Beware of Secretive, Litigious State-Owned Banks

Large financial institutions tend to be reluctant to get involved in lawsuits, even when it would benefit their clients or shareholders. German state-owned banks are a notable exception to the rule.

Former shareholders of National Home Health Care Corp, which was acquired by Angelo Gordon last year, receive an extra payout of $0.10 per share, or a little more than one extra dividend, thanks to litigation brought by Helaba Invest Kapitalanlagegesellschaft, an investment advisory subsidiary of state-owned Hessische Landesbank with a focus on absolute returns through hedge fund-like strategies. It is very unusual to see state-owned banks take shareholder activism to such a level. State-owned banks like SachsenLB, LBBW or IKB normally make headlines when they need multi-billion dollar bailouts following losses in their off-balance sheet SIVs.

Helaba is not alone in its legal wrangling. Swiss bank UBS (UBS) suffered the wrath of state-owned HSH Nordbank this week over a $500 million investment in a CDO called North Street 2002-4. HSH claims that UBS did not manage the assets as agreed and engaged in self-dealing. UBS has since filed a counter suit.

HSH Nordbank is no newcomer to lawsuits involving CDOs. In 2005 it sued Barclays Capital for £80 million after it incurred losses in another transaction. The suit was settled confidentially out of court.

Landesbanks are the opposite of the Fannie Mae (FNM)/Freddie Mac (FRE) model. While the GSEs are publicly owned with an implicit government guaranty, the Landesbanks’ government guaranty was removed by order of the European Union’s antitrust watchdog, but they remain under government ownership. HSH was partly privatized two years ago when JC Flowers acquired a 24.1% stake from another state-owned bank, WestLB, for €1.25bn.

We wanted to understand better the motivations of Helaba to go the litigation route rather than just take the loss and move on, as other institutions do in such a scenario. Unfortunately, Helaba refused to answer our questions after several attempts to contact them, citing “contractual” and “legal” reasons. Instead, they threatened us with “further steps” should they not like our blog posting (here is our unsolicited response: bring it on!).

We applaud all actions that help to enforce shareholder rights, and would commend Helaba for its bold actions that netted shareholders a extra $0.10 per share. Litigation is often the only way to go for shareholders to obtain full value in mergers, as in Lukoil’s (LUKOY.PK) acquisition of Chaparral Resources. What vexes us is Helaba’s secrecy. Other state owned banks in Germany have not fared well with lack of transparency.

Trivia: “Hessische Landesbank” is a mouthful. It’s easier to remember the anagram “A Blackness Hides Hens,” which underlines our point.

Lack of openness and transparency has been discussed much recently in connection with some high profile investments by Sovereign Wealth Funds [SWF]. It is far from being a problem of the new sovereign investors only. More traditional state-owned banks suffer from the same secrecy that somehow appears to be ingrained in all government bureaucracies. And it is a fair assumption that lack of transparency contributed to some of the recent failures of state-owned banks, who consider “full disclosure” tantamount to “bad business.”

We are eagerly awaiting to see whether SWFs will follow state-owned banks in the rigorous enforcement of shareholder rights. If they do, you can bet that calls for restrictions on their activities will only intensify. In the meantime, we wonder whether Helaba’s litigation was a one-off or the beginning of a string of rigorous activism. It certainly would not hurt if a new breed of activists promoted full value in buyouts. Unfortunately, Helaba refuses to answer that question.

Disclosures: Thomas Kirchner is long FNM. The Pennsylvnia Avenue Event-Driven Fund [PAEDX] used to hold shares of Chaparral Resources.