Near-collapse of German bank and its Irish subsidiary shrouded in mystery

There were few tears in Germany this week when Munich's Hypo Real Estate announced it was auctioning off its Dublin-based lender, Depfa.

In a caustic commentary, reflecting a common view in German finance circles, the Handelsblatt business daily denounced the IFSC institution as the "source of all evil".

Five years on, the near-collapse of Germany’s HRE banking group and its Irish subsidiary remain shrouded in mystery.

Yet as Ireland prepares to exit the bailout necessitated largely by Anglo Irish Bank’s collapse, it’s worth recalling just how near a miss Ireland had with Depfa.

Though not a household name – in Germany or Ireland – the lender opened an Irish operation in the 1990s and pursued a highly profitable, if speculative, business model: lending money for long-term infrastructure and commercial property projects which the bank borrowed, in turn, on short-term money markets at lower interest rates. The short-long interest rate difference was Depfa’s profit.

When Lehmann Brothers collapsed five years ago, short-term liquidity evaporated as lenders battened down the hatches. Facing ruin, Depfa put in an emergency call to its HRE parent which, in turn, appealed to Frankfurt banks and the federal government in Berlin.

The hole in Depfa's balance sheet widened from an initial estimate of €10 billion to €30 billion, then €100 billion and beyond.

Berlin steps in
Fearing a domino effect in Germany, and possible collapse of finance markets around Europe and worldwide, Berlin stepped in with loans and guarantees and, a year later, the first – and to date only – nationalisation of a financial institution in Germany's post-war history.

The problem landed in Berlin’s lap because, just one year earlier, HRE had taken over Depfa in Dublin.

Had that fateful deal not gone through, it is very likely the mess would have been Dublin's problem. In the history books, the name of the bank that broke Ireland might not have been Anglo Irish Bank, but Depfa – to the tune of around €130 billion and counting.

Five years after flirting with financial disaster, are we any the wiser as to what really happened?

Even now, the wall of silence surrounding the HRE/Depfa drama is almost impenetrable.

One of the few people willing to talk is former Deutsche Bank executive Michael Endres. He knows the books of HRE and Depfa like few others in Germany, as he was brought in as supervisory board chairman from November 2008 until the nationalisation a year later.

Sitting in his Frankfurt office, in the shadow of Deutsche Bank’s twin towers, the 75 year-old Bavarian says the mainstream view in German finance circles – that Depfa sank HRE – is not strictly correct.

“HRE would have gone down on its own, because of its own business,” he says, a view he formed during a hectic year studying HRE’s books.

The former Deutsche Bank board member doesn’t absolve Depfa: he has harsh words on its transformation, under the nose of a weak Irish regulator, from a “sleepy bank in Wiesbaden” to a Dublin dealer in “questionable business”.

A former Depfa board member agrees with this assessment. Speaking on condition of anonymity, the director says that Depfa became a victim of its own hubris. Its determination to enter the global capital slipstream in the last decade was not reflected in adequate oversight structures: a risk committee was only set up at board level in 2006.

“But whether the scale of Depfa’s dependence on the short-term capital markets grew to unacceptable levels, I don’t know,” said the ex-director.

The central figure in the HRE/Depfa meltdown is the bank's former chief executive Gerhard Bruckermann.

The son of a savings bank manager from Solingen, a small town east of Düsseldorf, Bruckermann joined Depfa in 1991 when it was still called the Deutsche Pfandbriefanstalt.

It was originally founded in 1922 to provide residential property loans, but moved into the commercial sector in the 1970s and privatised in 1990.

It opened an Irish office and eventually transferred its headquarters from Wiesbaden to Dublin.

The then Fianna Fáil government enacted special legislation in 2002 to ease the transition, hoping to establish Dublin as a trading centre for the booming market in Depfa's speciality of covered bonds – specialised debt securities invented in Prussia in the 18th century.

As Depfa chief executive in Dublin, Bruckermann expanded Depfa’s commercial, property and infrastructure loan business radically, lending long and borrowing short to generate equity returns of almost 33 per cent.

The spike in profits was matched by a rise in salaries. Mr Bruckermann earned a reported €7.4 million in 2004, telling this newspaper: “We like to see that every employee makes at least €1 million after tax.”

The generous pay extended to the bank’s board: in 2005 the 13 directors gave themselves a €34 million pay package, up 68 per cent on the previous year, and rising to €44 million the next year.

In November 2005, Mr Bruckermann told Ireland's About Banking magazine he was "happy overall" with Irish regulation of the financial sector but warned that "too much stifles growth, too little creates a difficult working environment".

He also discussed the bank's co-operation with Concern on micro-financing projects in Mozambique and Cambodia. Mr Bruckermann insisted Depfa was "not trying to make any PR capital out of this" but had a determination to help end world poverty.

"He was a very personable man and I liked him a great deal," said Tom Arnold, former chief executive of Concern and chairman of the Irish Times Trust. "He joined the board of the microfinance institution, travelled to Cambodia and, I think, became genuinely interested in the mission we were dealing with."

Mr Arnold said Depfa's involvement with Concern ended in 2007 or 2008.

In the red
It was around that time that Depfa slipped into the red and Mr Bruckermann began making discreet visits to Germany in search of a buyer.

He struck gold when he met Georg Funke, head of Hypo Real Estate, a commerical and property lender founded four years previously as a spin-off from the HypoVereinsbank.

The deal, finalised in October 2007, saw HRE pay €5.7 billion for Depfa and leaving the Munich-based lender, in Mr Funke’s fateful worlds, “well-equipped for further growth”.

