It took Bayerische Vereinsbank’s chief executive Albrecht Schmidt an age to gain the politicians’ approval for a major bank merger. It eventually turned out to be with Bayerische Hypo-Bank. Part of the time was also taken up with concocting a plausible strategy for the merged bank – which would be the second-largest in Europe, persuading his arch-rival of the benefits and finally devising a way to avoid punitive capital-gains taxation on the deal.
Schmidt had been watching the situation carefully, but it was Deutsche Bank that made the first overt move when in July 1996 it revealed that it had built up a stake of over 5% in Vereinsbank. “It was unexpected and too early,” says Schmidt, “because our plans weren’t sufficiently advanced to respond.” But he skilfully made use of the takeover speculation, which pushed up his bank’s share price. Some observers, such as WestLB banking analyst Stefan Ermisch, even suggest that the rumours were fuelled “from Munich boardrooms” for that purpose.
Schmidt had another reason to be grateful to Deutsche. The intransigence of the German establishment, rather than lack of energy on his part, had caused his scheme to limp along before that day last summer.
The German market leader’s surprise announcement convinced other German bankers that mega-mergers were inevitable and should be considered seriously. Schmidt met Martin Kohlhaussen of Commerzbank for talks, but the two failed to work out a meaningful strategy. By spring, the “merger of equals” with Hypo-Bank was agreed; presumably after Bavaria’s political masters, who knew both banks’ true business position, had induced Hypo-Bank boss Eberhard Martini to accept a merger as the best course (the price he paid was early retirement).
A grand scheme tempered by pragmatism and politics? No wonder Schmidt admits to misgivings about the rapturous reception investors have given his merger plan and the share swap that made it possible. “It’s gone almost too smoothly,” says Schmidt, who will head the new bank – Bayerische Hypo- und Vereinsbank (BHV).
So far, he has been lucky. Schmidt showed his hand in July, just as European bankers were beginning to doubt the wisdom of a costly commitment to investment banking. Now Barclays has decided to sell BZW. There’s doubt whether Commerzbank can succeed in its belated bid to join the world league in investment banking. Numerous commercial banks are wooing a few investment banks but shying away from high prices. So the equity market is highly vulnerable to the charms of a sizeable bank prepared to limit its ambitions in trading and sales, corporate finance and capital markets.
BHV aims to become a “super-regional” player in Europe with only limited ambitions as an investment bank. Rather, it will concentrate on generating handsome shareholder returns from retail and corporate banking, asset management and some capital-market business. Expressed so succinctly, the scheme sounds plausible. But it has limitations, in theory and in practice.
Months after the new strategy was revealed, it still isn’t clear how much potential there is to increase efficiency and reduce costs by merging the two banks. At roadshows in July, their officials told analysts that within five years they would jointly save Dm440 million ($247 million) on the branch network, Dm110 million on international operations and Dm500 million on headquarters and information technology – total potential savings of Dm1.05 billion a year.
On the other side of the equation, restructuring costs of Dm1.25 billion will be spread over the first two years. All the evidence suggests, however, that this figure is based on guesswork.
The great unknown is the cost of laying off staff – an expensive and cumbersome business in Germany – and closing branches. Both banks’ managements insist that they have not yet decided how many of the 40,000 employees will have to go. Although analysts reckon it could be as many as 10,000, the Bavarians denounce even informed guesses as irresponsible. One German banking consultant estimates that the substantial pay-offs to redundant staff will amount to no more than Dm500 million, but he’s guessing too. Pessimists suspect that the unions will mobilize political support so that redundancies are fewer and slower than Schmidt would like.
“There’s so much inflexibility in the [German] labour market, so the restructuring will be neither as drastic nor can it be effected as quickly as, say, in the UK,” says Christian Landers, head of equity sales at Fidelity Capital Markets. “What you hear is politics. The question is what you are going to see.”
