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It began on July 30, when small to medium enterprise (SME)specialist lender, IKB Deutsche Industriebank (IKB)revealed that its expected €280 million (US$388 million)2007-08 profit was unlikely to materialise. Theannouncement came just 10 days after the Düsseldorf-basedbank reaffirmed its profit target – but few were capable ofsurprise by this point, numbed as most market participants

have been by the massive fallout from the US sub-prime crisisthat engulfed global markets in the closing weeks of July.

As the first German entity to disclose significant sub-primerelated instability, IKB’s Rhineland Funding conduit – which wassuddenly unable to access funding following the crisis in investorconfidence in the sub-prime product – became the lighteningrod for both severe criticism over its diversification strategy andstrong support from a market unwilling to let it go under.

KfW Bankengruppe (KfW), which owns 38 per cent ofIKB, stepped up to protect IKB, allocating €2.5 billion from itsgeneral bank risk funds to cover the losses. A consortium ofbanks was prevailed upon by the German Minister for Financeto cover an extra €1 billion, bringing the IKB rescue fund toapproximately €3.5 billion. KfW provided a €8.1 billionliquidity line to Rhineland Funding and KfW assumed all therisks associated with Rhineland Funding as well as expectedpossible losses up to €1 billion from risk-exposed positions onthe IKB balance sheet.

Although complete collapse was averted by the swiftintervention of KfW and other banks, the reputational damage

was done after the first press release, with international pressbeginning to ask questions about the exposure of German banksto US sub-prime assets. And things were about to get worse.

As IKB was unravelling and more fears were beingexpressed about hidden losses, another German bank began tototter. On August 17 SachsenLB, a small Landesbank owned bythe state of Saxony, revealed that its €17.3 billion asset-backedcommercial paper (ABCP) conduit, Ormond Quay, which wassupported by a credit line from the bank, was also unable tosecure funding. Again, the announcement came just one week

The German banking sector has faced some significant hurdles this year,with an avalanche of negative press accompanying two high-profile

near-collapses in the wake of the US sub-prime crisis. KangaNews examines the impact of the turbulence on the funding plans of German issuers

and the outlook for consolidation in a highly fragmented industry.

B Y K I M B E R L E Y G A S K I N

FEARandFUNDINGin theGERMANBANK SECTOR

2,000

1,800

1,600

1,400

1,200

1,000

800

600

400

200

0

12

10

8

6

4

2

0

1,825

1,200

VO

LU

ME

(A

$M

)

NU

MB

ER

O

F D

EA

LS

VOLUME AND NUMBER OF GERMAN ISSUANCE

IN THE KANGAROO MARKET PER QUARTER

SOURCE: KANGANEWS SEPTEMBER 17 2007

325

1,825

7 7

2

1Q 06 2Q 06 3Q 06 4Q 06 1Q 07 2Q 07 3Q 07

1,400

10

0 0

7

1 5

1 6 | K A N G A N E W S O C T O B E R 2 0 0 7

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after the bank assured investors it would not be significantlyaffected by events in the US mortgage market.

In the first instance the rescue of SachsenLB came fromthe German savings bank association, which provided a creditfacility of €17.3 billion. Nine days after the initialannouncement the bank was taken over by Landesbank Baden-Württemburg (LBBW) (see p19 for more details).

Peter Burbank, vice president and senior analyst at Moody’sInvestors Service (Moody’s) in London, says banks across theglobe are now scrutinising credit facilities and re-evaluatingcounterparty risks. He adds that this concern is not restricted tothe German market. “Nonetheless, thecases of IKB and SachsenLB have raisedspecific concerns regarding the relativeextent to which German banks are exposedto US sub-prime mortgages, structuredproducts, off-balance sheet conduits andleveraged loans,” he comments.

LIQUIDITY LOWDOWN

Events in the US have certainlyconspired to create a liquidity crisis inGermany, and indeed across the

globe. The key issue has been rapid fear-based contagion based simply on theinability of the ABCP conduits to findinvestors to roll their commercial paper,forcing those vehicles to draw on theirbank-provided liquidity facilities.

