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Germany's Tricky Commerzbank Merger

The government-backed takeover of No. 2 German bank Dresdner by its smaller rival seemed like a good idea until the financial crisis worsened

The chancellor's favorite banker looks small in his dark-blue suit and white shirt, especially against a huge green-and-yellow screen. In the pale light of the Dresdner Bank training center, he looks older than he actually is.

Gone is the youthful charm that distinguished Martin Blessing, 45, only a few months ago. An oblong scar on his face from a childhood bicycle accident seems more pronounced. Like Harry Potter's famous scar, Blessing's vanishes on good days.

But the sorcerer's apprentice of German banking has been under near-constant pressure since Aug. 31, 2008, shortly before the bankruptcy of US investment bank Lehman Brothers plunged the financial markets into chaos. That was when Blessing, in his job for less than four months, announced a Commerzbank (CBKG.DE) takeover of its rival, Dresdner Bank . Since then he has had to declare billions in losses and accept bailout protection, twice, from the German government.

The balance sheets of both banks still have €55 billion ($73 billion) in toxic securities, and if the European Commission had its way in Brussels, it would declare the entire operation a case for restructuring—i.e., a "bad bank." Now, during the world's largest financial crisis since 1929, Blessing is expected to navigate one of the biggest mergers in German banking history.

As is often the case on Tuesdays, Blessing has worked a 12-hour day, including two board meetings, by the time he reaches Dresdner Bank's training center near Frankfurt to address about 150 young managers. A Dresdner sales manager says her customers would be displeased if the name of their bank were to disappear. Wouldn't it be better, she says, to allow both banks—represented by their trademark colors on the screen behind Blessing, green and yellow—to coexist?

But under the terms of the merger, the name of her 137-year-old Dresdner Bank will disappear by the end of next year. Even the weather forecast on two popular German TV shows, "heute-journal" and "Tagesthemen," is no longer introduced by its longtime sponsor's green umbrella, but by an umbrella in Commerzbank yellow.

Blessing understands the skepticism, and the emotions, associated with the takeover. The upstart Commerzbank, traditionally the third largest of Germany's major private banks, is swallowing Dresdner, once the proud number two, behind Deutsche Bank.

Chancellor Angela Merkel and Finance Minister Peer Steinbrück have pledged €33.2 billion ($44 billion) to make sure the experiment succeeds. Fifteen billion euros of that will go to government-backed loan guarantees for the bank's bonds, which would otherwise be almost impossible to sell to private investors. With the remaining €18.2 billion, the federal government will acquire silent partnerships and shares in the bank.

Berlin's coalition government, for once, has agreed on something—that the merger must not fail. It's expected to result in a second major German bank, one devoted primarily to doing business with small and mid-sized companies. The government is also prepared to inject more money—also running into the double-digit billions—to isolate the risks on the inflated balance sheet of the new Commerzbank.

But is Blessing the right man for the job? This ambitious careerist, a former McKinsey consultant whose critics dismiss him as a technocrat, is known internally as Blessing the Third, because his grandfather led Germany's central bank and his father was on the board of Deutsche Bank (DB).

German Finance Minister Peer Steinbrück appeared with Blessing on a recent TV chat show. He dominated the young bank chief with talkative arguments that seemed to make clear just who would call the shots at Commerzbank—even though the government's acquisition of a 25-percent stake in the merged entity wasn't (and still isn't) complete. Blessing seemed uncharacteristically nervous, tensing up when it was time to show the viewing public the right mix of humility and competence. "We bankers have made mistakes," he said, but it sounded less than convincing.

So what mistakes did Blessing himself make? Didn't he fatally underestimate the risks hidden in Dresdner's accounts? Blessing brushes aside such questions. "You can only make decisions based on the information at your disposal at that particular time," he says.

If he has any self-doubt, he hasn't shown it—not on the talk show and certainly not when speaking to the young managers at Dresdner Bank. Blessing is in his element at this event. His concern for the audience's ambivalent feelings never extends beyond simple acknowledgment.

