VZCZCXRO1909
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHMZ #0130/01 0931532
ZNR UUUUU ZZH
P 021532Z APR 08 ZDK CCY
FM AMCONSUL MUNICH
TO RUEHC/SECSTATE WASHDC PRIORITY 4348
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCNFRG/FRG COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 MUNICH 000130 
 
SIPDIS 
 
C O R R E C T E D  C O P Y //CHGD SIGNATURE LINE TOREAD NELSON 
VICE GUY// 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON ETRD GM PGOV PREL
SUBJECT: BAYERNLB - SUBPRIME CRISIS HITS BAVARIA 
 
MUNICH 00000130  001.2 OF 002 
 
 
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SUMMARY 
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¶1.  A BayernLB official told ConGen Munich that the bank,s 
subprime losses would exceed the embarrassing 1.9 billion 
euros already declared in February.  Both Moody,s and 
Bavarian Minister-President Beckstein share this view, saying 
as much as 4 billion euros may be at risk.  While the losses 
don,t appear to threaten the solvency of the bank, they have 
raised questions about the lack of oversight by bank and 
state officials, and may potentially provide the catalyst for 
a merger with Landesbank Baden-Wuerttemberg at some point 
after Bavaria,s fall elections, creating Germany,s second 
largest bank. 
 
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BAVARIA,S STATE BANK 
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¶2.  ConGen Munich met with Peter Kulmburg, BayernLB,s head 
of communications, March 27 to discuss the impact of the 
financial crisis in the U.S. on BayernLB and the prospects of 
a merger with its counterpart Landesbank Baden-Wuerttemberg 
(LBBW).  BayernLB is a semi-public bank, owned jointly by the 
state of Bavaria and the regional savings bank association 
(Sparkassen).  The bank serves as a &house bank8 to the 
state of Bavaria and as a clearing house for the Sparkassen 
located in the state. 
 
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SUBPRIME LOSSES BUILD 
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¶3.  As with most of the German banking sector, BayernLB has 
not been immune to the effects of the U.S. subprime crisis. 
In February, the bank admitted losses of approximately 1.9 
billion euros (USD 3 billion) because of a number of 
non-performing loans backed by U.S. mortgage securities.  The 
losses were particularly embarrassing given that BayernLB 
officials had previously maintained that their exposure to 
the subprime crisis was minor.  As a result, CEO Werner 
Schmidt was forced to step-down and was replaced by Michael 
Klemmer.  The affair also embarrassed Bavarian Finance 
Minister and Christian Social Union (CSU) chief Erwin Huber, 
a member of the bank,s supervisory board. 
 
¶4.  Kulmburg explained that BayernLB owned a portfolio of 
asset-backed securities previously valued at 30 billion euros 
(USD 46.8 billion).  For a significant part of the package it 
was not possible to determine current market prices, he said, 
as there were currently no buyers.  As result, a valuations 
model had to be accepted by the bank,s auditors to determine 
the value of the package.  The &loss8 of 1.9 billion euros 
BayernLB reported in February was composed of a write-down of 
600 million euros (USD 936.3 million) of subprime related 
investments and a revaluation of assets resulting in the 
reduction of their book value by 1.3 billion euros (USD 2 
billion). 
 
¶5.  Kulmburg pointed out that BayernLB was determined to keep 
these assets because it expected that a good part of them 
would perform nonetheless.  He explained, however, that the 
losses would likely exceed the 1.9 billion euros, as problems 
with U.S. mortgage-backed securities had deepened during the 
first quarter.  This view is shared by ratings agency Moody's 
Investors Service, which announced March 25 that it had put 
BayernLB's &C-8 bank financial strength rating on review 
for possible downgrade.  "Moody's decision ... reflects the 
bank's significant 32 billion euro (USD 49.9 billion) 
exposure to structured credit products, of which more than 4 
billion euros (USD 6.2 billion) is subprime related," said 
Peter Burbank, lead analyst for BayernLB at Moody's. 
Kulmburg,s and Moody,s comments appear to also be shared by 
Bavarian Minister-President Beckstein, who told the press on 
March 31 that he also expected the bank,s losses could 
ultimately mount to as much as 4 billion euros. 
 
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NOT ALL BAD NEWS 
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¶6.  Kulmburg explained that even though the crisis was 
clearly bad news for the bank, it posed no threat to 
BayernLB,s survival.  He added that the bad news related to 
subprime losses overshadowed the bank,s successes, such as 
its well-run business loan program which had almost no 
insolvencies.  Another strength was the bank,s growing 
business in southeastern Europe, which BayernLB was pursuing 
through its Austrian subsidiary, Hypo Alpe Adria Group. 
Kulmburg said BayernLB,s overall strategy included a 
 
MUNICH 00000130  002.2 OF 002 
 
 
stronger focus on retail banking, especially in southeastern 
Europe, loans to small and medium sized firms, and a 
reduction of its securities trading activities. 
 
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MERGER ACTIVIITY? 
----------------- 
 
¶7.  Kulmburg said despite rumors, a merger with another 
German Landesbank was not immediately forthcoming, especially 
not before Bavarian state elections in September.  He 
nevertheless expressed the view that a merger of BayernLB 
with another Landesbank, preferably Landesbank 
Baden-Wuerttemberg (LBBW), might be in the cards at some 
point in the future.  Kulmburg noted that there had already 
been merger negotiations last fall, which the Bavarian state 
government had stalled, arguing that it wanted to maintain 
BayernLB as an independent entity in order to preserve 
Bavaria,s importance as a financial center.  Despite the 
Bavarian government,s desire to keep BayernLB independent, 
the savings banks in Bavaria and Baden-Wuerttemberg, which 
each own 50 percent of their respective state banks, would 
have welcomed the merger, arguing that a merged bank would 
result in better and cheaper services. 
 
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COMMENT 
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¶8.  At this point, BayernLB,s losses represent more of an 
embarrassment for the bank and the Bavarian government than a 
threat to the viability of the institution.  However, it is 
an example of the questionable business model of state banks. 
 Even BayernLB's successful operations in southeastern Europe 
barely conceal the fact that the actual role of state banks 
-- to provide higher financial volume than regional savings 
banks could provide -- has vanished.  Together with 
North-Rhine Westphalia's WestLB, BayernLB is a prime case of 
how (parochial) state government policymaking prevents 
desirable banking consolidation in Germany. 
 
¶9.  It is not yet clear whether frustration on the part of 
the savings banks and the public (which ultimately will pay 
for losses with tax money) with the bank,s leadership and 
apparent lack of government oversight could be the catalyst 
for a merger between BayernLB and LBBW, the two largest 
German state banks.  A merged institution would become 
Germany,s second biggest bank after Deutsche Bank, with its 
business focused on Germany,s most economically dynamic 
region.  However, despite economies of scale, a combined bank 
would face the challenge of needing to report to two separate 
state governments interested in securing the greatest number 
of jobs and other benefits for their states. 
 
¶10.  This report has been coordinated with Embassy Berlin. 
 
¶11.  Previous reporting from Munich is available on our 
SIPRNET website at www.state.sgov.gov/p/eur/munich/ . 
 
NELSON