The Anglo File: German Banks Look Abroad for Potential Partners

The domestic consolidation of Europe's banks is picking up pace, but the Germans seem immune to the benefits of this.
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The Spanish have done it, the Italians are doing it and the French are bickering about it. Unfortunately, the Germans just can't seem to get down to it.

The consolidation of Europe's banking industry is, by most accounts, a much needed and welcome process. Although not entirely a recent phenomenon, this rationalization has certainly been accelerated by the euro, which is creating a pan-European market for capital and exposing financial institutions to keener competition.

Last week saw not one but two major proposed mergers in Italy between

UniCredito

and

Banca Commerciale Italiana

and between

San Paolo-IMI

and

Banca di Roma

. This followed

Banque National de Paris'

bid to get in on the merger between

Societe Generale

and

Paribas

and, earlier this year,

Banco Santander's

(STD)

agreement to merge with

Banco Central Hispano

(BCH) - Get Report

.

Hopes that this process might spill over to Germany, however, remain unrealistic. The problem largely lies with the structure of the German banking market, which is dominated by the big public-sector

Landesbanken

and the smaller state-owned

Sparkassen

savings.

Germany is one of Europe's most fragmented banking markets, with the top five banks controlling only about 24% of the market. This compares with the Netherlands, where the top five banks control some 80% of the market. Germany is overbanked and overbranched, with the country having 0.58 branches per 1,000 people, compared with the U.K., which has a meager 0.26 branches.

There has been some demutualization, but last year's collapse of the proposed merger between

Nord LB

, Germany's third-largest Landesbank, and

Bankgesellschaft Berlin

is symptomatic of how difficult and drawn-out this process is likely to be.

The German banks' "reluctance to acknowledge even the potential benefits of in-market consolidation is starting to undermine their credibility,"

Salomon Smith Barney

wrote this week in its

European Bank Weekly

.

The share prices of the three Frankfurt banks --

Deutsche Bank

,

Dresdner Bank

and

Commerzbank

-- have all underperformed the

Xetra Dax

index by 20% to 30% over the past 12 months.

Most worrisome for the banks is that they are slipping perilously down the ranking of European financial institutions in terms of market capitalization. Germany's four largest banks are all below the 30-billion-euro minimum level, which many analysts feel is required to achieve the economies of scale and pricing power necessary to compete effectively on a European scale.

According to

Primark Datastream

, a global information services company, should the recent bank mergers in France and Italy go through, Germany's largest bank, Deutsche, is only No. 15 in the rankings.

Commerz, the smallest of the three Frankfurt banks with a market cap of 13.6 billion euros, had looked the most vulnerable to takeover by one of the other Frankfurt banks. But its decision to enter a cooperation agreement with Italian insurer

Generali

, which took a 5% stake in Commerz, effectively squashed any hopes of this.

With little available at home, the three Frankfurt banks are setting their sights across Europe's borders. However, there are questions whether cross-border deals can offer the same value creation that comes from domestic mergers.

Despite the euro, cross-border deals are still difficult to execute on account of different regulatory environments, meddling governments and parsimonious shareholders who question the cost-effectiveness of international mergers when banking margins remain so tight.

Deutsche has pursued a policy of creating strategic alliances with other European financial institutions. It acquired a 4.5% stake in Italy's BCI and a 0.75% stake in UniCredito, and it has interests in Spain, Belgium and Greece. The only major market in which it has tried, but so far failed, to strike up a partnership is France, which is proving hard for most foreign banks.

Unfortunately, all these investments and alliances may not necessarily be good for the shareholders. As one analyst puts it, "Deutsche Bank tends to do what it thinks is right, not necessarily what is in the shareholders' interests." This is perfectly illustrated by the

Bankers Trust

(BT)

acquisition, which is proving unpopular with just about anyone with an interest in the matter.

Unfortunately for Deutsche, there are two main problems with its European excursions. First, the bank is viewed with a degree of suspicion by other banks, which assume it is in Deutsche's nature to dominate any joint venture. Second, Deutsche has a formidable rival in German insurer

Allianz

, which owns a 21% stake in Dresdner.

According to Keith Baird, an analyst at

Enskilda Securities

, Allianz is the "spider in the European web of cross-holdings and may use its interests to frustrate Deutsche's attempts to forge alliances with other European banks in France and Italy, the two key markets for Deutsche."

Deutsche is boxed in strategically, which could be why it decided to go after Bankers Trust.

Dresdner is also facing dwindling options. The management has stated it wants to make a strategic move in Euroland, but with a lack of suitable partners, it could risk rushing into a less-than-ideal investment.

Alternatively, Dresdner may go down the same route as Deutsche and buy a U.S. investment bank such as

PaineWebber

(PWJ)

. There would be significant risks associated with such an acquisition, but according to a report by

J.P. Morgan

, if handled correctly, it would provide scope for considerable cost savings in investment banking operations.

Despite Commerz's stated intention to remain independent, it may find itself forced into a deal to protect itself. One option is a merger with

AMB

, the German subsidiary of Generali.

The overwhelming feeling is that the German banks have to do something for fear of being left behind in a market that their country, probably more than any other, helped to create. But before embarking on grand European ventures, they would do worse than to remember that there's really no place like home.