markets have taken their toll, too, as banks have seen the
value of their equity portfolios fall steeply. The downturn in the economy
and rise in bankruptcies has merely served to high light structural
faultlines in the sector. Germany's banking industry is a paradox. On one
hand it is too competitive, on the other it is not sufficiently competitive.

Take the income side. Big banks such as Deutsche, Commerzbank, HVB and
Dresdner Bank - which is part of the Allianz empire - face competition from
the landesbanks, which are backed by the regional state governments.

That gives them a better credit rating, which in turn allows them to borrow
more cheaply than private sector rivals. The terms at which they can onlend
then puts a squeeze on the margins of their private sector rivals, who have
to pay more for their capital.

The competition authorities in Brussels have cottoned to the mismatch and
ordered the German authorities to level things up, but the changes won't
come until 2005. Even then, there will be a strong case for saying that
Germany has too many banks. Some analysts reckon fragmentation will make it
difficult to exert much by way of pricing pressure.

Strong competition might have been expected to produce a lean, mean, banking
machine. If only. The big banks are making huge efforts to chop out costs,
but still have a long way to go.

Commerzbank analysts calculate that Deutsche Bank will have a cost to income
ratio of almost 85% this year, while the figure for HVB will be just over
72%. By comparison the figures for Barclays and HSBC are 55% and 59%
respectively.

"There is a way out if the economy improves. But if things keep going
downhill, the rate at which [the banks] are burning capital will compound
the problem," said one analyst.

The banks are not only suffering from the downturn, they are fast becoming
part of the economic problem itself. Faced with soaring loan losses there
are clear signs that they are taking a tougher line on lending.

Last week, a survey by financial magazine DMEuro reported that
three-quarters of Mittelstand companies were running into problems borrowing
money - from higher rates to outright rejection.

"The commercial banks are becoming more and more risk-averse in lending, and
we think they will be restrictive in lending in the future," says Jürgen
Michels at Schroder Salomon Smith Barney.

The landesbanks may be prepared to pick up some of the slack, but their
capacity is finite. The last thing the German economy - and, by extension,
the German banking system - needs is a credit crunch. The parlous position
of both, however, means they might just get one.