Germany SoFFin Capital Injections

The German government passed the Financial Market Stabilization Fund Act (Finanzmarktstabilisierungsfondsgesetz “FMStFG”), a package of crisis response measures that created the Financial Market Stabilization Agency (FMSA). FMSA was responsible for managing the fund in SoFFin. FMStFG also established SoFFin, which was to be used for three financial stability strategies: capital injections, guarantees, and risk shields (FMStFG 2008). Section 7 of the FMStFG authorized the recapitalization scheme in particular. Borrowing by the fund was financed by issuing debt up to a maximum of €100 billion (European Commission 2008a).

The Deutsche Bundesbank is responsible for the general jurisdiction of the Fund, which may act, sue, and be sued in its own name. No other measures of compulsory execution against the Fund may be attached (FMStFG 2008).

The European Commission bans “state aid,” or government interventions that privilege a specific company, industry, or region in a way that distorts trade or competition. Capital injections would normally be considered such a privilege (European Commission 2019). However, the European Commission (EC) permitted capital injections from SoFFin due to Article 87(3)(b) of the EC Treaty, which permits state aid to “remedy a serious disturbance in the economy of a Member State” (European Commission 2008a).

The Federal Ministry of Finance controls FMSA, a public-law federal agency. It is managed by a three-member Management Committee appointed by the Ministry of Finance in consultation with the Bundesbank. An inter-ministerial Steering Committee decides on agency proposals, though the Federal Ministry of Finance is responsible for the actual administration of the Fund. The Steering Committee is composed of one member each from the Federal Chancellery, Ministry of Finance, Ministry of Justice, Ministry of Economics and Technology, and one member proposed by the Lӓnder. The Federal Government has the capacity to create guidelines that govern administration of the SoFFin fund, and does not required consent of the Bundesrat to do so (FMStFG 2008). As of January 1, 2018, SoFFin has been managed by the Federal Ministry of Finance, which has been funding it since its inception in 2008 (Bundesrepublik Deutschland 2019).

The Federal Ministry of Finance could take loans of up to €70 billion in order to fund SoFFin and the three strategies for which it is responsible. There was a possible extension of 10 billion additional Euros with the consent of the Budget Committee of the Deutscher Bundestag. Each individual institution was eligible for a maximum of €10 billion of recapitalization funds prior to the deadline of December 31, 2009 (FMStFG 2008).

The initial deadline for applications for recapitalization funds was December 31, 2009, provided the crisis lasted that long (European Commission 2008b). However, with approval from the European Commission, Germany successfully appealed to have the deadline extended three times to December 31, 2010. SoFFin was reopened in 2012 with a final closure in 2015 (Bundesrepublik Deutschland 2019; European Commission 2010).

The Federal Ministry of Finance would decide on the participation of SoFFin in a recapitalization scheme when there was a substantial interest on the part of the Federation and the purpose sought by the Federation could not better and more economically be achieved by other means (FMStFG 2008). The institutions receiving recapitalization aid from SoFFin were Aareal Bank, Commerzbank, Hypo Real Estate Gruppe (HRE), and Portigon (former West Landesbank).

SoFFin was meant to strengthen the capital base of institutions under section 1(1b) of the Banking Act, of insurance undertakings and pension funds under section 1(1) numbers 1 and 2 of the Insurance Supervision Act, of investment companies under the Investment Act, as well as of the operators of stock and futures exchanges and their respective parent enterprises, insofar as these financial holding companies, mixed financial holding companies, insurance holding companies or mixed insurance holding companies, and the abovementioned enterprises have their seat in Germany (financial-sector enterprises). Private-law-entrusted owners of Landesbanken organized under public law, even where the owners are not financial holding companies, were also considered to be financial-sector enterprises within the meaning of the first sentence above (FMStFG 2008).

