Mergers A La Carte

The increasing pace at which companies across the economic spectrum are coupling is a bit disquieting. Fueled in large part by excess capacity, giants in energy, communications, technology, retail, entertainment, autos, and manufacturing seem to be ever-swelling and flowing into each other. The value of corporate mergers in the first week of December exceeded those in all of November.

Now bankers and other industry observers are pondering the implications of Deutsche Bank’s $10.1 billion takeover of Bankers Trust, America’s eighth-largest bank. The merger created the world’s largest financial services group, with assets of $834 billion, which is now continuing its growth with the purchase of Credit Lyonnais Belgium for $588 million. As Deutsche Bank and Bankers Trust get hitched, the financial scene seems in line with other transcontinental industry expansions. Given how fluid capital is, it’s tempting to assume that the financial industry might be even more prone to global matchmaking. Are international mergers good for competition, or are such alliances a threat to U.S. banks’ franchises in the future? One thing is certain, such events can be a little disorienting to one’s view of the economic world, and of one’s place in it.

Siren song

There are a number of reasons U.S. banks hold international allure. “Foreign banks are facing many of the same fundamental industry dynamics as U.S. banks, including concerns about slowing top-line revenue growth and rapidly growing technology costs,” observes Herbert Lurie, head of global markets at Merrill Lynch. “In addition, many corporate customers of the larger banks are looking for one-stop shopping, necessitating a meaningful capital markets capability for banks to compete for their business.”

David Berry, director of research with Keefe, Bruyette & Woods, thinks U.S.-style capitalism, centered on capital markets, in ascendance over Continental-style (or Japanese-style) capitalism, centered on banks, is another drawing feature. Since U.S. capital markets are the capital markets for the world, that means the U.S. securities business holds significant interest internationally, he says.

F. Dieter Beintrexler, president of RZB Finance LLC, a subsidiary of RZB-Austria (Raiffeisen Zentralbank Osterrecich AG), also sees global service capabilities for corporate clients/target customers as a major attraction. Along with that, he believes foreign mergers allow companies to position themselves better, vis-u00c3 -vis the expected merging of corporate Europe. Specifically, he notes, this includes “buying into the U.S. M&A/LBO [merger and acquisition and leveraged buyout] and syndication know-how. Keep in mind that most large U.S. financial institutions that are active in the M&A field have enlarged their European presence and staff in anticipation of the consolidation with European industries and across borders.”

Even with these attractions to acquire, the largest foreign presence thus far is not through ownership of U.S. banks but through branches of foreign banks on U.S. soil. According to sources at the Federal Reserve Bank, this past fall, all branches of foreign banks had a combined $220 billion in loans outstanding out of a total of $920.6 billion in domestic loans, or about 24.1%. Some domestically chartered banks owned by foreign banks, as Bankers Trust will soon be, have a few more percent. Real estate loans are much smaller, with foreign branches and agencies totaling only about 1.8%. Despite all the sudden attention generated by Deutsche Bank, these figures actually represent a slight decline of the share of the U.S. loan pie from a year before, when the figures were 26.4% and 2.2%, perhaps reflecting the pulling back of Japanese and Korean banks.

Blending corporate cultures

No matter how persuasive these mergers may appear to be, the mechanics of the integration are a key factor in their success. Sources close to Bankers Trust indicate that although the union of Deutsche Bank and Bankers Trust has been sold to the public as a merger, the reality is closer to a takeover. One indication that smiles around Bankers Trust might be in short supply is that of 4,000 jobs to be cut in the New York areau00e2u20ac”approximately 75% are said to be from Bankers Trustu00e2u20ac”with the commercial lending side taking the biggest hit. And among financial services experts, there is a fair amount of skepticism as to how smoothly the relationship will run.

Thus, an intriguing factor in any financial merger, but even more so when the borders are cross-national, is figuring out how to merge the corporate cultures. Beintrexler points out that “if the blending of cultures is not handled right, wholesale defections of staff may occur.”

And while Beintrexler concedes that mergers themselves are not likely to generate major customer defections to other banks, “if a clash of different corporate cultures leads to paralysis within the organization, then one could see migration. But there are a number of successful examples. The acquisition of Lasalle by ABN-Amro (Amsterdam) seems to have worked out, as has the Harris International acquisition by the Bank of Montreal. It also worked when Texas Commerce was bought by Chemicalu00e2u20ac”this was almost a ‘foreign country’ acquisition.”

One issue that is often problematic in corporate mergers is a difference in views toward appropriate ethical standards. For example, a foreign construction company might be more amenable to giving bribes in foreign countries, while a U.S. one is strictly prohibited from such activities under U.S. law. But this is a decreasing factor with banks, says Beintrexler, as “a great number of similarities in bank supervision exists already between U.S. and European countries. Issues of who to do business with, hot-money trafficking, or cartel-like price collusion get a great deal of attention in industrial countries and by the supervisory bodies of the European Union.” Interestingly, hiring and firing policies and issues like sex discrimination do not create many problems as “European supervisors tend to give freedom to local practices and customs,” he explains.

But overall, diplomacy and communication are the keys to implementing a smooth and successful integration. “Keep in mind,” says Beintrexler, “European banks and companies have operated in the U.S. for many years, as have U.S. firms in Europe. Nevertheless, two very large companies from different cultures coming together could lead to misunderstandings, communication problems, and even a power struggle, if handled poorly.”

