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OO RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFT #1581/01 1421303
ZNR UUUUU ZZH
O 211303Z MAY 08
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6533
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCNMEM/EU MEMBER STATES  IMMEDIATE
RUCNFRG/FRG COLLECTIVE IMMEDIATE

UNCLAS SECTION 01 OF 02 FRANKFURT 001581 
 
DEPARTMENT FOR EUR/AGS 
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EU GM
 
SUBJECT: German Banks See Light at End of Subprime Tunnel, but Few 
Mergers Ahead 
 
Ref: Berlin 0469, Berlin 0112, Frankfurt 1001 
 
ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR INTERNET 
DISTRIBUTION 
 
¶1.  Summary:  Following first quarter reports showing further 
write-downs, major German banks are beginning to see signs of 
recovery in the financial sector, as the real economy exceeds 
expectations in both growth and employment.  Industry insiders see 
challenges ahead in finding new, profitable business models, but 
find little cause for worry about the soundness of Germany's banking 
structure even though profits are down sharply.  If the industry 
recovers and profits return, calls for further mergers in the state 
banking sector or for the state to privatize Postbank may diminish. 
 
Banking Industry Resilient through Turmoil 
------------------------------------------ 
 
¶2.  First quarter 2008 earning reports revealed losses in most major 
German banks, reflecting ongoing turmoil in the financial sector. 
Deutsche Bank reported its first negative quarter in five years, 
with a write-down of 2.7 billion euros ($4.19 billion), while rival 
Commerzbank announced a write-down of 1.4 billion euros ($2.17 
billion).  Dresdner Bank, a subsidiary of Allianz, appears to be in 
worse shape, with losses of 0.9 billion euros ($1.4 billion), as 
rumors circulate that it will be broken up and sold off.  In the 
state banking sector, where quarterly reporting is voluntary, the 
greatest write-downs were announced by BayernLB (2.0 billion euros 
or $3.1 billion) with smaller ones also reported by Landesbank 
Baden-Wuerttemberg (LBBW), Helaba, NordLB and HSH Nordbank. 
Financial authorities also froze assets of Weserbank as it 
approached insolvency, while a group of banks bailed out 
Duesseldorfer Hypothekenbank, which faced a liquidity crunch. 
 
¶3.  Despite the bad news, financial experts see signs that the worst 
is over.  A senior economist at Deutsche Bank told Econ Off that 
high corporate profitability, good employment data and better than 
expected growth in Germany all point to the relative health of the 
real economy.  Meanwhile, Deutsche Bank's business model remains 
sound, with strong returns in equity issuances and asset management 
in Asia.  A Commerzbank executive also saw reason for optimism, 
saying that his bank saw an opportunity to invest in distressed 
assets where others were afraid to act.  He did, however, admit that 
Germany's small- and middle-sized enterprises had been slow to 
adjust to the higher price of capital and were still reluctant to 
resume normal levels of borrowing.  The write-downs of the last year 
also mean that expected profits were greatly diminished, which has 
altered banks' planning. 
 
¶4.  Some state banks such as Helaba and LBBW saw the recent turmoil 
as a vindication of Germany's dispersed financial sector and their 
business model.  A senior LBBW executive told Frankfurt Consul 
General that his bank was less affected by the turmoil since it is 
structured like a universal bank and has steady retail income. 
Executives at Helaba told Econ Off that their business model, which 
is focused on conservative retail and wholesale banking, has only 
suffered losses because of changes in spreads in lending markets. 
Several sources argued that heavy losses at WestLB, BayernLB and 
Weserbank were due to flawed strategies, which focused on riskier 
capital markets, and not systemic weaknesses.  Meanwhile, the 
relative success of traditional retail banking among the savings 
banks and banks like Helaba has only served to confirm the viability 
of traditional banking. 
 
¶5.  Most sources ascribed the slowdown in profits to a short-term 
readjustment in the financial sector and a downward overshooting in 
the accounting valuations of assets.  While asset markets find their 
floor, volumes of leveraged buy-outs, corporate bond issuances, 
home-mortgage lending and other sources of traditional bank income 
are all down in the current cautious market.  Meanwhile, lending 
spreads have increased, raising transaction costs for banks.  The 
implementation of Basel II at the start of the year has also 
required banks to raise capital holdings, creating a need to hold 
capital. 
 
Prospects for Mergers Low 
------------------------- 
 
¶6.  Few experts saw reason to believe that Germany's dispersed 
financial system would consolidate further, especially if greater 
stability returns to the sector. 
Sources at Deutsche Bank and Commerzbank expressed doubt that the 
government would privatize Germany's largest retail bank, Postbank, 
since that would result in many lost jobs.  Although both banks 
might be interested in purchasing Postbank and benefiting from 
steady retail banking income, the Commerzbank executive said his 
 
FRANKFURT 00001581  002 OF 002 
 
 
bank saw better opportunities elsewhere (his bank was currently 
conducting due diligences on two eastern European banks). 
Representatives of both banks agreed that Allianz would be foolish 
to break up and sell off pieces, if not all, of troubled Dresdner 
Bank at a time when its price would be at an all-time low.  However, 
both Deutsche Bank and Commerzbank are allegedly stock-piling cash 
for mergers, either at home or abroad. 
 
¶7.  Despite LBBW's successful acquisition of SachsenLB, executives 
in the state bank sector see little reason to believe that there 
will be more consolidation.  Referring to rumors that LBBW would 
acquire WestLB or BayernLB, the senior LBBW executive told Frankfurt 
Consul General that state banks should merge only if they are 
profit-making enterprises.  Executives at Helaba told Econ Off that 
both the savings banks (who partially own the state banks) and the 
federal Ministry of Finance would push for more consolidation among 
state banks, but this would continue to be opposed by state-level 
minister presidents intent on protecting local interests.  They did, 
however, express some confidence that LBBW would take over BayernLB 
in the next twelve to eighteen months. 
 
¶8.  Comment.  Despite a bad first quarter, German bankers remain 
optimistic that the worst of the subprime turmoil is behind them and 
blame bad business models in certain banks as well as an adjustment 
to new conditions for most of the trouble.  If economic fundamentals 
such as employment and growth remain strong in Germany, there is 
reason to believe that an overall downturn will be avoided and the 
financial sector will rebound.  However, the turmoil has resulted in 
lower than expected real profits for banks and forced many 
institutions to change plans and strategies.  If the sector does 
bounce back, pressure to consolidate may also diminish even though 
many experts feel the industry has too many players.  End Comment. 
 
¶9.  This cable was coordinated with Embassy Berlin. 
POWELL