Smokescreen at German State-Owned Bank BayernLB Concealing True Extent of Subprime Losses

German state-owned bank BayernLB is concealing the true extent of its losses incurred as a result of the subprime crisis in the United States. Now the Bavarian savings banks are threatening to give up their 50-percent stake in the bank.
Von Conny Neumann und Wolfgang Reuter

Erwin Huber's banishment lasted exactly nine years. When the Bavarian state cabinet was formed in 1998, Huber, a 61-year-old veteran Bavarian politician from the town of Reisbach, was forced to leave his beloved Bavarian Finance Ministry and switch first to the state Chancellery and later to the state Economics Ministry.

Huber, who is an expert on tax issues, suffered in silence. He has a cool head for figures, so much so that he could probably rattle off the individual items from the state's budget plan off the top of his head.

Huber was only allowed to return from exile last October. He was elected chairman of Bavaria's conservative Christian Social Union (CSU), the sister party to Angela Merkel's Christian Democratic Union. What may have actually been more important for him was the fact that he also regained the position of finance minister of the prosperous state of Bavaria.

His power seemed so endless, and the state's coffers so over-flowing, that Huber was already planning his next career move. In 2009, after nationwide parliamentary elections, he wanted to become more than just Bavaria's bean counter. Instead, he hoped to make the jump to Berlin and become the federal finance minister, so that he could finally show all of Germany what a numbers wizard he really is.

But Huber miscalculated on a grand scale. His over-ambitious calculations have caused a snowballing affair involving the Bavarian state-owned bank BayernLB that has seriously damaged the CSU -- in a Bavarian election year, of all times. Suddenly he runs the risk of stumbling over the very numbers that have been his constant companion throughout his political life.

Together with top BayernLB executives, Huber, who is the deputy head of the BayernLB executive board, attempted to cover up write-offs in the billions at the bank. The reason was to prevent Bavarian citizens from discovering, before municipal elections on March 2 and even before the state parliamentary election in late September, just how much their top bankers have gambled away on the US mortgage market.

The affair will put the party and the cabinet of Bavarian Governor Günther Beckstein under pressure for months, and not just because the opposition is preparing an investigation into the cover-up. Experts are convinced that Huber and the Bavarian bank are still concealing information. The bank's real losses are apparently far greater than the €1.9 billion ($2.8 billion) in write-offs it recently disclosed .

The events that have transpired since Feb. 12 are already enough to characterize Huber's second term as finance minister as a complete failure. To this day, the CSU leader told members of parliament, the bank's management has failed to provide any information on exactly how high its write-offs have been in the wake of the US subprime crisis . The bank allegedly told Huber that it hasn't managed to calculate the exact amount yet, citing 1,200 individual items that are still being examined. Bank officials said that this could take until mid-April. Huber and the BayernLB executives agreed not to mention any numbers for the time being.

On Feb. 12 the media reported, once again, that BayernLB had incurred billions in write-offs from its US investments. At a board meeting that morning, a furious Werner Schmidt, the bank's CEO, said that the numbers reported in the media were incorrect. He went on the offensive, suddenly managing to come up with a figure after all, one that he said was 95 percent accurate.

According to the new calculations, the bank's losses amounted to €1.89 billion ($2.79 billion). Schmidt drafted a press release including this figure at 4 p.m.

An hour earlier, however, Huber had just given the old official version to the state parliament's budget committee, claiming that the losses amounted to only €100 million ($148 million), and that there was no reliable estimate of the size of the write-off. When Huber left the meeting at 4:10 p.m., he read a text message on his mobile phone telling him that Schmidt was going to announce a reliable number.

The finance minister felt that he had been snubbed. He called Schmidt and snapped: "What's going on here? I thought there was no number?" Schmidt replied that he had calculated a portion of it and estimated the rest.

'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

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