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EUROPE: "Taxation of Cross-Border Mergers and Acquisitions: Germany"

EUROPE: "Taxation of Cross-Border Mergers and Acquisitions: Germany". 14-page report by KPMG.

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back to index backEUROtalk August,  2005

Hausbank doctor

Dresdner Bank's new priorities underline the changes that lie ahead for Germany's bank-company relations.

Klaus Rosenfeld is the new face of German banking. It's not just that, at 38, he is easily the youngest finance chief of a major German commercial bank. Rather, it's the message he carries about the future of the industry: that the cosy Hausbank relationships—for decades the mainstay of German business—are history.

As Dresdner comes through one of the most difficult periods of its 132-year existence, and as German and European financial services seemingly enter a prolonged period of restructuring and consolidation, it is at the forefront of a rapidly changing banking culture in its home market.

Case in point: after stepping into the CFO role nearly three years ago, Rosenfeld put in place a regime that requires bankers to demonstrate profitability on a case-by-case basis before they write new corporate loan business. That leads to the fact that you sometimes have to tell your clients, ‘Sorry, we are not going to do this,' and that clearly creates tension here and there,” Rosenfeld says. But you simply can't survive by constantly underpricing risk.”

As obvious a statement as that seems, the chronic underpricing of risk over decades has left German banks in a relatively weak position, compared with large rivals in the US and elsewhere, and now even the biggest of them is seen as a takeover target. As Rosenfeld points out, although Germany boasts four world-class car makers and similar strength in other industries, Deutsche Bank is the only bank that can claim to be world class, earning revenue of €22 billion in 2004. But even Deutsche lags well behind the world's largest bank, Citigroup, with €68 billion in revenue and higher profitability. And Deutsche's CEO, Josef Ackermann, had to deny rumours in June that Citigroup might take over his bank. Dresdner, Germany's number two commercial bank since HVB agreed to sell to Italy's Unicredito in June, had operating revenue of about €6 billion last year.

The relative underdevelopment of Germany's bank sector and capital markets is now widely seen as a factor holding back growth. German companies rely much more than their counterparts elsewhere on bank credit than on capital markets to finance themselves. And German banks have traditionally held equity and sat on the boards of client companies. Michael Koetter, one of the authors of a recent Keil Institute report on German banking and now a Bundesbank researcher, says: German banking is a lighthouse case for underperformance compared with international peers.” This is reflected in the deterioration of German banks' key relative performance indicators such as cost/income ratios (see chart below) and net lending margins during the last decade.

Germany's top bankers, regulators and politicians recognise this, but action has been slow in coming. Within the antiquated bank system, for example, the local government guarantees that had kept down the cost of capital for regional banks, or Landesbanken, were removed only this July, and although mergers have occurred in protected sectors, there is still fierce opposition to letting commercial banks buy municipal savings banks.

Even within the commercial bank sector, merger bids have failed spectacularly, thereby exacerbating the damage done by the attempts to expand at home and abroad that overreached in the late 1990s. Dresdner was a prime example of this.

Ringside seat

Despite his youth, Rosenfeld has had a ringside seat for much of the high-level manoeuvring. Having been an apprentice at Dresdner in the 1980s, served in the Navy and studied at the University of Münster, Rosenfeld returned to Dresdner in 1993 for an initial four-year stint in investment banking. He was then plucked by Dresdner Vorstand member Bernhard Walter in 1997 to advise on strategic projects, including a failed merger attempt with Deutsche Bank in 1998 that went virtually unnoticed at the time. Having struggled to make the Kleinwort Benson investment banking arm it had bought in 1995 competitive, in 2000 Dresdner paid $1.6 billion (too much,” Rosenfeld says) for Wasserstein Perella, an American M&A boutique” founded by two high-profile Wall Street bankers.

Looking back, Rosenfeld recounts how things went from bad to worse. The second attempt to sell to Deutsche Bank failed in 2000—according to reports at the time, because Deutsche wanted to gut Dresdner's investment banking unit. Walter, Rosenfeld's mentor, resigned as CEO. His successor, Bernd Fahrolz, failed to agree a 50:50 merger with rival Commerzbank. All of these attempts to create a German banking national champion” were being orchestrated by Allianz, Germany's €96 billion insurance behemoth, which owned 21% of Dresdner. After these failures, Allianz CFO Paul Achleitner came up with a plan that would allow Allianz itself to take over Dresdner by unwinding cross-shareholdings in HVB and Munich Re to pay for the deal.

Rosenfeld was in the small inner circle holding secret talks in early 2001 that resulted in the €25 billion deal in March. For his trouble, he was handed the job of integrating Dresdner into Allianz and named successor to CFO Bernd Voss, whom he succeeded in 2002. Allianz had a pretty brave long-term vision of how to establish an integrated financial services provider,” Rosenfeld says now. But we went into a perfect storm—with turmoil in the capital markets and 9/11, with a business model that was stuck in the middle and problems with the ‘long book.

As operating losses deepened—to €844m in 2001 and to €2.3 billion in 2002—Dresdner took drastic action. It slashed the company's cost and asset base to a level that could sustain profit, and reduced staff numbers by one-third, much deeper than its rivals. (See graph below.) In all, the cost base has been cut from €9 billion to a run rate this year of about €5 billion.