In the first week of August interbankovernight lending rates in Europe rose to 4.6 per cent, around60 basis points above the European Central Bank (ECB)’sbenchmark rate of 4 per cent, as European banks had becomereluctant to lend money to each other, says Reto Bachmann,strategist at UBS Investment Research. “The ECB intervenedand offered unlimited funds at 4 per cent. By the end of thatday, the central bank had lent a staggering €95 billion toEurozone banks. This sum was the ECB’s largest-ever infusionof cash into the banking system, far exceeding the €69 billionit injected on September 12 2001.” The ECB intervened againin early August, lending some €61 billion at 4.08 per cent.

German market participants all report German banks havefelt the lash of the liquidity crisis. But they are adamant that it isa crisis of trust based on misplaced fear rather than a crisis of

true credit impairment. Says Marcel Kullmann, head offunding at Eurohypo in Frankfurt: “The fear factor meansbanks are hoarding liquidity, just in case the interbank ordomestic market does not provide that what it usually does.”

Jens Remmers, head of capital markets at Hypothekenbankin Essen (Essenhyp), argues that the ECB is in fact providingmore liquidity to the European banking sector than neededbecause of the distrust in the sector. He believes the liquiditycrisis may not be resolved fully until the banks are completelytransparent about their exposures to sub-prime. “The banks havebecome much more restrictive in providing credit lines to other

institutions because no-one knows reallyabout the P&L impacts each bank is facingdue to the sub-prime crisis,” he comments.

While interbank lending levels are slowlysubsiding from their record high rates,Andreas Schenk, managing director at HypoReal Estate Bank International (HypoInternational) in Münich, believes spreadlevels on asset-backed securities and seniorunsecured funds are unlikely to return to pre-June levels, which were at historic lows. “Wewill come back to a functioning market, butwith higher spread levels,” he comments.

L-Bank’s Karlsruhe-based internationalfunding officer, Sven Lautenschläger, has aglass half-full perspective on the liquiditycrunch, however. He believes it has forcedpeople to start differentiating credit in themoney market. “Good credits pay low yields

and bad credits pay high yields. That is a very normal state ofaffairs, but it has not always prevailed. The ECB’s weeklytransaction tender for repo transactions recently showed bidsranging from 3.8 per cent to 5 per cent, which demonstratesthe extent of the differentiation which has now come into themarket.” Liquidity starts to have a different price for differentmarket participants, he adds.

FACING THE FEAR

Either of the SachsenLB or IKB cases in isolation wouldprobably not have elicited such a fervent response fromboth the German and international banking communities

and, indeed, the press. Together, they’ve sparked significantuncertainty about the German banking sector.

5,000

4,500

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

VO

LU

ME

(A

$M

)

QUARTERLY KANGAROO ISSUANCE

BY GERMAN ISSUERS

SOURCE: KANGANEWS SEPTEMBER 17 2007

* 0 DEALS IN Q2 &Q3 2007

1ST Q

1,825 1,800

1,400

1,200

325

2006 2007 ytd*

2ND Q 3RD Q 4TH Q

“The ECB’s weekly transaction tender for repo transactions demonstrates the extent of the differentiation which has now come into the market.”SVEN LAUTENSCHLÄGER L-BANK

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The issue has been complicated by the backdrop of eventsat WestLB, former Landesbank for the federal state of North-Rhine Westphalia. To date the year has been something of anannus horribilis for the bank, which posted a loss of €38 millionfor the first half of 2007 – down from a €289 million profit inthe previous year – following a proprietary trading scandalwhich resulted in losses of €604 million and the dismissal ofWestLB’s chairman, Thomas Fischer, and chief risk officer,Matthijs van den Adel. Seven current and former members ofthe managing board are under investigation for a breach of theGerman Stock Corporation Act.

The bank says it has just half a percent of its balance sheetrelated to sub-prime assets and does not expect any largerlosses in the second half of 2007 from the crisis in the US realestate and securitisation markets. WestLB expects to post apositive result before taxes for the year as a whole, assumingthat the crisis will not take a drastic turn for the worse.

There’s no doubt that confidence across the banking sectorhas taken a hit, but do three problematic situations – all ofwhich are in the process of being resolved or rescued –constitute a systemic crisis?

Of all the German banks, the Landesbanks are attractingthe most significant concern. But it is clear that the entirebanking sector is impacted by the structural problems endemicto this sub-sector.

