By Laura Noonan
HAMBURG (Reuters) - To the casual observer, the Landesbanken's results for the first half of this year might suggest Germany's publicly-owned regional banks are in rude financial health.
But the headline numbers belie a more complex reality.
Four of the five major Landesbanken boasted improvements in profits for the first half of 2013, sometimes quite dramatic, like the 400 percent increase in pre-tax profits at Hamburg and Kiel based shipping lender HSH Nordbank.
As a group, their 'tier one capital ratios' - a measure of how much high quality capital they have to weather future losses - came in slightly ahead of Europe's thirty largest banks by market capitalisation.
Both measures are open to particular quirks in the Landesbanken world.
Take HSH - Christian van Beek, of ratings agency Fitch, points out that the bank can actually obtain compensation as some loans that were expected not to be repaid are sold off at a loss or a write down is agreed.
This is because, a provision for a bad loan comes off HSH's profit and loss account, but once the loss on certain loans is actually crystallised, HSH can claim against a 10 billion euros state-sponsored asset guarantee scheme.
"Net income/loss is currently not a good indicator for the bank's progress in establishing a viable business model," said van Beek, who instead focuses on the bank's new business generation.
On the capital front, while European banks are tapping their shareholders for more support, some Landesbanken will be treading the opposite path as they wean themselves off state aid.
"BayernLB needs to return major amounts of capital to its owners to fully comply with compensation measures for state aid, and also LBBW will need to make further efforts to regain its independence," said Katharina Barten, a Frankfurt-based analyst at Moody's, referring to the two biggest Landesbanken.
Bayern was ordered to pay back 5 billion euros by 2019, it has already paid back 1.1 billion euros to the Free State of Bavaria, beating a repayment schedule that has not been made public. LBBW must reduce its reliance on a state guarantee, as the guarantee is eased, the bank's capital position will worsen.
The terms of the European Commission agreement only allow deviations from the repayment schedule if the bank's regulator objects. If this happens more than once, a new state aid application must be made. LBBW does not have a binding repayment schedule.
Brussels could ease up on the demands if the banks' profits are too low, but there are no guarantees. Barten said experience suggests Europe would open a fresh competition investigation if "bank specific" reasons meant the aid could not be repaid.
"If a bank can prove that it has done everything in its power to comply with its EC-set targets, but due to extremely adverse market conditions it is not in a position to comply, the EC's ruling is likely to take these circumstances into account," she added.
A more pertinent measure for sector-watchers is profit margin.
Annualised return on equity ranges greatly across the Landesbanken, from 10.3 percent at Bayern LB to 2.5 percent at Nord LB for the first half of 2013, to average 6.12 percent across the group.
Europe's 30 biggest banks had an annualised average return on equity of 8 percent, according to an analysis by Reuters of the largest banks as ranked by market capitalisation.
"Will Landesbanken ever make very strong European competitive banking? - The answer is no, the banking structure does not allow high market share, big penetration or earnings power," a senior Landesbanken banker told Reuters.
(Editing by Philippa Fletcher)