Head of Commerzbank Corporates and Markets discusses how he intends to succeed where others have failed with Dresdner Kleinwort.

 

Two years ago, in an interview with The Banker, Commerzbank chairman Klaus Peter Müller bemoaned the fact that his bank’s market capitalisation was not large enough to enable it to grow by acquisition. In Germany, most rival banks were too big to buy, and the rest of the sector was state-owned and off limits. What a different world we now inhabit. With a market cap of just over €3bn as The Banker went to press, Commerzbank is paying about €5.1bn for Dresdner Bank in a mix of cash, shares and the swap of some assets.

While size still matters, bank merger and acquisition (M&A) is no longer a straightforward numbers game: politics is just as important. Governments around the globe are recapitalising beleaguered domestic banks and supporting rescue mergers that may come at the expense of shareholder interest. To ensure the Dresdner takeover succeeded, the German government injected €18.2bn in two tranches, but has taken a mere 25% stake. Allianz, Dresdner’s former owner, will hold 14% courtesy of its share package and asset swap.

Politically sound

Politically, the deal has a lot going for it. It solves the perennial problem of what to do about Dresdner. A sizeable commercial bank with a large retail base and a troublesome investment bank, it has long sat unhappily within insurer Allianz’s business. Moreover, the move creates another sizeable German bank (which the government hopes will be a national champion) and by securing Dresdner’s future, the government also believes it will help to rebuild confidence in the German financial sector.

Shareholders, however, are not happy. When Commerzbank accepted the first capital injection of €8.6bn in November last year, shareholders were relieved their interests would not be diluted by a further equity issue, despite being told they would have to wait at least two years for a dividend payment. But the second €10bn comes at a pretty high price. When the bank returns to profit, it will have to pay 9% annually on a total of €16.4bn borrowed from the government in the form of ‘silent participations’ – bond-like instruments that count towards the bank’s Tier 1 capital. Furthermore, any losses suffered by Commerzbank will first eat into shareholders’ common equity before hitting other capital instruments.

Many believe that taking on Dresdner Kleinwort, the bank’s investment banking unit, is a fool’s errand. No previous owner or CEO has seemed able to make the bank add up to the sum of its considerable parts. But Michael Reuther, head of Commerzbank Corporates and Markets, who will take control of Dresdner Kleinwort Investment Bank (DKIB), says this, too, makes a lot of strategic sense – even if right now some find it hard to see where that sense lies.

“DKIB has built up many successful pockets of business, but that success has always been undermined by management’s neglect of cost control. It built up too much leverage and took too much proprietary risk. Management never delivered on its promise to return to a ‘sales-driven’ culture and to focus on client business. We will deliver on that,” he says.

Clear vision

Mr Reuther has a clear vision for what the bank will be and how to make it work. If this does not paint a pretty picture for London, where the bank plans to cut 1200 of its 3300 staff, it plays to the bank’s strengths and is a straightforward proposition.

Like many smaller investment banks, the strategy is to be a full service bank at home and have areas of specialism abroad. So the combined Commerzbank/DKIB is going to concentrate most of its fire-power – in terms of corporate lending, and debt and equity underwriting – on German clients and doing business for them abroad. Non-German franchises in M&A, equity research, and equity and debt underwriting will be massively cut back. DKIB’s emerging market strategy research unit will be downsized.

If this sounds like Commerz is shedding all of DKIB’s business in the creation of a purely ‘German’ investment bank, Mr Reuther says this is not the case. “We certainly plan to be the number one investment bank in Germany, and our corporate finance business will focus on Germany,” he says, “but several areas will have a broader footprint – such as trading, equity derivatives, fixed income and foreign exchange (FX). This is not just a German business; we will still have about 7% of the bank’s capital allocated to central and eastern Europe – where we are very happy with our businesses in Poland, for example – and about €750m of capital allocated to the US.

“We are also keeping quite a lot of DKIB capability, including FX, electronic trading and fixed income. For example, Commerzbank focused on the euro as a currency, DKIB brings on board its dollar capability, its flow desk and its primary dealership in the US, where we are one of 16 primary dealers. We will also keep much of the leveraged finance business, although we will be reducing the leverage levels from between 8x to 11x to the 4x or 6x leverage that we are more comfortable with.”