The fragmentary nature of the Landesbank sector – andthe existence of such a proliferation of smaller banks – seemsto lie at the heart of the problem. Stefan Best, director andteam leader at Standard & Poor’s (S&P) in Frankfurt, saysGermany’s banking industry risk is higher than that of otherlarge developed economies in Europe, North America, andAustralia as it still lags in terms of profitability and dynamism.“The German banking system remains dominated by publiclaw and cooperative banks, which are not primarily profitdriven. While mergers within these respective sectors havesubstantially reduced the total number of banking units in thecountry, the public and cooperative ownership impedes deeperdomestic consolidation and a move to more efficient andcompetitive institutions comparable to the diversified financialconglomerates that lead the banking industry in other largedeveloped countries,” he comments.

The fragmentation has translated into intensifiedcompetition for loan business and extremely small margins,which some market participants say has pushed some smaller

banks to seek higher margins through diversification outsideGermany and into riskier but higher-yielding assets. One sourcebelieves some Landesbanks were driven this way by the changein their status in 2005, when their twin state guarantees, whichallowed them to access cheap funding, were taken away.“Consequently Landesbanks could no longer win businessthrough offering cheaper loans. They came under muchpressure to replace the lost income,” he comments.

Klaus Rupprath, head of capital markets at NRW.BANK, thedevelopment agency for the state of North-Rhine Westphalia,says the situation reflects the unconsolidated nature of theGerman banking system. “Many players in this market had tolook for additional earnings outside Germany due to the smallsize of their home markets. They increased their risk appetitesignificantly and ended up in such assets as US sub-prime.”

For Rupprath, the tensions in the money market reflect realfears of what may still be hidden. “No-one trusts anyone at themoment and there is still some uncertainty as to who may behiding what,” he says. The fear is echoed by WestLB’s investorrelations manager, Holger Grawe, who, having passed throughthe fire of intense public scrutiny this year, believes a moretransparent approach to disclosure may emerge as aconsequence of crisis. “The only thing that will restore investorconfidence will be better disclosure, particularly of exposure tosub-prime assets and the impact on P&Ls,” he comments.

The Landesbanks in particularhave been subject to a flurry ofdoom-laden headlines since theimplosions of SachsenLB and IKB,even though IKB is not aLandesbank. But is the fear-mongering justified?

There’s no doubt that variousGerman banks have significantexposure to investment conduits, US

sub-prime, structured products and in some cases high-yieldassets. Burbank at Moody’s says with respect to Germany, muchof Moodys’ concern has focused on the Landesbanks, many ofwhich have generally weak profitability and only adequate levelsof capitalisation. “Combined with some Landesbanks’ relativelyhigh exposure to both liquidity commitments to conduitsand/or direct exposure to sub-prime and structured productsvia investment and trading books, this leaves some Landesbankspotentially vulnerable,” he comments.

But he emphasises that the level of relative exposure atSachsenLB is not representative of the Landesbank sector as awhole. “SachsenLB’s exposure to investment conduitsamounted to more than €17 billion, equivalent to more than 10times its core capital and more than one quarter of total assets.Should current market conditions persist, contingent calls onliquidity may be exercised for conduits linked to otherLandesbanks,” says Burbank.

Given most of the Landesbanks prefunded their balancesheets in 2005 in anticipation of the loss of the state

“We will come back to afunctioning market, butwith higher spread levels.”A N D R E AS SC H E N K H Y P O I N T E R N AT I O N A L

1 9

guarantees, most are the fortunate possessors of unpledgedhigh-quality liquidity resources to cope with potential liquidityoutflows, says Burbank – both individually and as a group,given the well-tested cross-support mechanisms available topublic sector banks. “Furthermore, in most cases,Landesbanks’ capital bases still appear adequate should theseinstitutions need to move assets from conduits to their ownbalance sheets,” he comments.

WestLB’s Düsseldorf-based Uli Corbach, head of funding,says the climate of fear surrounding all Landesbanks isunjustified, given the business models of most remain strong.WestLB reiterated its view that it would still record a full-yearprofit before taxes at the end of 2007, in its first-half resultsannouncement on August 30. And LBBW, new owner ofSachsenLB and widely touted as the potential purchaser ofWestLB, certainly seems to willing to demonstrate itsconfidence through merger action.

CONSOLIDATION ON THE CARDS

The crisis hasn’t been without its benefits. In fact, manymarket participants believe the shake-up will usher ina long-overdue era of consolidation in the

Landesbank sector, which has faced severe criticism for itsfragmentary nature.