"We have decided to call the bank Commerzbank," he says, a bit stiffly. Dresdner Bank's 22,000 employees know what that means: There will be nothing left of their bank. Senior management, the new company's business model and even the computer systems will come from Commerzbank. "Commerzbank is the blueprint," Blessing likes to say privately.

The only compromise he seems willing to make relates to the logo. The Commerzbank logo, a stylized leaf that employees liken to a head of cauliflower, and the Dresdner logo, which looks like a triangular eye, are up for debate, says Blessing.

But there are more pressing problems.

"You are steamrolling Dresdner Bank," said Bernd Pischetsrieder, a member of the Dresdner supervisory board who once led automakers like BMW and Volkswagen. He warned the takeover target that it faces an "invasion" and urged Blessing to consider the so-called soft factors associated with the merger, meaning emotions. Ignoring those, he said, could jeopardize the endeavor.

He said when merged automakers like Porsche and VW have their differences, the consequences are minor, because people still buy cars. But clashing corporate cultures can be damaging for banks. "It drives away customers," he said.

Blessing intends to show his predecessors in the industry just how things are done—since banking mergers routinely fail. He also wants to settle scores with some old adversaries at Dresdner, which once dealt him the only painful defeats of his career.

After working as a management consultant, Blessing took a position with Dresdner. But his aspirations to enter top management were thwarted by members of the bank's works council, who feared Blessing for his McKinsey-trained reputation as a hatchet man. "He lacked compassion," says one former associate. Instead of Blessing, Andreas Georgi became a member of Dresdner Bank's executive board. Georgi has now been forced to leave the bank, though not without a sizeable golden parachute.

Instead of joining Dresdner, Blessing became the chairman of the board at the Munich-based Advance Bank in 2000. After ongoing losses, though, Advance Bank failed in 2003. Blessing then secured a position on the board of Commerzbank in 2001. The bank was on the verge of bankruptcy in 2002 following reports about liquidity problems in Britain's Financial Times, which triggered rumors that likely generated enormous profits for a number of hedge funds. In the ensuing turbulence, Klaus-Peter Müller, Commerzbank's chief executive at the time, spent many a night sleeping at his office. The experience taught Müller that physical fitness could sometimes be part of the job. He was impressed by Blessing's ability to handle stress. He started to groom Blessing, an in-shape marathon runner, as his successor.

Müller, recognizing the latent risk that Commerzbank—as the weakest of the three major Frankfurt banks—could eventually disappear, pushed for expansion.

First, in late 2005, Commerzbank acquired Eurohypo for €4.6 billion ($6.1 billion), which made it Europe's biggest mortgage bank. In early 2008 it was clear that insurance giant Allianz wanted to sell Dresdner. Müller and Blessing saw a Dresdner takeover as an opportunity to turn Commerzbank into Germany's largest bank.

In the end, Blessing, who by then had replaced Müller as CEO, was able to announce the deal with Dresdner on Aug. 31. The transaction, an enthusiastic Blessing told analyst, would be "a benchmark-setting quantum leap."

Suddenly, an 'Existential Threat'

The Lehman bankruptcy a few days later spoiled a few best-laid plans. Dresdner's balance sheet was suddenly filled with gaping holes, and by the end of the year the value of its equity capital had shriveled by almost two-thirds—to a puny €4.5 billion. "The takeover represented an existential threat," says Dieter Hein, an analyst with Fairesearch who even called for Blessing's resignation.

But Blessing had the support of Supervisory Board Chairman Müller and, even more important, the federal government. When it became clear that Commerzbank could not manage the takeover on its own, Blessing's excellent relations with Berlin came in handy.

His predecessor, Müller, had maintained a strong relationship with government officials, including the chancellor, in the days when the bank was doing well. Müller, the son of a former Düsseldorf mayor, was always considered the most politically connected of all bankers.

