A Banking Breakthrough In Bavaria

J.P. Morgan puts together a model banking merger

The deal was a long time coming. Local wags say the two Munich-based banks, founded in the 19th century, have been talking merger almost ever since. But the agreement finally reached on July 21 by Bayerische Vereinsbank and Bayerische Hypotheken- und Wechselbank, creating a $412 billion behemoth second in Germany only to Deutsche Bank, looks as if it was worth the wait.

Unusually beneficial to shareholders, the merger involves a rare unraveling of the cross-shareholdings that protect many German companies from outside financial pressure. At the same time, the deal avoids severe job losses and allows shareholders to partially escape Germany's 50%-plus capital-gains tax. If it works, it could be a model for other big German financial institutions, which carry huge equity investments on their books at a fraction of market value.

BIG OBSTACLES. Unloading such holdings would free up cash to earn higher returns--or buy up other banks. "There's no question that these cross-shareholdings have to be diminished, given the pressure on companies to produce higher returns," says Walter A. Gubert, head of European operations at J.P. Morgan & Co., which engineered the merger. Among the candidates to sell off assets and use them to acquire smaller rivals: Deutsche Bank, Dresdner Bank, and insurance giant Allianz. Deutsche Bank Chief Executive Rolf E. Breuer calls the deal a potential "coup" if it works.

The Munich merger has overcome big obstacles. With 40,200 employees, the two banks are among Bavaria's biggest employers. The deal also pitted two financial powerhouses against each other. Deutsche Bank last year took a 5.2% stake in Vereinsbank, a move analysts thought signaled an eventual takeover bid. On the other side were Deutsche Bank rival Allianz and its ally Munich Re, which have minority stakes in both Bavarian banks. They wanted to ensure a Deutsche takeover didn't happen.

Enter J.P. Morgan. Representing both banks, Morgan spent more than a year reconciling conflicting interests. One key to the deal's success was a two-tier structure that benefited both the banks' and Allianz' shareholders. Vereinsbank will use its 19.3 million Allianz shares to buy the first 45% of Hypo-Bank. Vereinsbank's sell-off of its Allianz shares is unusual in Germany, where such cross-holdings were until fairly recently not even disclosed. "The fact that it was sold and the benefits distributed to shareholders is a real breakthrough," says Neil Crowder, a Goldman Sachs analyst in London.

And because the transaction is in shares, under German law Vereinsbank is exempt from capital-gains tax on the sale of its Allianz stock. The Vereins offer thus makes the deal worth substantially more than what analysts had expected. Hypo, Vereins, and Allianz shares all soared on the announcement.

The political maneuvering was delicate, too. The banks had to reassure Bavarian Prime Minister Edmund Stoiber that it would be a "soft" deal, says Ulrich Wilhelm, Stoiber's spokesman, with staff cuts coming from the combined banks' normal attrition of about 2,000 workers per year. But the big selling point was that it would keep the banks out of the hands of Frankfurt-based banks, such as Deutsche or Dresdner. "We were absolutely interested in not having a bank from outside Munich involved," Wilhelm says.

Given these exigencies, the merger won't save anything like what a U.S. bank merger of similar size would. The principals put the cost savings at about $560 million annually after five years, or about 12% of the merged institution's total costs. That's about half the average in the U.S., where layoffs cut deeper and come faster. And the deal, scheduled to be completed next spring, could still run into trouble. Vereinsbank's chief executive, Albrecht Schmidt, and Hypo-Bank CEO Eberhard Martini plan to run the new bank jointly at first--a recipe for conflict.

Nonetheless, the deal represents a coup for all participants, especially in one of Europe's most hidebound financial markets. German competitors are sure to be watching the outcome.