According to a variety of market participants, GermanMinister of Finance, Peter Steinbrück, has been waxing lyricalabout the opportunity the crisis presents to clean up the sector.“The Landesbanks must use the opportunity to combine theirstrengths. It is right that consolidation be on the agenda. Justholding on to the status quo and sitting it out will not be to theadvantage of any of the institutions involved,” Steinbrück iswidely reported to have said.

His position has strong support in the banking sector,particularly among the larger Landesbanks. Comments LBBW’sStuttgart-based head of international funding and investorrelations, Peter Kammerer: “Germany needs more, largerbanks committed to supporting the economy. Many Germanbanks are too small to support the country’s corporates, whichare all too often advised by foreign investment banks. We needconsolidation in the Landesbank sector to facilitate the creationof a few larger Landesbanks.”

LBBW certainly saw an opportunity when it presenteditself, snatching up SachsenLB from joint owners Sachsen-Finanzgruppe and the Free State of Saxony in an exquisitely

executed takeover on August 26. The transaction includes a€250 million emergency capital injection, but the purchase priceis not yet fixed as the evaluation has not been finalised.

The deal followed the near-collapse of Sachsen’s conduitOrmond Quay, which was heavily invested in US asset-backedsecurities. A €17.8 billion bail-out from German savings bankassociation Sparkassen-Finanzgruppe was required to securethe liquidity of the conduit.

Although there are some reports that the Landesbankswere under pressure from the BaFin to find a buyer for thebeleaguered Saxony bank, Siegfried Jaschinski, chairman of theboard of managing directors of LBBW, insists the bank is agood match for LBBW. “Regardless of its current problems,SachsenLB has a strong market position in its home region. Weintend to exploit this potential,” he comments.

For LBBW, the strength of the state of Saxony is certainly acarrot, as is the opportunity of expanding the SME business andhigh-end retail banking operations in Saxony. Adds Jaschinski:“In the takeover of SachsenLB we see good chances of furtherexpanding our operational business on a sustained basis and oflinking the two strong economic areas Baden-Württemberg andSaxony more closely and efficiently in the banking sector.”

Burbank at Moody’s affirms the assumption underlying thetransaction that SachsenLB’s overall liquidity was not the onlyissue regarding the Moody’s rating action, in which the bank’sfinancial strength rating of C- was placed under review for

“Germany needs more, larger bankscommitted to supporting the economy.Many German banks are too small to support the country’s corporates.”P E T E R K A M M E R E R L B B W

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

VO

LU

ME

(A

$M

)

GERMAN ISSUERS IN THE KANGAROO MARKET

SOURCE: KANGANEWS SEPTEMBER 17 2007

KfW

Ren

ten

ban

k

Hyp

o In

tl.

L-B

ank

LBB

W

Bay

ern

LB

NR

W.B

AN

K

Ess

enH

yp

Dep

fa D

euts

che

Pf.B

ank

DS

L

TOTAL OUTSTANDING TOTAL MATURED

5,800

600

5,650

925 700 650325 300 225

1,550

300

1,000

2 0 | K A N G A N E W S O C T O B E R 2 0 0 7

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possible downgrade. “Franchise impairment is also a keyproblem. The bank’s business model and profitability wasskewed towards earnings from the structured market.Consequently, the drying up of business in that marketweakens its business model going forward. It was liquidityconcerns at SachsenLB which triggered the initial problems,primarily reflecting the bank’s sizeable potential exposure to itssponsored conduits. Yet the bank has good liquidity and inaddition, it has proven strong cross-sector support fromGerman public-sector banks and from its public-sector owners,most prominently the Free State of Saxony,” he explains.

Although the transaction was opportunistic in terms oftiming, it certainly aligned with LBBW’s longer-term strategy.LBBW – the largest Landesbank in Germany – has longadvocated fewer and stronger Landesbanks to eliminate thevery risk that almost took out SachsenLB. The bank displayedits appetite for Landesbank-flavoured assets in 2005, purchasingLandesbank Rhineland-Pfalz, and has flagged clear interest intasting what North Rhine-Westphalia has to offer. CommentsJaschinski: “We will take a constructive approach with regard to

thoughts on a possible merger of LBBW with WestLB.”WestLB, a commercial bank with strong roots in the federal

