Germany: IKB Deutsche Industriebank Capital Injection, 2008

In February 2008, after earlier efforts by the German authorities to aid IKB proved insufficient (see Key Design Decision No. 2, Part of a Package), the German government mandated that KfW furnish an additional EUR 2.3 billion to IKB (EC 2009). This capital injection was necessary to keep the IKB from breaching its minimum capital requirements and provided additional risk protection (EC 2009; KfW 2008). These capital injections permitted IKB to maintain a Tier 1 capital ratio of 5.3%, above the 4% mandated minimum. The total capital ratio stood at 8.7% for IKB, which helped them meet the mandated minimum of 8%. IKB as a whole was also able to maintain Tier 1 capital ratio of 6% and total capital ratio of 9.8% (IKB 2008d). IKB had considered bringing Rhineland Funding (its off-balance-sheet investment vehicle) onto its balance sheet in October 2007 (Simensen 2007). It retroactively consolidated Rhineland Funding in the 2006-­07 annual accounts, as restated in February 2008 (IKB n.d.).

KfW’s 2008 annual report asserts that capital injection was to preserve a bank for small- and medium-sized enterprises as well as to protect the confidence in the German financial market and its economy from “destabilization” and “damage” (KfW 2009a). However, in its October 2008 State Aid decision, the EC noted that it did not agree with the perception of the German authorities that the problem would have resulted in a systemic crisis (EC 2009).

In July 2007, prompted by BaFin, IKB’s biggest shareholder, KfW, provided the first set of protection for IKB for losses incurred from EUR 8.1 billion worth of a liquidity facility provided to IKB’s off-balance-sheet vehicle Rhineland Funding. KfW also agreed to cover up to EUR 1 billion of IKB’s potential losses on on-balance-sheet investments in portfolios with exposure to subprime mortgages (EC 2009).

Three German private banking associations—BdB, BVR and DSGV—afterwards agreed to cover 30% of KfW’s costs under this protection for IKB with a cap of EUR 1 billion. On November 30, 2007, KfW and the three private banking associations agreed to cover additional risks of IKB amounting to USD 350 million (EC 2009).

In January 2008, KfW provided IKB with a secured refinancing liquidity facility in the amount of EUR 1.5 billion (IKB 2008b). The capital injection took place starting February 2008. KfW then created a second liquidity facility on July 18, 2008, after the capital injection, for an additional EUR 1.5 billion (EC 2009; IKB 2009). Both of these liquidity facilities charged an interest rate based on a spread over the Euro Interbank Offered Rate (Euribor). Collateral requirements were set high enough, at more than 100%, to aim to cover the loans even in a “worst-case scenario” (EC 2009). Some of the portfolio investments of IKB that were not sold to Lone Star Funds were restructured and packaged.

For details about the emergency liquidity provided to IKB, see George (forthcoming).

The German government relied on the existing Article 2, Paragraph 4 of the Law Concerning KfW to carry out the capital injections (KfW 2008; KfW 2020). This authority empowered the German government to direct KfW’s financing activities toward operations in which the government had a state interest (KfW 2020).

In addition to their national law, the German government also required approval from the EC to assess whether the measures taken to protect IKB amounted to State Aid (EC 2009). The EC found that the risk shield and capital contribution measures failed the private investor test and therefore had to be regarded as State Aid. The EC further held that these measures did not qualify for the exception to the general prohibition against State Aid under Article 107(3)(b) Treaty on the Functioning of the European Union (TFEU), which allows EU member states to grant State Aid to remedy a serious disturbance in the economy. As the IKB episode took place before the financial crisis fully developed into a systemic crisis, the EC considered this failure to be firm-specific as opposed to systemic and did not expect IKB's insolvency to have systemic consequences. However, the EC found that the aid could qualify for an exception under the Rescue and Restructuring guidelines, subject to a restructuring plan to be implemented by 2011 (Frisch 2017).

KfW administered the capital injections at the behest of the German government (EC 2009; KfW 2009a). Moreover, the EC also reported that all of KfW’s decisions were attributable to the German state as the Federal Ministry of Finance was involved in the capital injection decision making and administration processes (EC 2009).

The capital injection was subject to both EC oversight and State Aid rules (EC 2009). An article by Klaus Engelen in the journal International Economy criticized the lack of diligent reports and summaries disclosed during the episode (Engelen 2008).

On February 11, 2008, Dow Jones reported that authorities considered using tax money to bail out IKB and that sources familiar with this situation asserted that “no option is taboo.” The same article stated that while the BaFin president threatened to close down IKB, he was dissuaded by the president of the Bundesbank (Dow Jones International News 2008). IKB’s shares fell by more than 20 percent that day, before the capital injection plan was to be discussed; the same article posited that some observers believed that IKB’s crisis was being turned into a “game of brinkmanship” by IKB’s shareholders to pressure for a private sector bailout (Morarjee and Benoit 2008).