Every analyst assumes that branches will be significantly reduced in number, since both banks have hundreds concentrated in the state of Bavaria. But they may be disappointed. Analysts reckon 350 of the 1,300 branches could be eliminated without inconveniencing customers. But Schmidt is hinting that there may be far fewer closures. “It would be madness just to close branches down,” he says. “We’ll give them another purpose instead.”
Five years
The schedule for knitting the two banks together is also unclear. Initially Schmidt said the merger would have to be completed rapidly, now there’s talk of “five years at least”.
Staff at the two head offices, both in Munich, are most worried about the decision to merge back-office and support functions. “Be the best and you will still have a job,” was the message they received. They have also been told that there will be no co-heads in any position; many have interpreted this as a command to compete openly with their counterparts at the other bank, as well as within their own bank.
One Vereinsbank executive describes how several of his colleagues, in Munich and at international subsidiaries, have begun jostling for attention from the board members they report to by firing off memos containing grand new strategic designs. “You’d think they could have got around to it before,” he comments with some bitterness.
The vying is particularly ferocious at Hypo-Bank, where many staffers describe the so-called “merger of equals” as a takeover by Vereinsbank, particularly as their boss, Martini, has effectively ceded to Schmidt by announcing his retirement for next year.
In their view, Schmidt did his best to seize the initiative even before the merger announcement. Equity capital markets is just one example. Vereinsbank had long had no one heading that business and Schmidt evidently perceived that if the position remained unfilled it might be claimed by a Hypo-Bank staffer. Two days before the merger was made public, Olaf Schuth was hired from Dresdner Bank to take the Vereinsbank vacancy (he didn’t know about the merger either at the time). It’s likely Schuth will retain that role in the new bank.
Consolation for Hypo-Bank’s staff has come in the form of a new staff share scheme and an advertising campaign, bizarrely launched after the merger was announced. But it has been noticed that Hypo’s board members are already allowing Schmidt to speak for them, even though Hypo will remain independent for another year.
Although Schmidt pays lip service to the merger of equals, common sense suggests he is more likely to select the staff he knows, from the board down. “I don’t have to be diplomatic or distribute jobs fifty-fifty,” he says. “I just need to get the best person for the job.”
From their tower block on the other side of Munich’s Englischer Garten, Hypo-Bank’s management appears to be losing out. At first sight, indeed, it is unclear why Hypo agreed to the merger at all. Vereinsbank’s management readily admits that Hypo-Bank has been admirably daring in new business ventures, and some of these have been resounding successes, such as Direkt Anlage Bank, Germany’s first discount broker. Hypo is also notably stronger in asset management, particularly on the institutional side. Its cost-income ratio is less than 60%, lower than any other big German bank.
A merger with Vereinsbank was probably regarded as a lesser evil than the other possibility: a far less considerate takeover by Dresdner Bank. Hence Martini may have accepted the merger and his own retirement as the price for a relatively equal partnership.
Vereinsbank also has notable successes on its track record. Vereinsbank was the first German bank to articulate a “regional” strategy involving countries in eastern Europe and remains one of the leading innovators in the huge Pfandbrief market. Over the past two years it has set up Germany’s first up-market direct bank and is the first German bank with corporate television. Unlike its competitors, Vereinsbank has continued to increase staff numbers in recent years by expanding.
For Schmidt, however, this was just the start. Vereinsbank’s boss is emerging from relative obscurity as an ambitious banker determined to make an impact on European banking – within a relatively short time. He admits to impatience: “I don’t want to wait until I’m retired to see these plans succeed.”
The staff of both Bavarian banks have always jocularly split themselves into two groups: the jovial Bavarians and the disciplined “Prussians” (other Germans and the few foreigners who work on either side of the park in Munich). Schmidt is firmly in the latter group. He admits he can’t speak Bavarian dialect but nevertheless tries to cultivate the common touch. Sometimes he goes to Munich beer gardens hoping to overhear his staff or customers giving their candid opinion of the bank, tongues loosened by the local brew.