state of North Rhine-Westphalia, has yet to reveal a finalintention with regard to its future. The state of North Rhine-Westphalia now owns just over 17 per cent of the bank, whileWestfälisch-Lippische savings bank association and theRheinische Sparkassen und Giroverband together own 50.6 percent of WestLB. While it is rumoured that several privateinvestors, including Commerzbank and J.C. Flowers & Co –which last year bought WestLB’s 24.1 per cent of the capital ofHSH Nordbank – are interested in purchasing the government’sstake, it is likely LBBW will win out, with both the savings banksowners of WestLB – which have the right to buy the state ofNorth Rhine-Westphalia’s stake – rumoured to have stronglyreiterated their preference for a merger with LBBW.

Some market participants also believe more attentionshould be paid to the dynamic between the Landesbanks andthe savings banks, particularly in an environment where dealslike SachsenLB-LBBW or LBBW-WestLB can happen quickly.The savings bank market is just as, if not more, fragmentarythan the Landesbank sector, and therefore equally vulnerable toproblems in credit markets. Due to their regional focus, thesavings banks’ domestic market delivers only marginaldiversification in a sectoral or geographic sense.

MERGER POTENTIAL

Acritical question is the extent to which furtherconsolidation is possible in a sector which is so stronglypoliticised. Burbank at Moody’s points out that the

Landesbanks have historically played a political role within theirstates that has not necessarily been based on profitmaxmisation. The political element in allowing the takeover ofa Landesbank can be a particularly delicate situation.“Politicians want the function in their state – they want the jobsand they want the economic positives that having aLandesbank brings. Consequently, there needs to be more thanan economic imperative to drive consolidation – there must bepolitical will,” he comments.

In the case of SachsenLB, these two factors combined todrive the sale through. To some extent one could argue thatWestLB’s difficult year may also have lubricated the wheels ofthe M&A train. But at this stage no-one is aware of any otherdeals either on or near the table. However, that hasn’t stoppedsome market participants from indulging in wishful thinking.Comments one banker: “At the moment consolidation is only

happening due to the emergency circumstances.But the crisis means most of the smallerLandesbanks will have to think about how theyposition themselves to survive.”

The point is particularly salient at thisparticular market crossroads. In July 2005 theLandesbanks lost their twin state guarantees,which immediately eliminated the naturalfunding advantage they enjoyed. The largerLandesbanks made moves to reinvent their

business models to adapt to the new competitive environment,focusing more emphatically on their relationships with theregional savings banks and on retail and mid-cap business (SeeKangaNews Volume 1 Issue 4 October 2006 p7). In so doing,they generally remain protected from the worst of the falloutfrom the US sub-prime debacle by virtue of their morestrongly diversified businesses. LBBW and WestLB report thatwhile spread widening is painful, it certainly isn’t crippling.Corbach at WestLB adds that spreads are widening on the assetside too so there could be opportunities to benefit in thecurrent environment.

Outside the Landesbank sector consolidation is also on thecards. In early July the boards of real estate bankingcooperatives Deutsche Genossenschafts-Hypothekenbank(DG HYP) and Münchener Hypothekenbank(MünchenerHyp) signed a memorandum of understandingregarding a planned merger. MünchenerHyp will bring itsbusiness activities into an interim company and will retain itscurrent legal status as a cooperative. The interim company willthen merge DG HYP with MünchenerHyp and DZ BANK –the parent company of DG HYP – owning all shares in thenew bank, with the majority held by DZ BANK. The newbank will be named Münchener Hypothekenbank and its mainoffice will be located in Münich.

“There needs to be more than an economic imperative to drive consolidation – theremust be political will.”P E T E R BU R BA N K M O O DY ’S I N V E STO R S S E RV I C E

2 1

Certainly the Kangaroo markethas felt the impact of the globalcredit crisis. German-basedissuers traditionally comprisethe third-biggest sector bycountry of the Kangaroomarket, after US financials andsupra/sovereigns.

By September 17 the volume ofKangaroo issuance from thissector had droppeddramatically. In the year toSeptember 15 just A$1.8 billion(US$1.5 billion) of Kangarooissuance from Germany

issuers was recorded,compared with A$4.4 billion inthe same period last year.Of this volume, just A$200million came from a sourceother than the two big federalagency banks – KfWBankengruppe andRentenbank – L-Bank’s new2011 deal. This compares withA$1.1 billion of non-agencyissuance recorded over thesame period last year.None of the issuers interviewedby KangaNews were ready tocommit to coming to the

Kangaroo market this yeargiven current spread levels.

