When it comes to calculating risks, nobody does it better than insurance executives. It is, after all, their business. And when it comes to insurance executives, there is no better exponent than Henning Schulte-Noelle, chairman and chief executive of Munich-based insurance giant Allianz.
It seems ironic then that Mr Schulte-Noelle and the rest of Allianz's management board could have so woefully miscalculated the risks associated with buying Dresdner Bank when they took it over 15 months ago. Far from helping them to fulfil their ambition to create a global player in the bancassurance industry, Dresdner has emerged as financial black hole due to huge losses at its corporate lending business and investment bank, known as Dresdner Kleinwort Wasserstein (DrKW).
Profit warning
How difficult Dresdner has made things for Allianz became apparent on July 31, when the insurer surprised the markets by issuing a profit warning. In the warning, Allianz said that following a E350m loss in the second quarter, which was caused in large part by Dresdner, its net profit in 2002 would fall well short of a E3bn target.
Although the warning was thin on detail, the insurer attributed the problems at Dresdner to a steep increase in bad loans - notably in Latin America and the US - amid the ongoing global economic slowdown, and the weakness in capital markets, which hit DrKW hard.
The profit warning was particularly bitter for Allianz for two reasons. First, as one of the titans of German finance with a long track record of solid profitability, it was in the embarrassing position of having to disappoint its investors. Second, it was again frustrated in its aim to achieve E3bn in net profit, not because of anything it was doing but, arguably, because of something outside its business. Last year, for example, claims payments resulting from the destruction of the World Trade Center on September 11 cut in half the E3bn in profit that Allianz otherwise would have earned in 2001.
Tip of the iceberg
Even worse for Allianz, banking sources told The Banker that the second quarter was just the tip of the iceberg as far as Dresdner was concerned. They say the proliferation of bad loans combined with the sheer lack of M&A and underwriting activity due to bearish markets has led to E700m in losses at the Dresdner divisions, collectively named corporates & markets, in the first half of 2002. They say that corporates & markets will continue to haemorrhage money unless Allianz takes drastic action.
Much to the surprise of the German financial capital of Frankfurt, the debacle at Dresdner also debunked the myth that the bank, which is the country's third-largest in terms of assets, was in a stronger position than fourth-ranked Commerzbank. Until now, Commerzbank has been considered the "sick man" of the city's banking giants (see The Banker, 11/2001, p38). In fact, while Dresdner accounted for nearly all of Allianz's loss in the difficult second-quarter, Commerzbank managed to make an operating profit of E25m for the period. "What I've been hearing from Allianz executives in Munich is that the takeover of Dresdner was the worst mistake in the insurer's history," says one investment banker in London who asked not to be named.
Analysts said that, while it is unfortunate that the global economy and the markets have turned against Allianz since its takeover of Dresdner, Mr Schulte-Noelle and his board colleagues have only themselves to blame for their predicament. The risks associated with buying the bank were clear enough when Allianz bid for it in April 2001, they say. Considering the events surrounding the bid, it is hard to disagree.
As 2001 began, Dresdner was licking its wounds after failing to close two mergers, the first with Deutsche Bank and the second with Commerzbank in the spring and summer of 2000. The latter failure was particularly unfortunate because Commerzbank was well suited to Dresdner due to its size and strong focus on the domestic corporate and retail market.
"The failed merger talks, as well as Bernhardt Walter's [then Dresdner CEO] unsuccessful helicopter trip to Paris for talks with BNP Paribas, showed a bank that was just drifting instead of having a clear strategy," says Konrad Becker, bank analyst at the Munich-based private bank Merck Finck & Co. Dresdner's weakened position in early 2001 prompted intense speculation in Frankfurt that it would soon by taken over by a foreign bank. Industry experts also began to wonder aloud whether the beleaguered Dresdner, like Commerzbank, was strong enough to weather the nascent economic downturn.
Warnings ignored
It was amid this uncertainty that Allianz, which had been a major stakeholder in Dresdner (around 30%) for decades, and, as such, exerted a great deal of influence, decided to intervene in the bank's fate. Mr Schulte-Noelle, flanked by Paul Achleitner, the former Goldman Sachs investment banker who is the number two at Allianz, announced that the insurer would fully acquire Dresdner in a E24bn deal as part of an ambitious bancassurance project.
Beyond the question of whether it was wise for Allianz's board to get more involved with a bank that had already suffered two serious setbacks and whose fortunes were flagging, the conditions for the takeover were less than ideal. Financial markets continued to tumble due to the bursting of the new economy bubble and there were indications that Germany was heading for recession.
Analysts noted that Mr Schulte-Noelle and his colleagues ignored these warnings not only because they wished to prevent a feared takeover of Dresdner by a foreign bank but, more importantly, because they wanted to exploit the bank's extensive network of retail branches for their new insurance products related to the government's recent pension reforms. The reforms permitted millions of Germans to set up a private pension scheme that is independent from the government programme.
"The decision to buy Dresdner was primarily motivated by the hope that the insurance market would boom in Germany as a result of the government pension reform (so-called "Riester-Rente"). The trouble is that the Riester-Rente has proven to be a flop," says Mr Becker.
