Germany 2006 All to play for
The past 12 months have seen significant changes for German banks. Unicredit acquired Hypovereinsbank, DrKW began to integrate more closely with its parent bank under a new head, while Commerzbank acquired Eurohypo. Deutsche Bank continues to shine internationally and retains a substantial share of its domestic market. At the same time, Germany is under attack from foreign banks. Owen Wild reports.
German banks have traditionally had the small and mid-cap sector all to themselves, as long as international banks have only been interested in banking big-ticket clients. But with each passing year, the domestic banks' inbuilt local advantage is eroding as international banks aggressively court more clients.
In ECM, Credit Suisse was joint bookrunner on the €49.6m IPO of biotech Jerini, while Morgan Stanley ran the books on the €83.2m flotation of gaming company Tipp24. The appearance of international banks on deals of this size is a threat to the quasi-monopoly that had previously existed with regard to Mittelstand companies.
“Many international banks ceased providing mid-cap research and brokerage in recent years," said Eberhard Dilger, head of ECM at Commerzbank. "Hedge funds and private equity are now prompting them to rebuild teams. This will trickle down into investment banking but international banks' fee requirements are greater due to higher costs, limiting their ability to compete in the Mittelstand."
German banks have been refocusing their businesses over the past two years to ensure they retain control of the mid-market. Commerzbank is the first to have seen the boost that restructuring can provide. In November 2004, the bank made 900 staff redundant as it re-aligned its business.
“We decided to change our business mix,” said Nicholas Teller, head of corporates and markets at Commerzbank. “There was too much proprietary trading which led to too much risk for the underlying business so we cut this and took VaR down substantially. We also closed Tokyo and reduced the size of the US business.”
The need for the dramatic cutback was shown in the bank’s results for Q3 2004 which showed an operating loss of €171m, including a €9m loss from trading, principally from convertibles and proprietary equity trading. Corporate and investment banking was split into three covering Mittelstand banking, international corporate banking and corporates and markets. The C&M group is now focused on servicing 120 key clients rather than proprietary activities.
“Over 90% of our business is now client driven,” said Teller. “We only trade where client business is underlying it. We are now focused on our product franchise and serving our multinational, retail and institutional clients plus the Bank's Mittelstand corporate base."
On maintaining an international footprint, Teller noted that “if selling equity it can’t just be placed in Germany, you need to be able to sell in to Scandinavia, the UK, US and everywhere else in Europe. To construct complex products you may need to source local credit. You need the know-how globally to serve clients locally".
The result of the bank’s renewed focus has been a significant improvement in performance. C&M moved from a loss-making position in 2004 to profit in 2005. The business turned a return on equity of -10.2% in 2004 into 11.4% in 2005, and is now targeting 15% in 2006 rapidly rising to 20% the following year. At present the bank is on track to meet this year’s target.
Prospects for consolidation are limited domestically, but Commerzbank made a significant change to its business with the €4.56bn acquisition of Eurohypo. The acquisition closes at the end of the first quarter and 17 project groups will report on how to integrate and grow the business at the end of May.
The acquisition provides Commerzbank with a stable business and predictable cashflows. But the bank is also acquiring a significant position in real estate financing. Following the acquisition, Commerz will account for 25% of pfandbrief issuance and be the largest issuer of mortgage-backed securities. To further smooth returns and free up capital, the bank will also securitise part of its loan book of US$4bn-$5bn in the second quarter with a CLO that will release US$180m of equity.
The transaction will be the first to come out of the loan portfolio management group that was established in the wake of losses caused by the downgrades of GM and Ford in 2005. The group is charged with smoothing the peaks and troughs in C&M and then the whole of the bank.
DrKW looks for growth
Commerzbank’s rapid turnaround shows the potential for Dresdner Kleinwort Wasserstein in restructuring its business. DrKW has been given a target ROE of 12% by parent Allianz, up from the 8.85% achieved in the last financial year. Dresdner Bank merged DrKW with its corporate bank at the end of 2005 in order to maximise the cross-over potential that other banks saw several years ago. The process is being led by new CEO Stefan Jentzsch, who oversaw a similar operation, albeit on a smaller scale, at HVB.