Equally, while cash equities and research will definitely focus on German stocks, Commerz will keep DKIB’s US team, which has built a successful platform selling German stocks into the US, and the research effort that supports the business. Key areas that will continue to be developed as more international businesses going forward include FX, fixed income sales and trading, electronic trading and equity derivatives, which Mr Reuther expects will chalk up “three-digit millions in net operating profit” in 2008.

He believes the industry’s immediate future will be defined by simple structures and flow business. “We will develop a franchise built on client-centric activities and strong sales capabilities, and products with less complexity. This is what clients want now.” This will also help to reduce the bank’s cost base, he adds.

To enable staff to focus on building future revenue streams instead of managing troubled assets, Commerzbank has created a divisional restructuring unit (DRU) into which it will transfer a large chunk of assets the bank wants to shed. Although it will contain some commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS) from Commerzbank, the lion’s share will be made up of structured credit and asset-backed securities from DKIB. In many ways, the DRU is similar to the institutional restructuring unit (IRU) created by Dresdner in 2003 as a means to downsize its non-strategic loan portfolio by E36bn and focus on key clients.

Disposal plan

Commerzbank’s internal ‘bad bank’ – which Mr Reuther thinks may become Germany’s preferred mechanism to dispose of assets rather than a national bad bank – has a three or four-year disposal plan. It will have a dedicated sales team and will be headed by Vijay Radhakishun, DKIB’s head of securitised finance who advised Dresdner on its IRU when he worked at Goldman Sachs’s special situations group. “Segregating these assets in DRU creates a clean break and will enable the rest of the bank to focus on developing new business without the distraction of asset disposal,” says Mr Reuther.

One of his biggest challenges will be to create a coherent whole out of the disparate parts of DKIB that Commerzbank is keeping, and marrying two very different cultures. The plan is to encapsulate the best of Commerzbank’s sales-focused, client-driven and risk-aware style and DKIB’s high-performance, innovation-oriented culture, without succumbing to the weaknesses of either.

It is a tall order that many senior managers have failed to achieve. Mr Reuther believes he has the right team. Four of the 12-strong senior management team are key DKIB managing directors, including Mr Radhakishun. The others are Berent Wallendahl, head of client relationship management, Ralf Werres, head of sales, and Susan Dingilian, the head of US operations.

Moreover, Mr Reuther is convinced that Commerzbank has already demonstrated its ability to de-risk a business – it has spent the past few years cutting back on risky trading at its investment bank operations – and to bring different parts of the business together to yield cross-sales and better client service. “Like other banks, we have made mistakes but we have demonstrated that we can deliver good results and connectivity between different parts of the business without letting costs get out of control,” he says.

Major task ahead

Mr Reuther is under no illusions about the mountainous task ahead: carrying out a difficult integration and downsizing in the most hostile of markets. But he thinks that Commerzbank’s German focus will pay off, and the outlook is not entirely bleak. For one thing, Germany’s corporates built up quite a big equity cushion during the good times. Equally, some business lines are doing pretty well. The bank’s equity derivatives, FX and fixed income businesses are growing, and its German debt underwriting business has been busy. Since the start of the year, it has been a bookrunner on Eurobonds for E.ON, BMW, Volkswagen and RWE, and it was a bookrunner on BNP Paribas’ €1.5bn covered bond, which reopened a market that had been closed since September 2008.

If anything, Mr Reuther seems to relish the challenge ahead and the chance to prove critics wrong. “We have had bad press about timing of the acquisition. We’ve got very little to lose, and everything to gain. In the long term, I think the strategic sense of the deal will look more obvious. In about three years, we will have proved that we can do it and it will look like a very smart deal.”

Career history

Michael Reuther

2006  Joined Commerzbank as a member of the Board of Management of Directors
2003  Promoted to global head of liquidity management, Treasurer Europe, Deutsche Bank in Frankfurt
2000  Appointed global head of liquidity management, treasurer at Deutsche Bank in London
1995  Appointed global head of liquidity management, Deutsche Bank in Frankfurt
1992  Posted to Deutsche’s Treasury operations in New York
1991  Moved to the treasury at Deutsche’s Frankfurt operations
1989  Joined Deutsche’s corporate finance division in Frankfurt am Main
1987  Joined Deutsche Bank in Osnabrück as a management trainee
1987  Graduated with a law degree from the Universities of Göttingen and Freiberg

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