German Banks Get Religion

Under pressure, they're finally beginning to restructure

Chief Executive Martin Kohlhaussen always says that Commerzbank is not up for grabs. But his insistence no longer deters predators as it once did. Ever since British mobile-phone operator Vodafone AirTouch PLC's run at Germany's Mannesmann group in early February, no company is really secure. "Vodafone's successful assault on Mannesmann has shown everyone that hostile takeovers can work in Germany," says Johannes Reich, head of research at Frankfurt private bank B. Metzler seel. Sohn & Co. "As a result, Commerzbank is suddenly much more vulnerable than it was." The Netherlands' ABN-Amro, Switzerland's Credit Suisse Group, and Germany's own Deutsche Bank are just three of the potential buyers eyeing Commerz' $380 billion worth of assets.

Whatever Commerz' fate, it seems that Germany's overcrowded banking sector is about to begin restructuring in earnest. Frankfurt is already abuzz with rumors of other possible mergers, hostile or not (table). Nearly all the big banks have watched their share prices soar lately in the expectation of imminent deals. Commerz has led the way: Its market capitalization surged by almost 15%, to $18.5 billion, between Feb. 7 and Feb. 14. "The pressure to consolidate is growing irresistible," says a management board member at one of Germany's largest private banks. "We can't keep bucking the trend much longer."

Mergers among financial institutions in most European Union countries have become almost routine since the January, 1999, launch of the euro. But not in tradition-bound Germany. Public-sector savings institutions control 50% of the banking market there, leaving those in the private sector little room to maneuver. That's largely why such banks are slipping behind their foreign rivals in terms of profitability, market capitalization, even balance-sheet clout. The average return on equity at German banks in 1999 was just 10%--well below the average 17% for EU banks as a whole. "Because they've not been involved in mergers or acquisitions, the German banks have found it more difficult to exploit economies of scale and cost-cutting opportunities," says Kiri Vijayarajah, a banking analyst at Salomon Smith Barney in London. "They've got the worst return on equity in the EU."

Before Vodafone's deal, institutional and private investors were usually willing to put up with the banks' dwindling stature and sluggish performance because of their longstanding business relationships. Not any more. German investors say they are determined to get better returns on their banking stakes--even if that means selling out to hostile bidders. "Friendly deals are always best," says the chief investment officer of a large institutional fund in Cologne. "But we'd feel happy supporting an unfriendly one if it was in our interest."

CROSS-BORDER BANE. Analysts calculate that shareholders would get more value from their investments in Commerz, Germany's fourth-largest listed bank, if it were acquired by a foreign player such as ABN-Amro. The Dutch bank is eager to expand in Germany, where its domestic archrival ING Group already owns BHF-Bank, the country's sixth-largest private-sector bank. ABN-Amro, say analysts, would probably be willing to pay more for Commerz than Credit Suisse, which is not under much pressure to expand in Germany, or Deutsche, which seems more interested in expanding abroad.

But Kohlhaussen argues that megamergers rarely yield the expected benefits and that cross-border deals are particularly risky, all the more so if they're unfriendly. "With mergers there is nothing more nationalistic than the finance industry," he says. So he is busy weaving a web of partnerships with friendly banks such as Spain's Banco Santander Central Hispano, France's Credit Lyonnais, and Austria's Erste Bank. These alliances, claims Kohlhaussen, should give Commerz a stronger international presence without sacrificing its identity.

Kohlhaussen's opposition means that any takeover attempt might turn into a prolonged battle. Rijkman Groenink, who will become ABN-Amro's chairman in May, is an aggressive and cunning tactician. He was responsible for the ambitious restructuring plan--ABN-Amro will slash its Dutch workforce by 10%--that the bank announced in January. And he also spearheaded its unsuccessful bid for Belgium's Generale Bank in 1998. "What he learned from that experience could be useful for future hostile bids," says Keith Baird, a banking analyst at Enskilda Securities in London.

Maybe. But Groenink doesn't want another failure on his hands. And the fact that Commerz' staff, some of its partner banks, and Italian insurer Assicurazione Generali--in which Commerz is seeking a cross shareholding--control a sizable 15% of Commerzbank's stock will make a hostile bid even more difficult than usual. The rest of the stock is held by a large number of institutional and private investors. That means putting together a sufficiently big group of allies would be difficult logistically. Moreover, Kohlhaussen's plan to float at least 25% of comdirect, Commerz' highly successful Internet banking subsidiary, could boost shareholder value enough to persuade investors to give the bank's go-it-alone strategy a chance. Comdirect is also talking about launching a joint venture with Deutsche Telekom to offer financial services both in and outside Germany.

The truth is that most German banks could restructure in ways that don't necessarily boost shareholder value furthest. The strategic interests of major institutional investors--such as Allianz, the big Munich insurer--may work against smaller ones. For example, analysts say that a merger between Deutsche and Dresdner Bank would yield huge savings and create an institution with the financial heft and geographical reach to succeed as a global player. But it's never going to happen. Allianz, which holds a 21.7% stake in Dresdner, considers Deutsche a rival of sorts since both sell insurance products. It has long opposed a retail-banking alliance with Deutsche. Instead, Allianz CEO Henning Schulte-Noelle is pushing Dresdner to join forces with HypoVereinsbank (in which Allianz has a 17.4% stake), even though that would probably yield less shareholder value than a Deutsche deal. An announcement to that end is expected as early as May.

Dresdner's investment-banking unit, Dresdner Kleinwort Benson (DKB), could be sold to another European bank shortly afterward. That sounds reasonable given that HVB, which would almost certainly be the senior partner in the merger, has never shown much interest in investment banking. Plus, DKB is now a separate subsidiary, which means hiving it off would be relatively easy. A more likely scenario, say insiders, is that the new Dresdner-HVB would combine its investment banking operations with those of BNP-Paribas Group. Dresdner has a longstanding relationship with the French bank, and the deal could be the prelude to a full-scale merger within the next two years. Such a massive cross-border alliance, though, would be less likely to yield savings because the two banks' operations wouldn't overlap very much. Of course, that would mean the share price might not get much of a lift, either.

German banking will certainly be transformed in a year's time either because of successful hostile bids that merge companies, or failed bids that scare banks into shaping up on their own. In the New Germany, executives such as Kohlhaussen are willing to restructure to remain independent. And while the returns may not always be the most that shareholders could hope for, at least the payoff should be better than what they're getting now.