These institutions needed to have a Tier 1 ratio of at least 7%, which was the threshold for solvency. If they did not meet this criterion, they were still eligible to apply for capital injections under SoFFin if they committed to reaching it within three months. This is in contrast to the Basel II Tier 1 ratio requirement of 4% of risk-weighted assets (Basel 2004). There was also a requirement to hold minimum regulatory capital under Basel II (8%) plus two percentage points (European Commission 2008b). This requirement indicates that SoFFin’s provision to inject capital was targeted towards solvent financial institutions in order to strengthen their capital base so that they could better withstand potential losses caused by liquidity crises in Europe and exposure to the U.S. housing market. It was also an attempt to restore confidence in the German economy (European Commission 2008a).

Capital injections to Commerzbank were announced on December 19, 2008. SoFFin made a silent participation of €8.2 billion in one tranche as of December 31, 2008, with annual interest of 9% paid on the silent participation (Commerzbank 2008a). Silent participation aid did not dilute shareholder control and gave the Federal Republic no direct influence on the operations of a bank (Mitchell 2016). In case of insolvency and liquidation, the debt was subordinate to all existing debt, pari passu with future hybrid offerings, and senior to shareholders. The silent participation is perpetual and could be terminated by Commerzbank with approval from the Ministry of Finance. It would be redeemed at nominal value (Commerzbank 2008b). There would not be a dividend for the first year, but in years with dividend payments, the interest rate applicable for the silent participation would increase. For each €4.4 million of dividend, one basis point would be added (Commerzbank 2008a). The first €4.1 billion of the contribution had an interest rate of 8.5% and the second €4.1 billion had an interest rate of 5.5% (Levitin 2008). To avoid legal limits on state aid to individual banks, Commerzbank and Dresdner Bank separately sought additional aid in early 2009, prior to Commerzbank’s planned acquisition of Dresdner Bank. The state refused this request, but eventually acquiesced to a €10 billion contribution to Commerzbank after threats of abandoning the merger. Dresdner Bank was struggling due to its real estate investments and would have otherwise required nationalization to save it, which the German state sought to avoid. Of the €10 billion the state contributed, €8.2 billion was an additional silent participation, but €1.8 billion consisted of ordinary shares amounting to a 25% stake (Clark 2011).This was the first time SoFFin had taken a direct position in a financial institution, and its contributions secured it veto power over decisions at Commerzbank. It also received three seats on the bank board, though it did not intend to influence any decision-making, or dilute ownership control by private shareholders (Mitchell 2016). Commerzbank had nine members on its board in 2009 (Commerzbank 2009).

Aareal Bank had sufficient cash and capital base throughout the 2009 financial year, and sought SoFFin support to strengthen it against further turbulence in financial markets. SoFFin injections to Aareal bank in 2009 amounted to €525 million with 9% annual interest (Aareal 2009b). To expedite the repayment of the silent participation, Aareal bank did not issue dividends in 2008 or 2009 (Aareal 2009a).

In 2009, WestLB, a major Landesbank with €288.1 Billion of assets at year-end 2008, was large enough to be considered a systemic risk (European Commission 2009b). Its exposure to American subprime assets was a problem first realized in losses of €2.5 billion on its subprime portfolio (Mitchell 2016). In November 2009, shareholders along with the German government agreed to establish a bad bank, Erste Abwicklungsanstalt. It took over a portfolio of risk positions and risky assets that would have otherwise negatively impacted the performance of WestLB. The capital injection from SoFFin to WestLB amounted to €3 billion in three installments. First, €672 million was injected on December 23, 2009; €1.5 billion was injected on January 4, 2010; and €828 million was injected on April 30, 2010. The capital injection was in the form of a non-callable silent participation, which was optionally convertible into ordinary shares after July 1, 2010 (European Commission 2011b). The terms dictated that SoFFin cannot become a majority shareholder of the company. If WestLB showed a sufficient year-end profit, the terms of the silent participation provided for a 10% remuneration per annum. In the case of loss, the silent participation would participate pari passu in the losses and forgo remuneration.

