Commerzbank’s share price has risen as dramatically over the last two days as it fell over the preceding three. At one point this week, its stock fell to a twenty-year low, fuelled by rumours that it was on the verge of a liquidity crisis brought on by massive credit derivative losses – rumours that the bank says were deliberately orchestrated to weaken it. Other big German banks, notably Deutsche Bank, also came under fire from nervous investors.

A show of strength by Germany’s top financial officials reversed the slide, and Commerzbank may feel vindicated by the German financial services authority’s (BAFin) announcement that it would investigate the source of the alleged whispering campaign. But analysts caution that its troubles may be repeated elsewhere in the German banking industry unless banks post improved figures over the coming months.

“It’s clear that German banks have to restructure and reform,” says Michael Zlotnik, a managing director with Standard & Poor’s (S&P) in Frankfurt. “But that takes time to feed through, and in the current environment, with investors so nervous, rumours can hit like hurricanes.”

This particular hurricane blew up in the UK, according to a spokesman at Commerzbank’s Frankfurt headquarters. On September 30, London-based employees of the bank called to warn their counterparts in Germany that the market was alive with talk of huge trading losses in Commerzbank’s credit derivatives business. S&P’s Zlotnik says there was no reason to believe the story. “Yes, Commerzbank has expanded in this area, as many banks have, but its trading activities are not big enough to cause a material impact.”

Nonetheless, Commerzbank shares fell nearly nine per cent that day. But further declines were limited, and the bank’s shares had lost “only” another 1.5 per cent by the close of trading on Thursday, October 3.

On Friday, though, concern mounted after reports suggested that Merrill Lynch, worried about Commerzbank’s credit risk, had asked S&P privately whether the rumours were true. News of Merrill’s enquiry hit the headlines. Commerzbank’s stock fell a further seven per cent, despite Merrill’s protestations that it had been making a routine enquiry and had not adjusted its credit policy towards the German bank. 

On Monday this week, Commerzbank fell 10 per cent. S&P downgraded the bank’s credit rating the next day, prompting a fall of another seven per cent, and taking the bank’s stock to levels it had not seen in more than twenty years.

By mid-week, traders in the default swap market were having trouble pinning down the level at which protection was trading. “Commerzbank has been extremely volatile,” says Olivier Staub, a credit derivative trader with Bear Stearns in London. “It’s about 360 to 450 basis points on subordinated debt and about 250 to 320 on senior. Those are wide spreads, but it’s been all over the place.”

It was an environment in which the market’s fear could begin to feed on itself. Commerzbank repeatedly denied the stories, but made little headway in winning back investors’ faith. New rumours suggested the bank was planning an urgent cash call; executives at other banks talked of systemic risks in the industry; and the Fed’s Alan Greenspan pointedly assured the markets that US banks were in good health.

The storm passed as quickly as it had first appeared. On Wednesday, senior officials in Germany’s finance ministry, central bank and financial regulator joined forces to tell investors that the country’s financial system was stable and that – by implication – Commerzbank was also stable. The stock, which had started the day by sliding lower, quickly changed direction to close the day up eight per cent, despite another downgrade – this one from Moody’s Investors Service. Other German bank stocks rallied, too.

Thursday went even better for Commerzbank. Chairman Klaus Peter-Mueller, took advantage of the changed mood to deliver a round of combative interviews to CNN, Bloomberg and a number of German newspapers. The stock closed almost 20 per cent higher, repairing almost all the damage done by the previous falls and seemingly drawing a line under the bank’s immediate concerns: the market had given back what it had taken.

But for how long? Commerzbank’s stock was sliding long before the rumours started – a fall of 71 per cent in six months undoubtedly reflects real disappointment with the bank’s performance – and there are also real concerns about its long-term health. “In terms of spread, it may look cheap – but things could get worse,” warns Raj Malhotra, an analyst at UBS Warburg in London, who notes that many of Commerzbank’s compatriots share its problems.  

Thomas Gross, a Frankfurt-based partner with the Boston Consulting Group (BCG), also believes that the market is right to view German banks cautiously. “If you look at the low profitability of German banks, and then you look at bad debts, the reserves they need to have, their cost ratios and securities write-downs – well, it’s hard to argue with market values that are below book values.”

Banks in the US and across Europe are also wrestling with their loan portfolios at the moment but, by and large, profits are high enough to ensure that loan losses can increase without putting any pressure on the capital base.

That’s not true in Germany, says Malhotra, who has just finished working on a research note about the country’s banks. “If you look at HypoVereinsbank, provisions amounted to 90 per cent of core earnings in the first half of this year,” he says. “At Commerzbank, it’s 76 per cent of core earnings. For comparisons, you could look at Nordea, where the figure is 15 per cent, or BNP Paribas, where it’s 20 per cent.”

Worryingly, there is no indication that German banks will be able either to improve profits, or reduce provisions, any time soon, says Malhotra, and there could be more problems for European banks from their transatlantic exposures – which could leave them close to breaching minimum capital requirements.

The latest US survey of large syndicated loans found that non-performing assets had increased by 39 per cent among European lenders, leaving them with a total of $62 billion in classified loans. “One scary figure is that one dollar in every four that European banks committed to US telecom and cable companies is now classified,” says Malhotra. Although he admits that it’s impossible to work out from the US data how much exposure individual banks have, Commerzbank will be under pressure as loan losses continue to increase. “I think they’ll avoid dipping below minimum capital levels, but it’s going to be tough.”  

This year’s problems have accelerated the use of risk-based pricing at German banks, says BCG’s Gross – but it’s far too late to make an impact during this credit cycle. “They should have started two or three years ago. Now, the loans are already in the portfolio, and if they can’t transfer the risk to investors or renegotiate terms with customers, they will just have to wait and hope that nothing happens.”

Commerzbank has taken a notably hard line this summer in discussions with ailing German corporates. As a major lender to both Holzmann and Babcock-Borsig, the bank was involved in discussions among other creditors aimed at saving the two troubled firms, but Commerzbank refused to extend any more credit in both cases – a decision that could be construed as evidence of risk aversion at the highest levels of the bank.

For the moment, Commerzbank is keen to put clear water between itself and the possibility of collapse. “There is no danger of bankruptcy – none at all,” says a spokesman. “Sure you can say, “if this, if that” but then there are no limits to what you could imagine. For the moment, and for this year and for next year, there is no danger.”

But will a market that has already shown a startling lack of faith in Commerzbank continue to accept these assurances? The bank has a problem. If the rumours were started and disseminated maliciously, it’s unlikely to have been a coincidence that Commerzbank was the subject. In its weakened state, the bank is the easiest of prey for wild speculation – and unless matters improve, the bank will remain vulnerable.

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