Blessing brought his own connections to the table. He was on good terms with Merkel's economic advisor, Jens Weidmann, as well as with Axel Nawrath, the new head of government-owned development bank KfW. Until recently, Nawrath was also the chairman of the board of directors of the Soffin Financial Market Stabilization Fund. "They are all on a first-name basis," says an official who feels uneasy about the government bailout program, given the billions it is costing taxpayers.

Blessing, Weidmann and his successor at Soffin, Jörg Asmussen, a state secretary in the Federal Ministry of Finance, belong to a pragmatic generation of industry executives in their mid-forties who were influenced by the Anglo-Saxon economic model and came to power as a result of the financial crisis. In what were dubbed "non-talks," the three men assembled the second bailout package for Commerzbank within a few days, even though the bank had not submitted an official request for it.

When an emergency meeting of the Soffin board of directors was convened between Christmas and New Year's, everything had been decided. Soffin held out the prospect of providing additional billions to safeguard the Dresdner acquisition. In return, the government intended to take a 25-percent stake in the bank's equity capital.

"According to the (Soffin) board of directors, Allianz was in bad shape," one of the participants recalls. The members of the German parliament, the Bundestag, charged with monitoring the billions in bank bailout funds, were told that if the deal fell apart, the Munich-based insurance giant could possibly be sucked down by the financial crisis. "Given those warnings, they weren't as eager to split hairs over a billion or two in the bailout package," said one of the Soffin officials.

Trouble With the European Commission

Now, though, the deal faces problems in the European Commission in Brussels, which has yet to approve the German government's second equity injection for Commerzbank. The Brussels officials place Commerzbank in a similar category as WestLB—that is, as a bank that would be in trouble even if there were no financial crisis. The Commission wants to see a sustainable reorganization concept that includes a radical reduction of risks and assets.

Only a few weeks after the release of its preliminary financial results, the new Commerzbank discovered an additional group of €55 billion ($73 billion) in toxic assets that now have to be liquidated. Blessing would prefer to see a government-financed "bad bank" take on a portion of these securities. His predecessor, Supervisory Board Chairman Müller, who is also the president of the Association of German Banks, has presented Berlin with a concept for a "bad bank," or government depot for toxic assets.

German banks hold an estimated €200 billion ($264 billion) in toxic securities, although that number could be significantly higher. The state-owned banks, or Landesbanken, are plunging from one calamity into the next.

Every German bank, from Deutsche Bank to Sparkasse Südholstein, a large northern German savings bank, has assets on its books that it would prefer to turn over to the government. But at what price? And who will assume the risks?

So far, Chancellor Merkel and Finance Minister Steinbrück have not succumbed to the charm of lobbyists. "The government can't afford it," says Steinbrück, who is using the absence of acute new crises in recent weeks to play for time.

But there has been no real improvement in the situation among German financial institutions. According to a plan currently being considered, a large number of small "bad banks" backed by government funds would be created for individual institutions. The plan also calls for an approach taken by the Americans, under which accounting rules would be relaxed to allow risky assets to seemingly disappear into the depths of balance sheets. The lenders would be allowed to tamper with their own pricing models in the future. "Bank balance sheets are becoming less and less trustworthy," warns Hugo Bänziger, Chief Risk Officer at Deutsche Bank.

Commerzbank's total assets amount to more than €1 trillion ($1.32 trillion). The task of managing the toxic assets included in that sum is complicated by the fact that Dresdner's investment bank is being phased out at the same time. Despite billions in losses, though, the entire management collected bonuses totaling €130 million ($172 million) before leaving the bank.

Dresdner's investment bank is to be reduced by half, and will no longer be referred to as an investment bank. By dismantling the business model, Blessing will be score points with employees whose own bonuses were ruined by the investment professionals' delusions of grandeur. Dresdner's operations in Japan have already been terminated, and most of the 1,000 positions in its US offices are in jeopardy. It is rumored that electronics giant Siemens may be forced to seek a new partner if it hopes to complete a planned €10 billion ($13 billion) deal in the United States.