Issuers feel that following theglobal crisis they need to issueinto their core markets to re-determine relative value.Comments Eurohypo’s head offunding, Marcel Kullmann: “Wehad intended issuing aKangaroo Pfandbrief inNovember, but with the marketturbulence it makes sense toreestablish oneself in a coremarket then move on to theKangaroo market.”

Andreas Schenk, managingdirector and head of funding atHypo Real Estate BankInternational, says it is not amatter of expecting the samelevel of funding in the Kangaroomarket that he could derivefrom other markets – heexpects to pay a premium fordiversification.“But anadditional liquidity premium ontop of a diversification premiumis too much,” he comments.

Frank Richter, head of investor

relations at NRW.BANK,believes even prior to the crisis,spreads for the NRW.BANKname in Australia wereproblematic – and in factmoving contrary to trend.“We’dlike to issue Kangaroos, but weneed our spread levels totighten as they have almosteverywhere else in the worldover the last 12 months. InAustralia they widened a little,which makes no sense.”

Peter Kammerer, head ofinternational funding andinvestor relations atLandesbank Baden-Württemburg (LBBW), agreesthat levels aren’t right for anissue at the moment. But hebelieves that consolidation inthe German banking sectormay benefit the Kangaroomarket.“If there is furtherconsolidation in Germany andlarger banks are created theywill need to look more forinternational funding – they willneed access to the Australianmarket,” he explains.

KANGAROOS JUST TOO EXPENSIVE

KANGAROO ISSUANCE BY COUNTRY JAN 1-SEP 17 2007

CO U N T RY

United States

Supranational

United Kingdom

Germany

Spain

Switzerland

Korea

France

Netherlands

Finland

Norway

TOTAL

RANK

1

2

3

4

5

6

7

8

9

10

11

% TOTA L

VO LU M E

48

13

12

10

4

4

2

2

2

1

1

100

VO LU M E

( A $ M )

8,450

2,200

2,050

1,800

750

750

400

350

300

200

200

17,450

LEAGUE TABLES FOR BOOKRUNNERS TO GERMAN

ISSUERS IN KANGAROO MARKET 1996 — 2007 YTD

SOURCE: KANGANEWS SEPTEMBER 17 2007

VOLUME

(A$M)

4,275

3,779

2,638

2,225

1,892

1,275

792

600

300

300

300

150

18 ,525

BOOKRUNNER

RBC Capital Markets

TD Securities

ABN AMRO

UBS Investment Bank

Commonwealth Bank

Deutsche Bank

Westpac Institutional Bank

ANZ Banking Group

Citigroup

Credit Suisse

nabCapital

BNP Paribas

TOTAL

% TOTAL

VOLUME

23

20

14

12

10

7

4

3

2

2

2

1

100

NO.

DEALS

33

21

14

13

10

6

6

4

2

2

2

1

KANGAROO ISSUANCE BY COUNTRY 1996-2007 YTD

CO U N T RY

United States

Supranational

Germany

United Kingdom

France

Netherlands

Spain

Canada

Iceland

United Arab Emirates

Sweden

Norway

TOTAL

RANK

1

2

3

4

5

6

7

8

9

10

11

12

% TOTA L

VO LU M E

32

22

15

9

8

7

4

1

1

1

1

1

100

VO LU M E

( A $ M )

10,550

7,000

4,750

2,865

2,500

2,150

1,400

300

290

250

216

200

32 ,471

“We’d like to issue Kangaroos, but we needour spread levels to tighten as they havealmost everywhere else in the world over the last 12 months.”FRANK RICHTER NRW.BANK

2 2 | K A N G A N E W S O C T O B E R 2 0 0 7

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The new bank’s main focus of business will remain thecooperative FinanzVerbund – the financial services network.It will operate in four areas of property finance: private andcommercial property finance, municipal lending and treasury,and credit treasury business. But the key focus will be privatehousing finance. A merger agreement is expected to besigned this year.

Weeks later, on July 23, Hypo Real EstateHolding – parent company of Hypo International– announced plans to acquire DEPFA BANK viaa scheme of arrangement under Irish law.