Social drinking aside, even Schmidt’s closest aides say they don’t know what he does in his spare time, though he has been seen on the ski slopes. His only known enthusiasm is contemporary art. During a visit to his home town Leipzig in October 1997 for the opening of the bank’s new premises there, Schmidt visited young artists who work in warehouses, unable to afford proper studios, to seek new acquisitions for his personal collection.
Schmidt is said to be dominant among board colleagues at Vereinsbank, some of whom didn’t know about the merger plan until just before it was announced. This is a man who consistently says “I” and never “we” when describing how the BHV strategy evolved.
“Schmidt places people around him who tend to listen and aren’t as active as he is. Sometimes he has genius ideas on the spur of the moment, but he isn’t a great strategist. His strength is managing day-to-day business,” says a senior German banker Schmidt recently tried to recruit. “He’s like a politician who goes on negotiating until he reaches a compromise everyone can accept.”
Schmidt’s fondness for negotiation may explain why the strategy of BHV is evidently still evolving, after months of talking between the two banks’ boards. Gradually, however, Schmidt’s true plans seem to be emerging.
While analysts have been enthusing about gains in efficiency and lower costs, Schmidt has gradually revealed his real objective: to grow BHV into a bank of the regions, with a significant presence throughout Europe. In terms of current assets (though not by capital), BHV will already be the second-largest bank in Europe. Diversifying elsewhere in Europe might enable it to overtake Deutsche Bank.
But do investors want this? The only part of the scheme that has really excited them is cost reduction and synergies. Unfortunately, the merger per se will do no more than that. The two banks are extremely similar, selling the same type of products to the same type of customers. So there will be no immediate opportunities to broaden the product range or cross-sell new products.
Analysts point out that the merger will bring neither greater international reach nor greater expertise in comparatively weak areas such as capital markets and asset management. If these are Schmidt’s real aims, he would have come much closer to them through a merger with Commerzbank.
“I’d known for a long time that Vereinsbank alone wasn’t capable of expanding into the European market,” Schmidt says. “Now we want to be big in every region of Europe.” Already, he boasts of a double-digit market share outside the bank’s home region of Bavaria, but that is only in the small markets of Hungary and the Czech Republic.
The business split
BHV will pursue much the same strategy as Vereinsbank before it, just on a larger scale. Business will be divided into five main areas: mortgage and real-estate lending; asset management; selected treasury products; retail banking and corporate banking, with an emphasis on medium-sized companies. The new pan-European ambition means, however, that each of those businesses will have to be transformed.
It’s not easy to find out exactly how this will happen. Schmidt’s Big Idea to create a super-regional bank in Europe is unclear and unpre-cedented. Even the terminology is confused. Schmidt began by talking of a super-regional bank, but has now switched to the notion of a multi-regional institution. That implies strength in some European markets but no overall coverage. In fact, Schmidt prefers volunteering information about what he doesn’t want to do. It’s hardly surprising that BHV doesn’t want to be a global investment bank; devising a more ambitious plan from such modest beginnings would be foolhardy.
All the details available suggest that BHV will have to invest massively, so that the stated aim to emulate Lloyds Bank and NationsBank as a champion of shareholder value may take years to accomplish.
In asset management, BHV will need to become much more significant than the two banks combined. At present they have some Dm160 billion under management, far less than competitors and less than the critical mass, which insiders estimate to be Dm200 billion. Almost all the current volume comes from retail clients and only Hypo-Bank has any noteworthy institutional business. To make matters worse, Vereinsbank is immersed in a bitter battle over Adig, the German retail fund manager it shares with Commerzbank. Both sides want full control, and the loser will cede around Dm20 billion of assets under management.
Expansion into other markets will probably mean purchasing a European asset management house and finding a cooperation partner in the US and Asian markets.