But these drastic measures are fraught with risk. The investment bank's specialists who devised its risky contracts disappeared from one day to the next. "Commerzbank has no idea what it got itself into," says one of the Dresdner executives who was let go.

But Ulrich Sieber disagrees, noting that Dresdner's investment banking activities are "not exactly sorcery." Sieber, the head of human resources at Commerzbank, worked at Dresdner until 2006, and developed a reputation for being a tough customer. He believes Commerzbank is now adequately managing Dresdner's toxic assets. In recent weeks, the individual assets were transferred to Commerzbank's accounts at current market prices, and many of them were promptly transferred to an internal bad bank.

At the same time, Sieber, at Blessing's behest, has stepped up the pace of cutbacks. Two of three headquarters in Frankfurt am Main (for Commerzbank, Dresdner and the investment subsidiary Dresdner Kleinwort) have already been eliminated. Almost all of the 11,400 employees there are worried about their jobs. They expect to be told soon whether their services will be needed in the future.

During a five-day closed meeting in late March, Sieber and the works council agreed on a severance scheme for the Frankfurt headquarters, where 2,200 jobs have already been slated for elimination. The operation should be complete by the end of 2011 and won't involve anymore layoffs forced by the economy. Even Hans-Georg Binder, the chairman of the works council for the Dresdner headquarters, praises "the fair negotiations."

After a disproportionately large number of Commerzbank employees on the first two levels of management were given a chance to apply for positions in the new merged bank, Dresdner employees will have the opportunity, too. According to Section C, Paragraph 8 of the Group Works Agreement, "transparency, fairness and equal opportunity, regardless of company affiliation, are the supreme principles of the process of filling positions."

In the coming weeks, several thousand employees in Frankfurt will be entitled to a "structured conversation" with their potential superiors, as they compete for roughly 900 jobs within the third and fourth levels of management. Blessing is determined to expedite the process. Employees seeking to go into partial retirement have been told to make up their minds by the end of July, and anyone who reaches a voluntary decision quickly will be rewarded with a "sprinter's bonus" of three months' salary. Employees with at least 10 years' tenure can choose to resign voluntarily and receive a lump-sum settlement.

'The Most Exciting IT Project in Germany'

Blessing may be attempting this merger during a financial crisis, but he's maneuvering in familiar territory. Blessing can structure it as he sees fit. Even his biggest critics at Dresdner know there is no turning back.

Commerzbank Chief Operating Officer Arno Walter, who spent much of his career at Dresdner, is only too aware of how massive an undertaking this is. Now his job entails managing its liquidation.

"More than half of the two banks' 60,000 employees will end up in different positions, even though many will be doing the same work in the same location," says Walter. Of the 1,540 branches Dresdner and Commerzbank branches still in existence today, 340 will be closed. By next summer, every employee will know where he or she will work in the future.

In the Frankfurt metropolitan area alone, the two banks, with their offices, trading rooms and branches, occupy 800,000 square meters (8.6 million square feet) of office space. By 2012, Walter is expected to have one-third of the space vacated—enough space to fill five large office buildings. One building, known as the Silver Tower, has been leased to Deutsche Bahn, Germany's national railway. Once Germany's tallest building, the former Dresdner headquarters will be renovated, and the new tenant can expect to move into the executive levels before the end of the year.

The merger will generate more than €12 billion in savings, but no one knows when it will be complete. Despite the planned cutbacks, Chief Information Officer Peter Leukert has already managed to ensure that all 4,300 computer specialists at both banks will remain on board. "I need every employee," says Leukert.

Dresdner Bank's systems will be shut down on a weekend in October 2010, at which point the bank's five million customers will see their accounts automatically transferred into the Commerzbank system. "This is the most exciting IT project in Germany," Leukert says enthusiastically.

And an expensive one. One the crucial day it will take 1,000 IT consultants to ensure that Dre

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