Mr Bruckermann earned a reported €100 million in the deal and was offered a position with Depfa’s new parent company. He declined, cashed in his HRE shares and vanished – first to Florida, then Cambodia. Today his whereabouts are unknown but his notoriety lives on in his absence in the German finance press, for a deal that shifed liability for the subsequent bank crash out of Ireland and over to Germany.

Over at Deutsche Bank’s Frankfurt headquarters, Michael Endres remembers hearing of Mr Bruckermann’s visits to town and his readiness to sell his bank “to anyone who wanted it or didn’t want it”.

“Whoever bought it knew it was not a solid business,” said Dr Endres, saying the “mismatch of risks was clear” in the HRE-Depfa sales agreement, which he has seen.

“Funke bought (Depfa) thinking, ‘if I have problems at home, I might solve them through acquisition of another problem. It’s not an unusual strategy.”

The current chief executive of the HRE holding group, Manuela Better, declined requests for an interview. The company disputes claims that HRE's position was in any way comparable to Depfa's difficulties in 2008 but declines to make any detailed information available.

And what of the view from the Depfa board room?

The ex-director says the board only ever had a limited overview of Depfa’s day-to-day activities. Keeping up with the competition was more important than keeping an eye on any potential liquidity risks lurking in Depfa’s balance sheet.

“Depfa’s loan book was not the issue. When HRE took it over, the liquidity issue hadn’t come to the fore,” said the ex-director.

So where did the problems lie in the HRE-Depfa meltdown? Official investigations suggest that Depfa’s liquidity issue was the spark, but that the sprawling group’s lack of oversight was the explosive.

Six months before the end, in early 2008, German financial regulator BaFin asked experts at the Bundesbank to conduct a full audit of all HRE operations.

Its final audit report warns about “serious deficits” right across the group’s structures – from Dublin to Munich – particularly in the division supposed to assess risk of investments worth around €400 billion. The audit took longer than planned, the authors of the 159-page report noted, because employees were often unable to answer questions about the bank’s activities.

Their conclusion: HRE executives had no idea what was going on at their bank – either in Germany, or in their Dublin subsidiary, Depfa – because they had “no adequate, timely presentation of the actual financial situation”.

The audit turned up 49 breaches of German finance regulations concerning “the orderly conduct of business and functionality of risk management”.

Reading the report now, it is remarkable that, given the problems it turned up in a time of deteriorating global markets, the German financial regulator did not seem concerned that the bank might have already been on a liquidity precipice.

Instead, at an emergency meeting with HRE chief executive Georg Funke in July 2008, BaFin demanded quarterly progress reports on remedial action. Six weeks later, HRE and Depfa went over the edge.

In September 2008, while Dublin grappled with the meltdown of Anglo, two all-night crisis sittings of bankers and officials in Germany agreed a state-backed package of loans and guarantees which has since reached €124 billion and counting.

A parliamentary inquiry the following summer in Berlin claimed no official scalps but did reveal how BaFin’s alarming audit reports on HRE/Depfa were sent for the attention of the finance ministry’s state secretary, Jörg Asmussen.

Asked at the inquiry why he hadn’t acted on the report’s warnings, Asmussen said he hadn’t seen them because he was on holiday when they came in and that his holiday cover had filed them away before his return.

Mr Asmussen is now a board member of the European Central Bank (ECB) and, to date, the German government has deflected opposition demands for further information into the HRE/Depfa case and about what really happened in 2008. The finance ministry, the effective owner of HRE/Depfa, through the federal finance stability fund (SoFFin) declined requests for an interview, points to the public inquiry report and says another audit is in the works.

Civil suit
Former bank shareholders, many of whom were ruined after being squeezed out in the 2009 nationalisation of HRE, complain they have been stonewalled by Berlin.

Munich lawyer Felix Weigend, representing shareholders in a €10 million compensation civil suit, claims information given about the state of the finances at HRE and Depfa was either incorrect, too little or too late – a policy that he alleges remains in place with the bank's current owner: the German state.

“The federal government in Berlin has no interest in a proper investigation because that might provide information for possible compensation claims,” he said.

The lawyers says that Munich courts, as part of their ongoing criminal investigation into the events of 2008, have demanded to see HRE files Berlin would rather have kept under lock and key. As a result Mr Weigend is optimistic that his civil suit will be heard before the end of the year and will turn up new information into the collapse.

Five years on HRE, now a holding company, is optimistic of auctioning off Depfa to the highest bidder by early next year. But the clock is ticking: HRE has to offload Depfa by the end of 2014 as a condition imposed by the European Commission on the 2008 rescue.

Though a shadow of its former self – Depfa is forbidden from doing any new business while nationalised – HRE says the Dublin business offers prospective buyers €40 billion in assets and sought-after expertise in the covered bond market. No-one in Munich is willing to predict what lies ahead for the bank’s 250 employees in the IFSC.

An expert report commissioned by Germany’s federal finance ministry into the bank’s reprivatisation prospects strikes a more pessimistic note.

The authors, a group of financial experts, warned in their 2011 assessment that a sale of Depfa was likely to bring “no substantial return” above its liquidation value.

The report welcomed the 95 per cent reduction of Depfa’s assets and said a sale should be considered if a price above the liquidiation price is likely to be achieved. However, they see a Depfa “sale in its current form as futile”.

Five years after their near-collapse, HRE and Depfa are unlikely to join Lehmann Brothers and Bear Stearns in the annals of banking notoriety. The banking group staggers on and most Germans have neither heard of the bank nationalised in their name, nor the required guarantee of €124 billion or the losses of €9.3 billion to date – mostly due to a writedown on Greek loans.

Only when the bank’s toxic investments are wound down and taken out of the bad bank freezer in the coming decade will anyone be able to quantify the final cost to Germany, and the considerable luck of the Irish, in the Depfa disaster.