In one of its boldest moves, Allianz brought in a Swede, Jan Kvarnström, to run the restructuring unit set up to dispose of €35 billion of non-core assets, a job he'd done at Nordbanken during Sweden's banking crisis in the 1990s. By selling subsidiaries, equity holdings from Latin America to Asia, and large bundles of non-performing loans, including German corporate loans, by June 2005 all but €8.6 billion of holdings had been sold, freeing up €2.5 billion of risk capital. The unit expects to wind up this year.

Reporting 2004 results in March, Dresdner said risk-weighted assets were €105 billion in 2004, down from €160 billion two years before. Revenue from interest, fees and trading were all down slightly, but costs and loan loss provisions had also shrunk by a total of €1.2 billion, so an operating loss of €228m in 2003 turned to an operating profit of €611m.

After trimming the bank to a manageable size, Rosenfeld says this year it is expected to be EVA-positive, which marks the end of the turnaround phase. The question now turns to how Dresdner Bank expects to grow. What is its future?

Losing ground

Among the casualties of Dresdner Bank's slump was Fahrolz, who was replaced in 2003 by Herbert Walter from Deutsche Bank. Also, at Dresdner Kleinwort Wasserstein (DrKW), long seen as the problem child in the group, Andrew Pisker replaced Leonhard Fischer as CEO.

Between 2001 and 2004 DrKW's position in the net revenue league table of investment banks in Europe dropped from 9th to 15th as its market share fell from 3.2% to 2.1%, according to database Dealogic. Debt capital markets held up well, but it lost ground elsewhere, most spectacularly in M&A, where its market share collapsed from 16% to just above 4% as rivals such as Goldman Sachs, Morgan Stanley and Merrill Lynch moved ahead.

When it bought Dresdner, Allianz was clearly focused on the retail and commercial piece of our business—on the 5m clients, on the branches, on the distribution power,” Rosenfeld says. When it was finally able to talk about delivering on that bancassurance model again this year, the focus was on the target of adding 300,000 new retail clients, primarily by selling via Allianz's huge insurance sales network. The liberalisation of Germany's individual pensions market was, after all, Allianz's central rationale for the merger in 2001.

Konrad Becker, a banking analyst at Merck Finck in Munich, says, In the current situation I don't think there is any immediate pressure to divest DrKW, but you have to wait and see. [Allianz CEO Michael Diekmann] has said that entities not meeting the target of at least 15% return on equity, and having little chance of making it, will have to leave the group.” Despite the huge turnaround effort, which cut capital employed from €3.5 billion to €2 billion, DrKW still has a 90% cost/income ratio, and its future remains in doubt as Allianz continues to entertain bids, both from third parties and from DrKW's management.

Once they have the chance to sell DrKW, they will,” predicts Marcel van Leeuwen, a banking consultant and CEO at, a research portal. But if Allianz were to sell the investment banking unit, it would leave Dresdner exposed in corporate banking, given the intense competition from both domestic and international banks.

Rosenfeld says investment and corporate banking have to be seen in the round, and points to recent mandates that benefited various parts of the group, including the sale in June of Dresdner's 25% stake in Bilfinger Berger, Germany's second largest builder, partly handled by DrKW.

But that sale also highlights the broader consequences of the focus of German banks on core clients” and the new approach to lending: as soon as Bilfinger's shares hit the market, the takeover speculation began. As companies are cast out into the capital markets, as their loans are sold into secondary markets, and as lending business is tied to capital market transactions, the old relationships are redefined.

This is certainly familiar to Lothar Lanz, CFO of ProSiebenSat.1, the €1.8 billion broadcaster at the centre of the failed Kirch group in 2002. Himself a banker until he became CFO of ProSieben eight years ago, Lanz says, When you look five, seven years back, banks were always keen to lend you money from their own balance sheets. Now banks only want to charge fees.” After control of ProSieben fell to private equity partners in 2003, Lanz says the company's debt financing is now mainly bonds. The downside is the loss of relationships and market exposure, but Lanz likes the independence. And there is a lot more competition,” he says, citing Royal Bank of Scotland. You didn't see them in the German market five years ago.”

Indeed, capital market development has quickened. Kreditanstalt für Wiederaufbau, a state development bank, has helped foster a local market for securitised loans, with Volkswagen the first issuer. New bank products such as PREPS, debt-equity hybrids, let even tiny firms raise money via debt capital markets.

The danger in this? As Ed Eyerman, an analyst at FitchRatings, points out, there are echoes of the recent experience in Italy, where the corporate bond market grew rapidly, but left dozens of firms exposed to souring market conditions, forcing asset sales, loss of control or liquidation. I appreciate the pressure the banks are under to survive, and they invent these products to keep the client relationships and let the capital markets assume the risk burden,” says Eyerman. It may be good for the banks, but is it good for the borrowers?”

The implications of these changes are not lost on Rosenfeld, who says the evolution of German banking is only beginning. I strongly believe that Germany is, in terms of the quality and depth of its capital markets, in the very early stages. These relationships are moving from the typical Hausbank—‘we do everything with you'—to more competitive ones, where certain transactions start to play a bigger role.” The only thing certain in German banking is that these relationships will change.”

Source: - GAI

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