More on German banking problems from the Sunday Telegraph, UK:
telegraph.co.uk
German banks teeter on the precipice
(Filed: 13/10/2002)
The finance director of HSBC has warned that the financial system is in jeopardy. Many of the risks stem from Germany. Grant Ringshaw reports
Finance directors do not normally make waves. But last week Douglas Flint, the number-cruncher at HSBC, the UK's biggest bank, sent ripples through the international banking world when he raised grave concerns about the stability of the world's financial system.
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He disclosed that HSBC was increasingly worried about the surge in bad debts at some banks. "It is something we are concerned about because of the systemic implications," he said. "We do worry about systemic risk [or the prospect of a domino effect of collapses]."
It was the first time a respected and senior banker had stated such worries about the robustness of the world's financial system.
Significantly, Flint also raised fears that the impact of the excesses of the late 1990s, the "exuberant" investing by US pension funds and the bursting of the dotcom bubble has still to fully unravel. The threat from the unwinding of the late 1990s boom has not yet gone away, he implied.
Flint and HSBC have since tried to play down the comments. But they could not have come at a worse time for a nervous financial sector.
Bank shares have plunged this year in the US and Europe. Investors have been unnerved by numerous profit warnings. And the underlying performance of banks is lamentable: the dive in stock markets has wiped tens of billions of pounds off banks' equity portfolios, there is evidence of rising bad debts and revenues are shrinking in important areas such as investment banking.
Even French banks, such as Société Générale and BNP Paribas, often viewed as more defensive because of their profitable and diverse retail operations, have seen their share prices hammered.
However, investors are most anxious about the banks in Germany, where a weak economy and declining profits have created disturbing parallels with crisis-stricken Japanese banks. So just how deep are the German banks' troubles? Even in these volatile market conditions, the past week has been hairy.
On three occasions, Commerzbank, Germany's third-largest listed bank, has been forced to deny suggestions that it is facing a liquidity crisis and rumours that it had sustained large losses in credit derivatives trading. Klaus Peter Muller, the chairman, dismissed the rumours as "malicious" and "wild speculation".
The fall of Germany's financial services giants has been astounding. Commerzbank's shares have slumped by around 70 per cent this year. It is now valued at just Eu3.9 billion (£2.5 billion) - less than Northern Rock, the specialist British mortgage bank.
Allianz, until a year ago viewed as one of the most feared and powerful insurers in the world, at one stage last week had a lower market capitalisation than Unicredito, the fast-growing Italian financial services group.
At the heart of the problem is the weakness of the German economy, which has led to a series of spectacular bankruptcies and saddled local banks with billions in loan losses. High-profile business failures have included Kirch, the sprawling media group, and Babcock Borsig, the engineering group.
In an ominous sign that the banks may no longer be willing or able to bail out troubled German companies, Holzmann, the construction group, was allowed to collapse. The listed banks led by Deutsche Bank, HypoVereinsbank, Commerzbank and Dresdner (now owned by Allianz) have also been plagued by high costs. Meanwhile, the value of their huge equity portfolios has plunged.
A further crippling factor is the fragmented nature of German banking, where competition from state-backed public sector banks has driven down margins and made retail banking a horribly unprofitable business.
In August HypoVereinsbank reported its first ever quarterly loss. Allianz has ordered Dresdner to slash costs after a surprising Eu350m second quarter loss. Commerzbank reported a meagre Eu25m pre-tax profit in the second quarter and admitted it was likely to miss its 2002 goal of a Eu700m to Eu800m profit.
The impact on jobs has been brutal. Since the beginning of 2001, the four leading German banks have slashed almost 40,000 staff.
Wafer-thin margins and weak profits have left German banks with little room for manoeuvre. "You have a banking sector where there is a substantial shortage of capital, just enough to support the asset base," says one German investment banker.
"More significant write-offs and the sector could be under water. The banks have to be recapitalised somehow, but it is difficult to see how." Stuart Graham, an analyst at Merrill Lynch, the investment bank, says: "We cannot remember ever having been so worried about the outlook for the industry."
Even in better times, German banks have struggled to meet the returns of their international rivals. The average return on equity - a key measure of profitability - touched 14 per cent in 1994, well below the 15 to 20 per cent earned by international peers. Overcapacity and economic slowdown have driven returns down savagely.
Two weeks ago, the Bundesbank - the central bank now affiliated to the European Central Bank - revealed that the industry average had fallen from 9.3 per cent in 2000 to 6.2 per cent in 2001. It predicted further sharp falls this year. This squeeze on profits means that the banks are facing a crunch in the capital that is available to fund new loans.
According to research from Merrill Lynch, growth in German banks' capital was a measly 2.9 per cent in 2001. This is alarmingly low and threatens to throttle the banks' crucial lending operations. The point is that German companies rely on debt financing far more heavily than European rivals.
The parallels between German banks and their crisis-stricken Japanese rivals are striking. Both have suffered from a weak economy, an ailing banking system, the banks' dependence on lending, a complex web of cross-shareholdings and the bursting of property and stock market bubbles.
Though the property bubble burst in Germany in the mid-1990s, there remains a legacy of problems. HVB's recent results were hit by bad debts on property deals.
Just as problematic is the web of cross-shareholdings. German tax reforms last year were designed to speed up the unwinding of these holdings. However, this has not happened as falling stock markets have led bank managements to hold on to their stakes in commercial enterprises. The impact has been severe.
According to Merrill Lynch, Commerzbank is facing losses of Eu1.8 billion on equity holdings. Deutsche Bank's unrealised gains on its equity holdings have plummeted from Eu9.2 billion at the end of last year to just Eu2.2 billion.
HVB's equity portfolio has catastrophically slumped from Eu6.9 billion to Eu180m in the same period. The bank is now thought to be facing a Eu430m loss on its investment in Munich Re, one of the world's largest reinsurers.
In theory, the most effective solution for the banks would be to increase their lending margins. Both Deutsche and Commerzbank have pointed out that the net interest margin on corporate loans has risen sharply. The problem is that the average life of a loan is three to five years, so it takes a while for the wider margins on new lending to feed through to profits.
However, the banks' own costs of funding have risen. Commerzbank and HVB have seen their creditworthiness downgraded by the rating agencies Moody's and Standard & Poor's, which means they have to pay more for credit on the money markets.
So the future looks bleak. Operating profits for the sector are expected to plunge by a whopping 57 per cent this year and provisions for bad debts may surge by 24 per cent, according to recent research by Schroder Salomon Smith Barney.
Some bankers and analysts believe the only solution for some ailing German banks will be to be taken over by better capitalised rivals. The frightening question is whether a controlled reconstruction of the industry can take place fast enough to pre-empt the possibility of complete collapse of confidence in some substantial institutions.
"To me Commerzbank and HVB are dead in the water but not bust," says a German investment banker. "They cannot grow out of their problems, but if they delay writing off loans they can continue to exist.
"It is a very sorry state of affairs." |