Hypo Real Estate (HRE) was nationalized by SoFFin. A credit line was extended to it in 2008, and SoFFin subsequently made a public takeover bid to acquire all shares in HRE. Though SoFFin could have nationalized HRE by law had its bid been unsuccessful, it acquired 38.65% of shares in the bid. This gave SoFFin 47.31% stake in HRE, and due to low shareholder attendance in the general assembly, SoFFin had de facto control of HRE (European Commission 2009a). In April 2009, SoFFin submitted an offer to HRE shareholders to purchase shares at €1.39 per share:

The Management Board and Supervisory Board of Hypo Real Estate Holding AG have resolved to propose an increase of the registered share capital against cash contributions, excluding shareholders’ pre-emptive subscription rights, pursuant to sections 182 et seq. AktG in conjunction with section 7 FMStFG, to an Extraordinary General Meeting on June 2, 2009. To strengthen the Company’s capital base in a sustained manner, it is proposed to increase the Company’s registered share capital (Grundkapital) of € 693,253,560 by cash contributions of up to € 5,639,282,040 to a total of up to € 6,332,535,600, through the issuance of up to 1,879,760,680 new no-par value bearer shares (Hypo Real Estate 2009).

SoFFin would subscribe new shares at the lowest price to obtain a 90% stake in the company. SoFFin intended to increase HRE equity from €700 million to around €6.3 billion, diluting the stake of existing shareholders (DW 2009). In October of 2009, SoFFin squeezed out remaining minority shareholders by forcing an offer of €1.30 a share, fully nationalizing HRE. Minority shareholder firm JC Flowers, along with other shareholders, took legal action against the full nationalization of HRE Gruppe, and filed a complaint with the European Union (Reuters 2009). However, the complainants lost this challenge, and the 2011 decision of the Munich courts was that Germany had a legal basis for the forced nationalization of HRE Gruppe (Wilson 2011).

As of December 2018, €14.6 billion are outstanding in Commerzbank, Hypo Real Estate (since nationalized) and Portigon (former WestLB) (FMSA 2019). SoFFin has no clear exit strategy for these involvements.

These included the consideration of the recapitalization, upper limits for the participation in own-fund items of individual organizations as well as particular types of fund items, the conditions under which the Fund could resell its participation in the own-fund items, and any other conditions required to safeguard the purpose of the Act under the context of recapitalization (FMStFG 2008). Financial enterprises seeking to utilize one of the stabilization measures in SoFFin had to guarantee a prudent business policy. (Petrovic and Tutsch 2009)

Each applicant to the recapitalization measure in SoFFin had to prove that their business activities were sustainable and that their risky activities were limited or abandoned. They were obligated to provide loans to SMEs. They were not allowed to pay dividends to any shareholders before the State, and individuals managing each firm were limited to €500,000 in annual compensation. They were not allowed to receive bonuses. (Petrovic and Tutsch 2009)

The Federal Government was empowered to issue additional requirements to these organizations on business strategy, use of monies received, remuneration of their bodies and employees, the level of their own funds, distribution of dividends, the period within which to fulfill requirements, measures to avoid distortions of competition, the way in which account was to be rendered to the Fund, an undertaking on compliance with the above enumerated requirements to be given by the authorized representative body with the consent of the supervisory body and to be published, and any other conditions required to safeguard the purpose of the FMStFG (FMStFG 2008).

As of December 2018, €14.6 billion were outstanding in Commerzbank, Hypo Real Estate (since nationalized) and Portigon (former WestLB). SoFFin has announced no clear plans to exit these capital injections, nor does FMStFG delineate clear exit strategies.

Germany passed the Bank Restructuring Act in January 2011. This act strengthened the coordination of various German federal agencies and European agencies in order to better deal with distressed systemically important banks. It creates procedures to recover struggling banks and reorganize insolvent ones by the Federal Financial Supervisory Authority (BaFin), the successor to FMSA. These measures will be funded by a Restructuring Fund to which all banks are required to contribute (Deutsche Bundesbank 2011).