The transaction will cost €5.7 billion, financedthrough a combination of equity, hybrid instrumentsand cash. The company will pay DEPFA BANKshareholders €6.80 plus 0.189 new shares of HypoReal Estate Holding for each share in DEPFABANK, which represents a premium of 17 per cent on the shareprice of DEPFA BANK on July 20. The scheme of arrangementis subject to regulatory and shareholder approval and is expectedto be finalised by the beginning of October 2007.

BENCHMARKS ON HOLD

To what extent has the current turmoil impacted thefunding plans of German banks? Almost all the banksinterviewed have hunkered down in terms of their public

benchmarks and non-core issuance and are waiting for theturmoil to subside before they re-enter capital markets in a big

way. Given the worst of the crisis occurred over Europeansummer – traditionally the very quietest part of the year interms of funding – no-one is too worried at this stage aboutnot meeting their funding targets.

The Landesbanks – WestLB and LBBW – remain in astrong liquidity position given their 2005 prefunding and theregular flow of funds from the retail and savings bank activities

as well structured issuance. “These funds, which are not ratingsensitive, have been very stable over recent years. Given ourliquidity position we do not have to go to the public market towrite large benchmarks. But we are receptive to ideas,” explainsWestLB’s Corbach. WestLB’s funding target for seniorunsecured and covered bonds for the 2007 year is around €11billion, of which €9 billion has been raised to date.

LBBW is looking for around €17 billion in funding acrossthe product spectrum, depending on growth in assets. To dateLBBW has completed €4 billion in benchmark fundingthrough public sector Pfandbriefe. Kammerer says the bank

Of all the German banksinterviewed by KangaNews,those specialising inPfandbriefe were least affectedover the European summer,with spreads in the productgenerally widening just a fewbasis points since June.

Comments Marcel Kullmann,head of funding at Eurohypo:“Banks that issue primarilyPfandbriefe have experiencedthe smallest changes in theirfunding levels during the crisis.Naturally the same holds truefor investors: in good timesconcentrating sometimes toomuch on pick-up, believingPfandbriefe to be tooexpensive. But when crisessuch as the current one hits,they begin to look much moreclosely at the composition oftheir portfolios and the risks

they are holding and realisingthe advantages of thePfandbrief’s transparency andproven legal framework.”

To date Eurohypo has issuedtwo euro-denomiated globaljumbo public sectorPfandbriefe, as well asnumerous domestic mortgageand public sector Pfandbriefe.

Jens Remmers, head of capitalmarkets at Hypothekenbank inEssen (Essenhyp), which usespublic sector Pfandbrief as itsmain funding tool, saysalthough the liquidity crisis hasdecimated senior unsecuredfunding for many banks,covered bonds have been littleaffected, with spreadswidening minimally. Essenhyphas raised ¤700 million(US$971 million) in mortgage

Pfandbrief and ¤4.4 billion inpublic sector Pfandbrief in2007. Remmers would like toissue more, but that willdepend on the availability ofassets. “I am looking foropportunities on the asset sideto buy sub-sovereignexposure. Then I can executesome new issues from thecover pool,” he comments.

It is not that all covered bondshave remained immune fromthe impact of fear-basedinvestor behaviour (seefeature p5 for more detail).Regina Kölsch, analyst at UBSin London, reports that sincemid-August certain coveredbonds underperformed themarket, including UK coveredbonds, Spanish cédulas andUS covered bonds. Certainly,Pfandbriefe of individual banks

related to negative US sub-prime headlines suffered. In astrictly German context, thecovered bonds of SachsenLBand WestLB underperformedtheir peers when it emergedthey are both liquiditysponsors for their ABCPconduits, even though themajority of their coveredbonds are public sectorPfandbriefe, which have noassociation with mortgagemarkets at all. AlthoughWestdeutscheImmobilienbank – a subsidiaryof WestLB – has somemortgage Pfandbriefoutstanding, sub-prime assetsare not eligible for inclusion inPfandbrief cover pools underthe strict Pfandbrieflegislation. Clearly, the issuehas been poor publicity asopposed to problematic pools.

COVERED BONDS TO THE RESCUE

“No-one trusts anyone at themoment and there is stillsome uncertainty as to whomay be hiding what.”K L AUS RU P P RAT H N R W. B A N K

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does not need to complete any more benchmarks. “We’ll onlylook at senior unsecured if we can acquire more assets withhigher spreads. We are also looking at opportunities inSchuldschein – promissory notes,” he comments.

