Germany's Hypo in urgent talks with watchdog-sources

By John O'Donnell and Gernot Heller

FRANKFURT/BERLIN, Sept 28 (Reuters) - Hypo Real Estate HRXG.DE is in urgent talks with German banking regulator Bafin and the finance ministry about solving a refinancing squeeze at the bank, sources with knowledge of the matter said on Sunday.

The bank, which lends money for property projects and to governments, is examining measures including the sale of assets such as loan portfolios to circumvent the squeeze, one of the sources said.

Hypo Real Estate, Bafin and the finance ministry all declined to comment.

"Everything is being done to find a solution," said one of the sources.

"There are a number of options," said another. "The bank could, for example, sell assets as Fortis (FOR.BR) did -- Hypo has assets such as portfolios of loans."

Talks, which began over the weekend following a sharp fall in Hypo's share price, are continuing, the sources added.

Hypo is especially vulnerable to the freeze in interbank lending, which worsened after the collapse of Wall Street investment bank Lehman Brothers.

Unlike its bigger rivals such as Commerzbank (CBKG.DE), Hypo does not have any customer deposits to fall back on as banks grow increasingly reluctant to lend to one another.

Hypo relies on this interbank market to borrow as well as on money lent by Germany's central bank to refinance roughly 50 billion euros ($73 billion) yearly, according to a company figure released earlier this year.

Most of the demand for this short-term unsecured refinancing comes from Hypo's business of lending to governments, who often require help bridging temporary holes in their budgets.

The bank lends to such clients as Italy, Japan, Tokyo and Istanbul among others, according to information on its website.

Short-term finance such as this often expires at the end of the quarter -- next Tuesday -- and this is placing pressure on Hypo to find a solution fast, one of the sources told Reuters.

Earlier this year, German watchdog Bafin had examined an emergency takeover of Hypo in the event that the bank ran into refinancing difficulties, sources familiar with the matter have said.

It had lined up Commerzbank as a would-be buyer, they said, but the plan was never used.

Hypo, with a market value of just under $4 billion, is worth just a fraction of Germany's flaghip lender Deutsche Bank (DBKGn.DE).