Banking sources also emphasise that it was folly for Allianz to take over all of Dresdner, including its bleeding corporates & markets division, when all it needed was the bank's retail branch network and fund management arm DIT to help it fulfil its bancassurance ambitions. "Allianz paid E24bn for Dresdner and now it realises it didn't need 80% of what the bank has to offer," says the London investment banker.
"It's true that Allianz does not need an investment bank to realise its goal of being a large global player in bancassurance," agrees Carsten Zielke, bank analyst at WestLB Panmure in Düsseldorf.
Scuppered plan
In fairness to Mr Schulte-Noelle, he had originally planned to sell DrKW after the Dresdner takeover but was dissuaded from doing so by Leonhard Fischer, head of the investment bank and the rest of corporates & markets. "The plan was to sell DrKW on the stock exchange but that was stopped when Mr Fischer argued that Dresdner's corporate clients needed capital markets services, including debt and equity platforms," says Mr Becker.
Yet, as witnessed during the 15 months since the Dresdner takeover, financial markets have continued their downward spiral, greatly discouraging companies from issuing either bonds or shares and engaging in any significant M&A activity.
Another big problem is DrKW itself. Born out of Dresdner's 1995 acquisition of the old UK investment bank Kleinwort Benson, the bank has not made much impact outside the UK. It has obtained only a 3% share of the European M&A market. Consequently, it lacks the connections, influence and (now more than ever) financial might to compete with the likes of Goldman Sachs, Morgan Stanley and Deutsche Bank for whatever European M&A deals may be on offer.
Dresdner's bad move
Even more aggravating for Allianz, Dresdner's purchase in late 2000 of the US investment bank Wasserstein Perrella, an M&A deals expert, has proven disastrous. Instead of enabling Dresdner to establish a badly-needed presence in the lucrative US M&A market, Wasserstein Perrella has taken the bank nowhere but down. The early departure of the investment bank's co-founder Bruce Wasserstein meant that DrKW lost valuable competence and connections for the US market; and the drying up of the M&A market has caused stinging losses at the bank. "For Dresdner, the purchase of Wasserstein Perrella was like throwing E1bn out the window," says the London investment banker.
Despite repeated attempts by The Banker, Leonhard Fischer, head of Dresdner corporates & markets, and Andrew Pisker, head of global equity and debt at DrKW in London, declined to be interviewed for this article.
In view of the violent shake-up taking place in the corporates & markets division, their reticence to speak to the media is understandable. A day after Allianz's bruising profit warning, Bernd Fahrholz, Dresdner CEO since late 2000, announced on the bank's website that 3000 of the unit's 10,800 jobs would be cut by 2003, with 95% to be affected immediately. This is in addition to thousands of previously announced job cuts at Dresdner, all of which are designed to save Allianz E2bn by the end of this year, although the insurer will take a E900m restructuring charge for the year.
Loan restructure
The proliferation of bad loans in Latin America and, to a lesser extent, the US also led Mr Fahrholz to disclose that the bank's non-European E40bn loan portfolio would be separated from corporates & markets and wound up in the next two or three years. In other words, the new entity will try to retrieve the loans that can still be paid or sell the loans on capital markets.
Banking sources say that, while it is wise for Allianz to cut its losses on the non-European credit front, it should brace itself for more damage to its bottom line caused by Dresdner dramatically increasing risk provisions. "Now the trouble really begins because many of these loans will be have to be written off, and it will be difficult to sell others on capital markets because investors demand nothing less than investment grade ratings," they say.
Few options for DrKW
DrKW's future, on the other hand, is a lot more uncertain. For Dresdner's part, Mr Fahrholz strongly denies that the investment bank will be separated from Allianz, noting that the cost-cutting measures now in place will suffice in turning the business around. On the website, he writes: "I have consistently denied this speculation [about a sale of DrKW]. It's totally superfluous. Our current strategy is to focus on increasing profitability. In concrete terms, this means stepping up sales activities and reducing costs."
But the analysts and banking sources questioned by The Banker agree that the insurer will sell DrKW at the earliest opportunity. Spinning it off, they say, is not an option due to its inability to survive on its own. And closing it down is not an option because Allianz wants desperately to save some face.
The only question Allianz must struggle with, therefore, is how soon the opportunity to sell DrKW will come. In today's difficult economic climate, no-one is willing to pay much for a second-tier investment bank with a mere 3% of the European M&A market and, at best, a marginal presence on Wall Street. "If Allianz is unlucky, DrKW will continue to bleed and, in the end, it will have to sell it for the symbolic value of £1 or E1. One can always find buyers for that. Even then, though, it will probably be happy to get rid of it," says Mr Becker. Whenever the sale is effected, the dismantling of Dresdner, once a powerhouse among Germany's commercial banks before embarking on an ill-advised international expansion in the 1990s, will be complete. All that will remain will be a retail branch network captive to Allianz's insurance and financial products, a high net-worth private banking unit and asset management operations, including DIT. The bank might as well begin changing its trademark green colour to Allianz's blue.