Both banks remain strongly involved in covered bondissuance (see box above) to take advantage of current stronginvestor interest in the product compared with seniorunsecured product.

The two state development agency banks, L-Bank andNRW.BANK, also say they are comfortably placed with regardto overall issuance. L-Bank has funded two-thirds of its €7billion funding target for 2007. Lautenschläger says the bankwill wait to issue its euro benchmark when market pricing ismore normalised, but is also looking keenly at other marketopportunities, including the Maple market. To this end, L-Bankwent on a non-deal roadshow to Canada in the week beginningSeptember 17.

NRW.BANK has completed 85 per cent of its €17 billionfunding volume target for 2007. “If markets permit we havelarge deal in the pipeline – a five- to seven-year eurobenchmark transaction to complete our euro curve,”comments Frank Richter, Düsseldorf-based head of investorrelations. He adds that next year the bank will concentratemore heavily on US dollar funding. “We’d like to build a curvein this market,” he comments.

Like other agency banks, both L-Bank and NRW.BANKare actually benefiting from the current turbulence in the

financial markets. International investors identify these issuersas a safe bet – close to the government segment. “We seestrong investor demand in maturities up to five years. We arealso quite active in the commercial paper market. Consequently,primary market levels will tighten significantly,” says Richter.

Eurohypo has raised €6.4 billion in mortgage and publicsector Pfandbriefe (as per June 30 2007), and together with itsowner, Commerzbank, has an estimated €30 billion of seniorand Pfandbrief needs this year. But Kullmann says benchmarkissuance in the jumbo Pfandbrief market has more or lesscome to a halt. “There has to be liquidity in the secondary,swap and govvie markets to facilitate a benchmark and that isstill a bit weak at the moment,” he comments.

Essenhyp has completed 50 per cent of its €10 billionfunding target for the year, but does not plan to return to themarket unless funding levels stabilise. To date the bank hascompleted €1.5 billion in benchmark funding via one benchmark.“We don’t need to come back to the market at the moment,”comments Remmers. The bank is keen to issue a benchmark inUS dollars, but has held off due to market circumstances.

According to Schenk, Hypo International plans to raise €14billion to €15 billion in senior unsecured funding this year andhas already hit more than 80 per cent of this funding. So he isrelaxed about the bank’s senior unsecured funding, which ispositive, given current market conditions, he says. “If themarkets do not allow us to issue a benchmark in the near future,we will stand on the sideline until we see the right opportunity.” •

The German Pfandbriefproduct includes some uniquefeatures that have enabled it toweather this most severe ofstorms. The stringent nature ofthe Pfandbrief law, whichregulates the inclusion ofassets into the cover pools andthe regular auditing of coverpools, has encouragedinvestors to maintain theirinterest in the product, saymarket participants.

Peter Kammerer, head ofinternational funding andinvestor relations at LBBW, saysthe bank has to date raised ¤13billion: ¤6.6 billion in Pfandbriefand the rest in senior unsecured.“Investors have certainly noticedhow safe the product is, which iswhy our issuance has increasedthis year.We’ve achieved verygood funding levels even duringthe crisis.”

While Kammerer says he doesnot have to return to capitalmarkets this year, he adds hewould consider completing thebalance of his fundingrequirement in covered bonds.“We have a very high level ofovercollateralisation so there isgood room in the cover pool,”he comments.The German product alsotends to have moregeographically diverse coverpools. The pools have some,but very little, US inclusion,

which is great from a marketingpoint of view at this point in themarket’s cycle.

Kölsch at UBS comments: “Theinternational mortgageexposure in some Pfandbriefcover pools is predominantly inthe form of commercial realestate financing (maximumLTV 60 per cent) situated in theEuropean Economic Area(EEA). Although primemortgages originated in the USare eligible as cover assets if

certain conditions are met,issuers have so far refrainedfrom including noteworthyamounts of US commercialmortgages in the pool, due tosome uncertainty with regardsto insolvency privilege on USmortgage loans.”

Kullmann at Eurohypo remainsphilosophical about the risk:“The biggest risk at this stage is simply the headlines – thecore quality of most banks hasnot changed.”

“The biggest risk at this stage is simply the headlines – the core quality of most banks has not changed.”MARCEL KULLMANN EUROHYPO