Mortgage and real-estate lending are probably the strongest suit for BHV, which will have a market share of more than 10% in Germany. Elsewhere in Europe it is already well established. But further expansion will require substantial investment in the retail market, because the mortgage bonds will need to be distributed to small investors.
Retail and corporate banking won’t be easy either, since the two banks’ customers are derived overwhelmingly from southern Germany and from the small markets in the Czech Republic and Hungary.
“This is all about distribution, and they don’t even have a national network, let alone a European network, and prices are so high that it’s not the time to buy,” says the head of asset management at a rival German bank.
Schmidt’s answer is to open even more branches in other parts of Germany and to consider venturing into retail banking in such countries as France and Italy. “What’s important is the number of contact points,” says Schmidt, implying that phone and direct banking would be used to create a new customer base in other European countries. Yet by the standards of its German direct subsidiary, Advance Bank, any progress will be gradual and expensive. Vereinsbank is now selling Advance Bank after 18 months because its losses have been so huge.
The most startling plans, however, are in the international financial markets. Schmidt talks of becoming a dominant European player in fixed-income, forex and some derivatives. He plans to sell all euro-denominated fixed-income products to investors worldwide; he will not be drawn, however, on how Vereinsbank’s current sales and research teams can be expanded to achieve that.
When asked about Vereinsbank’s particular strengths in fixed income and foreign exchange, he brags that the bank is number one in the Greek drachma market.
In equities. BHV’s aims are more modest. Schmidt says that the equity capital markets should concentrate on acquiring medium-sized clients in all European markets, while aiming to participate in major syndicates. But staff in the investment banking division argue that they will have to expand just to stand still, since syndicate roles for non-global banks will become rarer. In their view, the real challenge is to maintain Vereinsbank’s track record of participating in every issuing syndicate for a DAX (top-30 German listed) company. No decision has yet been made on how to achieve this.
The drawback is that these ambitions inherently increase operating costs and, at least in the short term, limit the revenues shareholders have already grown to expect.
Crucial to the success of BHV is a capital increase for Vereinsbank. The main part of this is a global offering which began with pre-marketing on October 10 and continued with a series of roadshows from October 22. In total, the issue is expected to raise over Dm3 billion.
Champagne or ginger beer?
Already, that figure looks too low. Practically the entire Dm3 billion will be needed to create acceptable capital ratios at the new bank. Little or nothing will be left for new investment, and cashflow will probably be absorbed by restructuring costs. Staff at both banks are asking why Schmidt does not increase the issue while investor confidence in the new bank and the general mood in the equities market are so strong.
“I would keep on increasing the issue until the share price dips below Dm100,” says one Vereinsbank senior manager (in the volatile market of late October the share price did in fact fall below this level from a mid-October price of Dm109). But Schmidt isn’t seeking the opinions of others.
With only ginger-beer money available, Schmidt’s champagne ideas may have to be compromised. The asset management division may end up seeking a cooperation because an acquisition would be too costly. Plans to expand retail and corporate banking into such markets as France and Italy may be postponed for years. It’s hard to imagine BHV trying to pay London salaries to its Munich-based traders and investment bankers.
Amid all this uncertainty, it’s no wonder that BHV’s promises of superior financial performance are equally vague. It’s worth asking whether it will be willing and able to live up to the standards of disclosure and performance suggested by the “super-regional” epithet.
So far, almost nothing has been said about long-term profitability. At an analysts’ meeting for the share swap in August, Schmidt became confused about the new bank’s return-on-equity target. Was the 15% target before or after tax? Before tax would certainly be too low (Deutsche Bank aspires to 25%), but 15% after tax may be over-optimistic for a company in Germany, where corporate tax is high. Schmidt has now compromised by sticking to the more ambitious aim, but promising it only “in the medium term”.
He is probably years away from approaching the performance of BHV’s model, Lloyds Bank, which achieved a return on equity in the first half of 1997 of more than 40% – after tax. Pro-forma calculations based on both banks’ 1996 results currently give 8% ROE for BHV, less than the current cost of capital.