Following the provision of a capital injection worth EUR 600 million in February 2008, the German Finance minister stated that the German government was aiming for a quick sale of IKB (Sobolewski 2008). KfW’s 2008 annual report asserts that the capital injection measures were made for additional risk protection as well as to protect the German economy from “destabilization” and “damage” (KfW 2009a). The 2009 EC State Aid decision included details pertaining to the capital injections but redacted some key figures.

Upon conversion of the bond one month after issuance, KfW’s ownership stake increased by 5.6%, from 37.8% to 43.4% in February 2008 (KfW 2008). According to Capital IQ data, the transaction excluded pre-emptive rights,^FThese rights refer to the right of existing shareholders to purchase newly issued stock of the corporation before it is offered to the others. Thus, exclusion of preemptive rights would dilute the stake of existing shareholders (Legal Information Institute n.d.). thereby proportionately diluting existing shareholders.

KfW injected capital into IKB through three different instruments: a convertible bond, a loan that it didn’t require IKB to repay, and common stock (EC 2009).

According to Capital IQ data, on January 7, 2008, IKB issued a one-year, 4.75% convertible bond that was fully subscribed by KfW, as part of the risk shield. The security was structured as senior debt prior to conversion; upon conversion one month after issuance, KfW received common equity amounting to 5.6% of IKB’s total equity (IKB 2008b). For pricing, the bond was issued at a 0.1% spread to the 12-month Euribor, which fluctuated between 4.65% and 4.88% during this period (Deutsche Bundesbank 2022). This conversion increased the subscribed capital of IKB from EUR 225.3 million to EUR 247.8 million comprising approximately 99 million notional no-par value bearer shares. The issuance of the convertible bonds was authorized by a resolution adopted by the general meeting of September 9, 2004, which entitled the board of managing directors to issue convertible bonds and/or bonds with warrants with an aggregate value of up to EUR 300 million and to grant the holders of such bonds or shares conversion or option rights for up to EUR 22.5 million of the share capital in accordance with the laid-down conditions until September 8, 2009 (IKB 2008d).

KfW invested EUR 1 billion in IKB in the form of loans on which it immediately waived IKB’s obligation to repay, making it possible to be counted toward Tier 1 capital per section 272(2)4 of HGB (German GAAP) (EC 2009). IKB received EUR 600 million of the EUR 1 billion loan on February 20, 2008, and EUR 450 million of the loan on March 20, 2008 (Reuters 2008; Sobolewski 2008). This loan did not entitle KfW to additional voting rights, nor did they indicate any change in KfW’s ownership stake in IKB (IKB 2008a). The loan was subject to a “better fortune” clause, under which IKB could repay the loan only if IKB did not incur an accounting loss under HGB and its regulatory capital was above 9%. Interest payments on the loan were due only if such payments did not incur a loss for IKB in its financial statements under HGB. These payments out of future profits, however, were to precede payments for other profit-participation certificates^FA profit-participation certificate is a security that entitles the holder to dividends based on the performance of the issuing company. Holders do not have a share of ownership in the company nor are they eligible to vote on company decisions (Moneyland n.d.). (IKB 2008b).

Additionally, in August 2008, KfW conditionally consented to subscribe to about 487 million new IKB shares (common stock) valued at EUR 2.56 per share. The condition of the capital injection was that the European Commission either determined that this share subscription was compatible with applicable State Aid rules under the EC Treaty or approved the IKB risk protection and support measures, in each case by no later than October 25, 2008. According to Capital IQ data, the transaction was structured as a subscription-rights-offering—a structure in which existing shareholders can purchase new shares of a secondary offering before these new shares are available to the open market. Existing shareholders were offered new shares at a ratio of 6:1. KfW transferred EUR 1.25 billion in connection with this transaction to a trust account (the satisfaction of their condition was still pending). This transaction was executed on October 24, 2008, following EC approval on October 21, 2008 and increased KfW’s stake from 45.5% to 90.8% (KfW 2009b).

The German government infused equity capital into IKB via the KfW by means of a EUR 54.3 million convertible bond, a EUR 1 billion loan that was eligible as Tier 1 capital under regulatory requirements, and a EUR 1.3 billion (before costs) purchase of newly issued common stock (EC 2009; IKB 2008c; KfW 2009b).

