U.S. Investor Has No Allies in Battle Over German Bank
FRANKFURT — Now more than ever, it’s Germany versus J. Christopher Flowers.
Mr. Flowers, who runs the U.S. private equity firm J.C. Flowers & Co., has threatened to take the government to court as he tries to salvage as much as he can from a €1.1 billion investment in a German bank, Hypo Real Estate, that is now effectively insolvent.
The fight has left Mr. Flowers, a former Goldman Sachs executive who once seemed to have the Midas touch, virtually isolated as he tries to save his $1.5 billion. The government in Berlin, which wants to buy the bank for a token price and wind it down, is paying him little heed, and neither are fellow shareholders. Even Hypo Real Estate wants to dump him.
The episode reflects a deep-seated German aversion to what many here see as wheeler-dealer financiers from Wall Street and London. It also reopens a debate that harks back, uncomfortably, to the country’s Nazi past.
At the same time, there is a wider issue at stake. Governments forced to step in to save the financial system would prefer to close or merge weak banks in order to revive lending as quickly as possible.
Shareholders like Mr. Flowers, angling to make lemonade out of lemons, want to eke out the best return they can, even if it delays a recovery.
Manuel Theisen, a business professor at the University of Munich, said the case of Hypo Real Estate, beyond its peculiarly German aspects, highlights “the question of systemic stability and the bets made by all sorts of investors.”
Mr. Flowers is unquestionably on the defensive. Since he bought about a quarter of the bank, the Munich-based real estate lender has already tapped over €100 billion in loan guarantees and new capital from the German government’s bank rescue fund. Last month, Parliament approved a law allowing the government to nationalize Hypo Real Estate. The law, drafted as a last resort, directs the government to first pursue other options.
So last week, the government offered to buy Hypo for €1.39 a share, far below the €22.50 a share Mr. Flowers paid for his stake in 2008. In a final slap at Mr. Flowers, Hypo’s management recommended Friday that shareholders take the money.
The bank is also backing the government’s strategy by issuing new shares that the state can soak up to ensure that the stake Mr. Flowers owns is watered down to below 10 percent. Then, the government could use German takeover laws that allow a shareholder with 90 percent or more of a company to compel the sale of the remaining stock.
This maneuver would avoid outright expropriation of Mr. Flowers’s shares, a move that calls to mind the darkest days of Germany’s past.
“Enteignung,” the German word that describes expropriation of private property — nationalization, by any other name — is most often applied to what the Nazi regime did to German Jews beginning in the 1930s. As a result, the current German constitution allows nationalization only if Parliament defines the limits of what the state will do, and, crucially for Mr. Flowers, subjects the process to judicial review.
Historical antecedents aside, analysts widely regard Hypo as a basket case, thanks to its exposure to some of the worst toxic assets created during the real estate boom.
“The current offer is a gift to shareholders,” said Dieter Hein, an analyst with the independent firm Fairesearch in Frankfurt. “This bank has no value anymore.”
Hypo’s public finance subsidiary, Depfa, arbitraged cheap, short-term loans against longer-term investments, a strategy that has become an impossible feat given illiquid credit markets. Depfa is now shrinking that business, and Hypo recently sold First Albany Securities, a small investment bank it purchased in 2007 with heady hopes of being a player in the U.S. municipal bond market.
The government made an offer for the bank in part because Chancellor Angela Merkel, a conservative who faces national elections later in the year, is losing voters to more business-friendly political parties. Mrs. Merkel, analysts agree, wants to keep the hand of the state as light as possible, and to avoid simply wiping out private investors.
But even opposition parties, which recently initiated a parliamentary investigation of the government’s handling of the Hypo case, have balked at the idea that Germany should bail out Mr. Flowers.
“I am not on the side of Herr Flowers,” said Volker Wissing, a member of the Free Democrats, the main opposition party. “I am on the side of the taxpayers.”
J.C. Flowers, based in New York, won its reputation as a private equity giant by revitalizing the Japanese firm that became Shinsei Bank. Shinsei’s subsequent profitability came about in part because it could, under the terms of its acquisition, offload many of the problem loans onto the Japanese taxpayer.
Perhaps Mr. Flowers was hoping to duplicate that feat. His 2008 investment in Hypo followed a 2006 decision to spend €1.25 billion as part of a group that took nearly a quarter stake in HSH Nordbank, a German lender specializing in shipping finance. That bank, too, is in trouble, and Mr. Flowers’s stake will be watered down as two state governments put money into it.
A German politician famously called private equity investors “locusts” that plunder good companies until they are worthless. The jibe underscored how Germany, with its prowess as a manufacturer, has long cast a jaundiced eye on the world of high finance.
And now that high finance has been laid low around the world, German officials have shown little remorse about ending Mr. Flowers’s engagement at Hypo.
“They absolutely despise Flowers,” said one official in Berlin briefed about the government’s efforts, who requested anonymity because the issue was unresolved. “They want to stick it to him.”
At the same time, Germany cannot simply allow the bank to fail. Like many German banks, Hypo partially finances its operations using the covered bond market, and now represents 10 percent of the market.
Covered bonds, or Pfandbriefe, are collateralized with high-quality assets that stay on a bank’s balance sheet. Invented in Germany, they have spread to other European countries and are now, slowly, taking root in the United States at the behest of the Treasury Department.
“It would disturb the market substantially to have Hypo Real Estate go bankrupt,” said Louis Hagen, executive director of the Association of German Covered Bond Banks.
Mr. Flowers, in a rare public appearance, told a committee of Parliament, during a hearing on the law, that nationalizing the bank would set a bad precedent.
He warned that Germany’s reputation as a safe place to invest would be “severely and adversely impacted” by an expropriation of his shares in Hypo. He is refusing to sell, and promising a court battle if he is stripped of his shares.
But analysts are quick to note that no German bank has problems on the level of Hypo. One that did, IKB Deutsche Industriebank, a small corporate lender that dallied in structured finance, was wound down with assistance from a state-owned bank, which then sold the rump operation to Lone Star Funds, a private equity firm based in Dallas.
Moreover, Hypo’s end would not crimp real estate lending itself, since it has plenty of competitors.
“This is business that someone else can do very easily,” said Mr. Hein, the Fairesearch analyst.
Even small investors in Hypo are shrugging at the thought of being forced out.
DSW, an organization representing small investors, has recommended that its members take the €1.39-a-share offer from the German government, since no better deal is likely, said Carsten Heise, a managing director of the group.
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