Market trends

In addition to the international merging of corporations, other trends have taken shape that involve global partnerships. One that appeals to Beintrexler is the use of corporate agreements that involve referrals of business and arrangements to share income. “This is an extremely attractive approach, providing the advantage of not having to build up a network in another place,” he notes. “This allows you to compete in most markets with banks with global operations. It minimizes the danger to regional banks of losing customers to very big banks with operations everywhere. If a middle-market company wants to set up a subsidiary elsewhere, that might be achieved by referral to another bank, and everyone benefits.” RZB is now talking to banks with similar arrangements in other parts of the world, including Asia.

Beintrexler also wonders if acquisition linkages might not start coming more from the United States. “I could almost see a reverse trend vis-u00c3 -vis Europe; as U.S., regionals reach the limits of acquisition growth in the U.S. they may look abroad. With the demise of Asian banks, there are also opportunities in Asia,” he adds.

Targeting in other parts of the world, says Beintrexler, includes “Spanish banks moving into Latin America, and Austrian, German, and French banks into Eastern Europe. With Western Europe’s integration, there will be cross-border mergers and acquisitions. A larger European market with an increasingly important common currency will attract U.S. banks.”

“Incidentally,” says Beintrexler, “the Euro will become, increasingly, the second currency in international trade. During my recent trip to Brazil and Argentina, many large trading companies and trade-related businesses told me they believe bills will be denominated in the future in either the U.S. dollar or the Euro, so lending facilities will offer both.”

If the price is right, Beintrexler envisions targets such as “investment banks with strong capability to sell to institutional investors, like pension funds, endowments, and insurance companies, particularly if these banks have M&A/LBO experience. Another potentially attractive group includes banks with strong, regional middle-market client bases, particularly clients [that] have the potential to sell their goods internationally or to acquire companies abroad. While current costs of acquiring such banks may be too high, that could change if some banks get into trouble.”

Another factor in today’s mergers is the need for financial institutions to underwrite large loans or security issues. “This requires a strong equity base on the one hand and syndication/distribution channels on the other,” Beintrexler says.

International acquisition: a ripple or a wave?

Have transatlantic appetites just been whetted? Other finacial giants such as Germany’s Dresder, also are said to be on the hunt. Should large and regional U.S. bankers fear they will have to start acquiring foreign accents?

Probably not. At least for the moment, numerous foreign takeovers of U.S banks do not appear to be in motion. According to Lurie of Merrill Lynch, who says he would not be surprised to see several more foreign bank acquisitions of U.S. securities firms, “the number of remaining viable entry vehicles to gain meaningful share of the U.S. capital markets business is quite small at this point.”

And while the pressures and motives driving the financial world are similar to those driving other industries, there are differences that may temper the onslaught on U.S. banking.

“With a few notable exceptions, the experience of foreign banks with U.S. retail banking acquisitions has not been great,” observes Lurie. “Nevertheless, in those selected cases where foreign banks have done well with such acquisitions here, I would expect to see continued interest in growing those franchises.” Examples Lurie points to are BNP, Allied Irish, ABN-Amro, and National Australian Bank. “I do not, however, expect to see a flood of foreign banks going after U.S. regional banks as new entries into the U.S.”

One reason for that is cost. “U.S. banks aren’t cheap,” says Bert Ely, a consultant on financial institutions and monetary policy based in Alexandria, Virginia. “Deutsche Bank is paying twice book for Bankers Trust. State Street sold for five times book. Prices of four to six times book aren’t out of the realm if banks have profitable servicing industries and well-developed fee income streams.”

Ely cautions against reading too much into the Deutsche Bank deal. “From the standpoint of U.S. banking, the whole thing is a big nod,” says Ely. The percentage of U.S. banking assets that are in foreign-owned banks is probably in the range of 3% or so. The Bankers Trust deal will increase the amount to perhaps 6%, but it’s not running away with the U.S. vault, he notes.

KBW’s Berry agrees, adding, “Deutsche’s acquisition of Bankers Trust doesn’t have a lot of implications for U.S. regional banks. They’re in different businesses, with the regionals focused on deposit and lending functions for consumers and small- and mid-sized businesses, while BT really had transformed itself into an investment bank, with expertise in high-yield finance, equity IPOs, risk management, and securities processing domestically and with a large part of its franchise offshore. There might be international banks that want to buy a U.S. regional bank presenceu00e2u20ac”and several already haveu00e2u20ac”but any additional moves like that I would not link to the Deutsche/Bankers Trust deal.”

“Often,” says Ely, “the foreign presence has been here awhile and people are unaware of it. How many of 1st Maryland’s customers know it is owned by Allied Irish Banks in Dublin? As long as a bank has an American personality, does anyone care if Union Bank in California is owned by the Bank of Tokyo Mitsubishi?”

Whatever skepticism Deutsche Bank has generated in its recent move, at least one observer gives the bank credit for being “gutsy.” Hans Morris, co-head, global financial institutions group, Solomon Smith Barney, says that while taking on a deal this size is risky, “the world is waiting to see what financial firms emerge that are ambitious enough to offer all services to their customers. That’s the game that exists for all the big banks. They all have strengths and weaknesses; it’s not clear which will emerge victorious. The risks that Morgan Stanley, Dean Witter, Chase, Citigroup and others face may not be that different than the risks that await Deutsche Bank and Bankers Trust.”

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