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Smokescreen at German State-Owned Bank

BayernLB Concealing True Extent of Subprime Losses

By Conny Neumann and Wolfgang Reuter

Part 2: 'A Giant Wave of Concealed Losses'

The next day, the number was adjusted upward again, to €1.9 billion ($2.8 billion). The opposition promptly took advantage of the contradiction to accuse the CSU leader of lying.

The party then spent the next six days claiming that the whole thing was a misunderstanding and accusing the opposition of engaging in ridiculous campaign tactics. During this period, a chain-smoking Schmidt became increasingly nervous. It was clear to him that Huber had been made to look like a fool for not being familiar with his own bank's finances. Schmidt was forced to resign on Feb. 19.

Although there was now someone to blame for the breakdown in communication, Huber was by no means in the clear. Only hours later, the finance minister was forced to admit that, as deputy chairman of BayernLB, he had received weekly updates on the bank's estimated write-offs. Huber's consistent claim that the bank faced write-offs of €100 million "plus X" had already been a running joke among financial experts for weeks. Everyone knew that this number couldn't be correct -- and they knew that Huber knew it too.

A simple calculation is all it takes to show that Huber must have known what was going on. The bank invested about €30 billion ($44 billion) in so-called structured securities, namely bundled business and consumer loans, mortgage loans and other receivables. The markdown on these investments, even for the highest-rated securities, is currently 6 to 7 percent. This means that the minimum write-off on a €30 billion investment would be €1.8 billion ($2.66 billion). To make matters worse, BayernLB, as it was quick to announce on the weekend before last, also has investments in lower-rated securities.

In an environment in which many state-owned banks are struggling to survive, Huber's supposed lack of knowledge seemed all the more implausible. It is simply inconceivable that the Bavarian finance minister, who holds 50 percent of the shares in the state-owned bank, would not have received daily updates on its latest losses.

It should also be clear to Huber that the figures are far from tentative. The risks arising from this crisis can be calculated precisely based on market data and with the help of models. It also seems unlikely that the finance minister had hoped against hope that the global financial crisis would dissolve into thin air in a few weeks, and that his bank's situation would improve by April.

Instead, the opposition assumes that the CSU leader pressured the state-owned bank to hold off on releasing its figures. Even the write-offs the bank has now announced were massaged using two accounting tricks. First, BayernLB used the balance-sheet date of Dec. 31 as the basis for its valuations. In fact, according to current accounting regulations, it had the option of using the lower, current values for February as the basis for its estimates -- the approach any prudent businessman would choose.

But that would have increased the write-offs by up to half, to between €2.5 billion and €3 billion ($3.7 billion and $4.4 billion). The truth is bound to come to light eventually. Even if the prices for these types of securities remained stable, within a year BayernLB will be forced to disclose the additional write-offs it already knows about today.

If this is the case, it is questionable whether the bank is even profitable any more. By all accounts, it should have ended the year 2007 with a loss, but bankers used another, completely legal trick to postpone the impending loss until the next year. Of a total of €1.9 billion ($2.89 billion) in write-offs, they placed €1.3 billion ($1.9 billion) into a so-called revaluation reserve. This is a sort of virtual account for securities for which valuation losses are considered temporary. Although the risks associated with the investments placed into this reserve are confirmed, they do not affect the bank's results.

The only glitch in this scheme is that all items in this quasi-separate account must be sold or properly written off within a year. But the truth is that all of these investments are virtually unmarketable in the longer term. This means that a write-off of this €1.3 billion ($1.9 billion) -- and a concomitant reduction in profits -- is unavoidable in the coming year.

According to one Frankfurt banker's assessment of the bank's accounting tricks, "BayernLB is pushing along a giant wave of concealed losses, which, when the figures are disclosed in one year, will inevitably reach the shore."

Just how much destructive force that wave will have remains to be seen. However it can hardly do more damage to Munich's status as a financial center than Huber and his predecessors under the administration of former Governor Edmund Stoiber have already done.

Within the last decade Munich, the state capital, has lost two private banks, both of them listed on Germany's DAX index of blue-chip stocks. This was the ultimate result of the merger of two Bavarian banks, Bayerische Hypotheken- und Wechsel-Bank (known as Hypo-Bank for short) and Bayerische Vereinsbank, a move that was undertaken to prevent both from being acquired by Frankfurt competitors. But the deal, made possible with the help of politicians and initially celebrated, was bound to fail.

The new entity, HypoVereinsbank, was initially burdened by the ailing real estate portfolio of the former Hypo-Bank, worth more than DM 5 billion at the time, and subsequently faced write-offs on the former Bayerische Vereinsbank's corporate loans. Italy's UniCredit acquired the bank in 2005 and essentially moved its operations to Milan.

The only independent -- albeit not publicly listed -- bank remaining in Munich is the crippled BayernLB. This is one of the reasons Erwin Huber has so vehemently opposed a proposal by the Bavarian savings banks, which own half of BayernLB, to allow it to merge with another state-owned bank, Landesbank Baden-Württemberg (LBBW).

Huber has really not been terribly successful since he took over the leadership of the CSU last autumn. This makes it all the more difficult for him to face the new pressure the savings banks are now exerting in the wake of the massive financial scandal.

If Huber continues to oppose the merger with the powerful LBBW, the savings banks have vowed to turn over their 50-percent share in BayernLB to the state government -- and withdraw completely.

"Then Huber can do what he likes with the place," says a representative of the savings banks. "The mood within our ranks, at any rate, is extremely poor."

Translated from the German by Christopher Sultan