German investment banks have not run a smooth course in recent years. Ever-increasing competition has led to falling earnings and even losses, but with foreign competitors failing to target mid-cap companies and lacking retail penetration, unique opportunities remain for the domestic houses. Owen Wild reports.
The course of German investment banking has not been smooth in recent years. Ever-increasing competition has led to challenges for all European banks. The greater penetration by the North American houses and the effective dissolution of borders caused by the advent of the euro has made the landscape much harsher, as well as offering opportunities in new markets. This has eradicated the closed-shop view of banking along national lines. (See Loans article in this report for how this is affecting one business area.)
The change this has brought about in Germany is clearly seen by the decisions of the government agency KfW, a repeat issuer in the equity and debt markets. Like many national bodies, KfW has traditionally included German houses in its transactions, however this is no longer the case. In November 2004 KfW decided to sell €4bn of Deutsche Telekom stock and invited a number of banks to bid for the business. The result of the auction saw three US houses as the victors, and no domestic involvement.
KfW felt this was of little significance because it is so often in the market and does not feel the need to always use German banks for political reasons.
Arguably German banks are just not able to compete in this space. Deutsche Bank the only house with the balance sheet to be able to bid for such business. However, the same deal highlighted the fact that German banks’ local presence can still be important – or at least appear so.
The DT sale included €1bn of warrants intended for domestic retail investors.
However, the US houses did not know how to place the warrants, and most
stayed on their books. Dresdner
Kleinwort Wasserstein, a bank with
retail penetration through parent
Dresdner Bank, was responsible for the structure of the deal.
Shareholder value
An auction process also highlights how much competition there is for every mandate across asset classes. As this reaches the point where deals are increasingly completed for zero fees, many can end in losses. Smaller houses suffer in this environment as they are unable to absorb these losses, while the rest are under pressure to compete just to maintain market share.
“Profit isn’t just measured in terms of money any more,” said one syndicate banker at a German house. “There are some deals where it is worth making a loss just to be doing it.”
But acting in such a manner is not always a viable option when one has to report to shareholders. And this is becoming an increasing concern, bankers now repeating the mantra of creating shareholder value.
In an environment as cut-throat as this, some banks have suffered more than others. Commerzbank has been beset by such difficulties in its investment banking business that it no longer refers to the group as such. Investment banking has operated under the brand Corporates & Markets since autumn 2004, having been merged with the corporate bank. However, after a long period of losses the bank now expects to achieve a positive result in 2005.
“We still do investment banking business, but we don’t call it that per se,” said a spokesperson for the bank. This is down to the significant cost of maintaining the business in recent years when banks have struggled to achieve returns on the risk taken. However, the situation may be changing with most banks now completing their retrenchment and looking to capitalise on improving markets.
The growth of the fixed-income market that has sustained banks recently looks to be on the downturn, but the return of equity capital markets that began in 2004 and the increases in merger and acquisition activity this year look likely to outweigh the decline. It is here that some much smaller German houses are looking to mark themselves out.
Mittelstand focus
The difficulty for many German banks is that with new entrants and the loss of a national currency, some are unable to identify their unique selling point to win the important mandates.
WestLB is limited in the business it can do as it does not have a massive balance sheet and cannot rely on that of its shareholders, so it has focused on the clients it can work with, such as Mittelstand companies. In ECM the bank has combined all its equity-related operations to bring together equity capital markets with equity derivatives and equity-linked.
By combining all the equity parts of its operation the bank is able to offer a much more structured and tailored solution to its clients, and use its limited balance sheet to better effect. This was shown by a transaction completed for car rental firm Sixt in October 2004, when WestLB constructed a tax efficient structure that took advantage of the differences between accounting and tax rules that Mittelstand companies work under. This led to the €100m placement of listed profit participation certificates (Genussschien) that offered investors an attractive coupon of 9% but was also very attractive for the company as it is classified as balance sheet equity. The bank used its balance sheet to guarantee to Sixt that it would take 40% of the deal.
Bankers highlight that there is a different level of competition at the mid-market level as much of that business is below other banks’ radar. This is partly due to the smaller size of transactions, but the fees that can be earned from structured transactions can be compensatingly attractive. WestLB also hopes to be well positioned for the expected flurry of M&A activity from small and mid-cap companies this year.
This approach has benefited WestLB and Commerzbank is focusing its efforts in this area in 2005 but it may not be suitable for those houses that seek to retain a tier-one position in German investment banking.
Natural alternative?
According to a spokesperson, Dresdner KW exists to be the natural alternative to Deutsche Bank, and as a result it needs to be leading deals for top-tier clients. DrKW believes it has made some progress towards this end, and cites a number of recent transactions across asset classes. But these suggest the bank is still some way short of its goal.
One of the transactions cited was the €1.4bn debt portion of Allianz’s three-in-one trade in January this year, which was bookrun by Dresdner KW. However, the award of the Allianz mandate is unsurprising considering that DrKW is ultimately owned by the insurer, and only served to highlight the bank’s absence in the equity and equity-linked portions of the transaction.
DrKW also highlights its involvement in the recent IPOs of biotechnology firm Paion and pay-TV operator Premiere. But the bank was also not the bookrunner on either IPO. It does have as yet undisclosed mandates for other German new issues later this year.
Dresdner KW also suggests that slip-ups by Deutsche Bank have allowed it to catch up. This includes the difficulties in completing the IPO of Deutsche Post in June 2004 and the distraction of last year’s court case surrounding the purchase of Mannesmann by Vodafone in 2000, which involved DB chief executive Josef Ackermann. However, Post has had a very successful aftermarket and the court case passed without incident.
Both Deutsche Bank and DrKW are still suffering from the uncertainty of their future ownership. Last year it was revealed that there had been discussions about a takeover of Deutsche Bank by Citigroup, although it was apparent that politics would hinder any Citigroup attempt to take over Germany’s largest bank.
Dresdner KW has also suffered from a lack of long-term commitment by its parent Allianz that is believed to have contributed to the March 2005 departure of DKW’s head of corporate finance and origination, Steven Berger. This has resulted in speculation that Dresdner KW could be an alternative M&A target, making long-term planning difficult.
Investors have a clear opinion on the present performance of the top German banks, and Commerzbank, Deutsche Bank and HVB have all underperformed the DAX over the past year. However, with general market sentiment on the up and all these investment banks having completed severe rounds of cost cutting in the past two years, the prospects for improved performance look good. The important thing is for Germany’s investment banking operations to identify where their true skills lie, and pitch them appropriately to their clients.