DrKW hopes to boost revenues from the German market by increasing sales of investment banking products to corporates. Driving this are Mittelstand businesses increasingly seeking different sources of financing, and M&A, which has taken off in Germany. The bank will leverage the 9,000 clients of the corporate bank to improve its position in Germany while retaining the international footprint.
Jentzsch has spent his first few months carrying out business reviews and is said to be bullish on the firm's prospects. In early March, DrKW was hired by Schering, alongside Morgan Stanley, as defence advisor on the €15bn hostile bid from Merck. If this was a boost to DrKW's and Jentzsch's confidence, it also supported the new CEO's sense that DrKW's ability to originate and execute quality investment banking business remains very high.
A key focus now is rebuilding the firm's client franchises principally in Germany and the UK, but also building out in France and Italy with the help of Allianz's powerful footprint (the insurer owns AGF and RAS). Jentzsch reportedly believes that DrKW has been far too internally focused; his mission is to refocus the bankers' attentions on clients.
He is also said to be keen to improve the poor internal relations between UK and Germany where, for example, the London and Frankfurt equity dealing rooms have been using different trading systems. The firm is combining the two trading capabilities and will likely locate the principal facility in London, helping in the process to allay concerns that Jentzsch's primary mission was to 'Germanise' the bank.
On this specific point, Jentzsch believes the bank has been neglecting a lot of low-hanging fruit in Germany, a market that continues to generate a high proportion of the European investment banking fee pool. But he also has international ambitions. DrKW claims the number one spot in distributing German equities into the US. Jentzsch does not see, for example, why the firm should not be able to expand its capabilities to become a leading distributor of pan-European equities into the US.
Whilst at HVB, Jentzsch had played a lead role in bringing the corporate and investment banking operations together. He also brought executives into offices overlooking the trading floor so they were closer to operations.
Following his departure, he was replaced by Ronald Seilheimer, but it remains unclear how the bank will move forward following the merger. HVB is not commenting on its plans. Unicredit holds a similar position in the Italian market as HVB holds in Germany, so there are some clear opportunities to work together.
While others restructure, Deutsche Bank is capturing an ever larger slice of German business thanks to its full-service offering and focus on the client rather than product groups. This is especially true with the resurgence in M&A.
“The dialogue with clients is key to winning each mandate as it has moved us away from a product-based platform,” said Berthold Fuerst, co-head of M&A Germany at Deutsche Bank. “BOC exemplifies this as Linde’s acquisition and our mandate for it comes from detailed dialogue on strategic options and not suggesting a particular product.”
Global house, local partner
The challenge from international banks is being stepped up as their focus moves away from the largest companies. At present, their relationships with mid-cap companies tend to be made through private equity firms. However a new partnership forged by JPMorgan and Sal Oppenheim shows how this could change.
The two banks formed a strategic partnership late last year for real estate investment banking in Germany. The move is designed to capitalise on the expected introduction of Real Estate Investment Trusts (REITs) in January 2007 and the increased demand for capital market services from real estate investment companies.
The move is an effective challenge to Deutsche Bank’s position, as JPMorgan will now be able to combine the benefits of being a global firm with Sal Oppenheim's greater access to domestic firms. The partnership has already yielded its first success in the form of the IPO of Patrizia Immobilien in March. Both firms were joint bookrunners alongside Deutsche Bank. Strategic partnerships such as this can offer an effective competitor to Deutsche Bank, but are limited in how widely they can be used without banks merging.
German banking is becoming more competitive as international houses increase the number of bankers located in-country. Announced M&A deals to March 13 2006 totalled US$110.7bn, up from just US$27.1bn the year before. The top five advisory banks this year includes only one German house, Deutsche Bank.
But the current M&A boom should be a prime opportunity for domestic houses to capture advisory mandates, particularly when the Mittelstand is seeing as much M&A activity as multinationals.