The common stock capital injection measure’s announced sizes were inconsistent with the sizes of the actual transactions. As per KfW’s 2008 Form 18-K submitted to the US Securities and Exchange Commission (SEC) and IKB’s press releases, KfW invested a total of EUR 2.3 billion of capital into IKB. This sum included EUR 1 billion as a loan and at least EUR 1.3 billion (before costs) in exchange for common stock. For the contribution of KfW’s EUR 2.3 billion, the German government guaranteed EUR 1.2 billion and the three private banking associations contributed an EUR 300 million (EC 2009; KfW 2009b). These supports come in to help KfW as it could not assume the entire financial risk from the investment into IKB because it would have placed the European Recovery Program (ERP) Special Fund at risk ^FThe ERP Special Fund is a source of capital that KfW draws upon to fund its promotional capacities under its federal mandate (KfW 2008). (KfW 2008).

Following the onset of the US subprime crisis, IKB was at risk of bankruptcy owing to the freezing of the commercial paper market. IKB faced acute pressure on July 27, 2007, after its counterparties froze their liquidity facilities. A couple of days later, BaFin told KfW and the Federal Ministry of Finance, that it would close IKB by imposing a moratorium if they could not reduce the risk exposure of IKB. By the end of the month, BaFin, the Federal Ministry of Finance, and KfW organized a loss-sharing agreement, known as a risk shield, to absorb some of the losses from IKB’s impaired assets (EC 2009).

But IKB’s losses continued to grow. In February 2008, the German government mandated that KfW provide an additional EUR 2.3 billion to IKB to increase its capital (EC 2009). KfW recapitalized IKB by means of a EUR 54 million convertible bond (converted to equity one month after issuance); a EUR 1 billion loan that BaFin qualified as Tier 1 regulatory capital because KfW immediately waived IKB’s obligation to make repayments unless and until IKB’s finances improved; and a purchase of EUR 1.3 billion of newly issued IKB common stock. KfW’s stake in IKB rose to 90.8% after these transactions (EC 2009).  

KfW sold its stake in IKB in August 2008 to Lone Star Funds, a US private equity group, for EUR 137 million (EC 2009; KfW 2009b; Reuters 2017). This sale was completed in October 2008 after the EC approved the deal (EC 2009; KfW 2009a; KfW 2009b).

The capital injection preceded the creation of a restructuring plan intended to downsize IKB’s risk portfolio and prioritize its core business lines (EC 2008; IKB 2008c). On October 29, 2008, KfW sold its stake (90.8%) to the US private equity fund Lone Star Funds (KfW 2009a; KfW 2009b).

A member of KfW’s board of managing directors replaced IKB’s CEO. In addition, IKB’s board of managing directors appointed a director from KfW. These appointments (which preceded the capital injection) were made on July 30, 2007, immediately upon the start of the government’s initial involvement with IKB (IKB Board of Directors 2007; IKB 2007a; IKB 2007b).

In the EC’s assessment of compensatory measures taken to avoid undue distortions of competition, these management replacements were recognized as a “valuable signal against moral hazard” (EC 2009).

The EC imposed a limitation of a balance sheet total amounting to EUR 33.5 billion until the end of the restructuring period (September 30, 2011). This was to ensure that IKB does not circumvent the closures and divestitures from restructuring through rebuilding the business in other parts of the bank or simply transferring it (EC 2009).

Before IKB could be sold, the following conditions had to be fulfilled: the EC’s decision in the State Aid proceedings, registration of IKB’s capital increase at the Düsseldorf local court, and exempting BaFin from making a mandatory offer in line with the Security Acquisition and Takeover Act  (IKB 2009).

Our research found no evidence of regulatory relief in these capital injections.

The restructuring plan outlined KfW’s intention to sell off its stake (90.8%) in IKB to interested bidders through an open, nondiscriminatory, and transparent bidding process (EC 2009). The sale process commenced in January 2008 and came to an end on August 21, 2008, when Lone Star was chosen as the winning bidder to acquire KfW’s stake; the sale was completed on October 29, 2008 (EC 2009; KfW 2009a; KfW 2009b).

The risk-sharing among the parties was as follows: On August 25, 2008, KfW assumed control over one of IKB’s portfolios worth EUR 1.6 billion for EUR 1 billion. Overall, KfW received a reimbursement of EUR 750 million from the German state for losses borne on these instruments. In addition to this, KfW indemnified IKB up to amounts agreed upon in connection to legal costs and provided IKB financing on market terms to IKB and other entities connected to IKB by providing EUR 0.6 billion in senior funding to a special purpose vehicle (KfW 2009b).

KfW sold its stake in IKB in August 2008 to Lone Star Funds, a US private equity group, for EUR 137 million (EC 2009; KfW 2009b; Reuters 2017). Ultimately, the compensation rights of KfW relating to future profits in connection with debt waivers worth EUR 1 billion also transferred over to the Lone Star Group (IKB 2009). Figure 2 displays the composition of the stakeholders of IKB before and after its sale to Lone Star.

Sources: (IKB 2008a; IKB 2009)