Nor has he attempted to match Lloyds’ shareholder pledge: to double the share price every three years. That is quite feasible now: after all, the Vereinsbank share has more than doubled since last July, but may not appear so easy once Schmidt starts spending.
Michael Kemmer, head of accounting at Vereinsbank, concedes that investors now expect more transparency in BHV’s accounts as part of the shareholder-value pledge, and says the new bank will probably have to offer “something extra” in its published accounts.
That is easier said than done, as Kemmer also concedes. Even if BHV achieves superlative performance, the limitations of its accounting systems mean that it cannot release those figures in the same depth as, say, Lloyds Bank.
Already, Vereinsbank’s plan to disclose more by adopting international accounting standards in the 1997 accounts has been abandoned, because Hypo-Bank is unable to do the same. Although Vereinsbank has already given some basic sectoral earnings figures, the limitations of both banks’ systems will make it tricky to publish any figures showing capital allocation per sector, Kemmer says.
In the meantime, Schmidt must somehow maintain investors’ confidence. Back in January, when WestLB published its visionary research report on German banks, which predicted a Vereinsbank/Hypo-Bank merger as the most likely scenario, both Bavarian institutions were viewed by analyst Stefan Ermisch as fundamentally overvalued. Even then, the euphoria over a possible merger was the main justification for the two banks’ share prices, Ermisch said. Since then, Vereinsbank’s price has risen much further still, from Dm60 to Dm113, and Hypo’s price from Dm48 to Dm86.
Ever since Deutsche Bank’s participation became known 16 months ago, Schmidt and his colleagues on the Vereinsbank board have been preoccupied with the “defence strategy”, as it came to be known to insiders. Other projects, such as the planned expansion in asset management, were put on ice to allow the board to devote its energies to repelling the hostile takeover bid that never came.
Now Schmidt is acutely aware of the time he has already lost. “My aim is to keep the pit stop as short as possible,” he says over and over again, referring to the dangerous 12 months ahead when the bank is most likely to lose customers and staff.
A year’s delay
But he must also be concerned about the limitless period which will follow, as BHV tries to reshape itself into the super-regional giant it promises to be.
Now, even the procedure of merger is testing investors’ patience. Unfortunately it’s taking far longer than Schmidt and his advisers at JP Morgan would like, because of the requirements of German law. The merger plan cannot be approved until the annual shareholder meetings in May. Several more months’ waiting time will then elapse before the merger is completed in law, probably in September or October 1998. Some insiders insist that Schmidt should have used international (essentially British) corporate law as the basis for the merger, just to get things done quicker.
As for future plans, the new BHV board can do little but talk until next September or October, when the merger is officially completed and Hypo-Bank is subsumed into Vereinsbank on the basis of a merger ratio now being calculated by external auditors.
“The time frame is the big problem,” says Landers of Fidelity Capital Markets. “The economies of scale and the process of restructuring will take too long from the US or UK investor’s point of view. This scheme will take five years at least, but in the US it could easily be realized in half that time.”
Hypo-Bank has given Schmidt just enough information about its business to enable him to formulate a strategy, but no real business plan is feasible yet. From inside both banks, Schmidt is being warned that investors may become disillusioned in the absence of good news for shareholders in the next few months. On the other hand, it is hard to see what good news is possible before the new strategy kicks in sometime after next autumn.
Although Schmidt insists otherwise, there’s no doubt that he is under pressure – at least from public opinion – to show results at BHV before the possibility of a further merger with Dresdner Bank becomes the subject of negotiations, rather than the present speculation.
Meanwhile, private opinion inside both banks is concerned with the immediate future. Many senior managers in both banks are still not convinced that the merger makes sense. They also complain that three months after the merger announcement, Schmidt has still not made fundamental decisions like naming the new bank’s board. “I want to know which board member I’m going to be working for,” says a senior Vereinsbank executive. “If that person doesn’t suit me, I’ll be gone.”
