Banking on Insurance

Allianz CEO Diekmann must fix Dresdner to regain investors’ favor.


Michael Diekmann ought to have plenty to be happy about. Since taking over five years ago as CEO of Allianz, Europe’s biggest insurer by market capitalization, he has restored much-needed rigor by tightening underwriting standards, consolidating back-office operations at home in Germany and exerting greater control over the group’s far-flung subsidiaries abroad. The results are impressive: Though revenues have grown by a modest 9.5 percent since 2003, to €102.6 billion ($151 billion) last year, net income at the once-stumbling insurance giant has nearly tripled, to €8.0 billion.

And Diekmann is hell-bent on stepping up the pace of change to drive a new growth spurt. He is applying cost-cutting methods honed in Germany to the group’s global operations, buying out minority investors overseas and ditching local nameplates to trumpet the Allianz brand in markets from France to Taiwan. The goal is to transform Allianz, traditionally more of a federation of national fiefdoms, into a truly global company.

“We are trying to show the sky’s the limit if you want to achieve something,” a confident Diekmann, 53, tells Institutional Investor in a recent interview in Allianz’s headquarters overlooking the verdant expanse of the Englischer Garten in central Munich. “Allianz has huge potential for growth in revenue and profits.”

Trouble is, Allianz isn’t just an insurer. It’s a bank too, and its controversial 2001 acquisition of Dresdner Bank continues to haunt it, overshadowing the revival of the group’s core insurance business. The bank never earned anywhere near enough to justify the €23.5 billion that Allianz paid for it. Write-downs of €845 million on asset-backed securities at investment banking arm Dresdner Kleinwort pushed the bank into the red in the first quarter of this year. And Dresdner may have to bite an even bigger bullet in coming months. The bank is winding down a structured investment vehicle, known as K2, set up by Dresdner Kleinwort, and it may have to take the SIV’s €13.5 billion in now-illiquid bank loans and mortgage-backed securities onto its balance sheet, with a potential for further losses.

In a bid to bring an end to this sorry episode, Diekmann announced last month that Allianz was in talks aimed at finding a merger partner in Germany for Dresdner’s retail banking business, which he regards as crucial for selling insurance products to consumers. He declined to elaborate, but bankers and analysts say a likely scenario would be a joint bid by Dresdner and Commerzbank to buy Deutsche Postbank, a subsidiary of the German post office, boasting the largest retail banking network in the country. Postbank’s chief executive, Wolfgang Klein, was quoted late last month as saying that a sale of the bank could take place within months. Meanwhile, banking sources say Citigroup is considering selling its 340-branch German retail subsidiary, which would present another potential retail merger for Dresdner. A spokeswoman in New York says Citi is exploring a variety of options for its German business.

Pulling off a Postbank deal wouldn’t be easy. The bank’s extensive network makes it an attractive target for other potential bidders, and it’s far from clear how Allianz would finance such a purchase — which bankers estimate would cost at least €10 billion — or manage the bank under a joint bid. A three-way merger could produce annual cost savings of €1 billion for the combined entity, says Michael Huttner, an insurance analyst at JPMorgan Securities in London, but he adds that such a deal “is complex and carries substantial execution risk.”

Moreover, a successful merger in retail banking wouldn’t solve Dresdner’s woes in investment banking. In March, Diekmann unveiled plans to split Dresdner’s consumer activities from its wholesale and investment banking operations as a prelude to fixing or selling both businesses. Potential buyers for investment banks are few and far between in today’s depressed capital markets environment, though. That’s particularly the case for a wounded, small-scale franchise like Dresdner Kleinwort, bankers and analysts say.

“I’m not sure it’s the right time for Allianz to be taking a bold decision,” John Mack, CEO of Morgan Stanley, tells II. “It would be better to wait and get a higher price.”

Standard & Poor’s downgraded its debt rating on Dresdner Bank after Diekmann said he would separate its retail and wholesale operations. The one-notch reduction, to A, is likely to raise the bank’s funding costs and make it harder for Dresdner Kleinwort’s fixed-income and currency trading operations — which depend on leverage — to make money. “We’ve always had doubts about the strategic importance of the wholesale bank for Allianz,” says Frankfurt-based S&P credit analyst Bernd Ackermann.

Allianz’s options are narrower than they were five years ago, when other banks expressed interest in acquiring all or part of Dresdner Kleinwort, sources familiar with the situation say. Diekmann rebuffed those overtures and decided to invest €2.3 billion in building up the investment bank, siding with colleagues like Paul Achleitner, Allianz’s board member in charge of finance and chief deal maker, who argued that the bank could build a profitable European franchise at a time of buoyant global markets.

Dresdner’s woes weigh heavily on Allianz. The group’s share price slumped to €117.88 late last month, down 70.5 percent from its all-time high of €399 in April 2000 but up 92 percent from May 2003, when Diekmann became CEO. By comparison, the Dow Jones Euro Stoxx insurance index was down 43.4 percent from April 2000 and up 56.8 percent since May 2003. At current levels, Allianz is trading at just 6.7 times expected 2009 earnings, compared with a multiple of 7.5 for France’s AXA, 10.7 for Italy’s Assicurazioni Generali and an average of 8.5 for all European insurers, according to estimates by JPMorgan analyst Huttner.

Investor impatience with Allianz’s bancassurance strategy erupted at its annual shareholder meeting in Munich last month. “The investment in Dresdner Bank has done a lot of damage,” Verena Brendel, a representative of Deutsche Schutzvereinigung für Wertpapierbesitz, a Düsseldorf-based association of some 28,000 private investors, told Diekmann and other top executives at Munich’s Olympiahalle. “We are waiting for you to finally solve the problem of Dresdner. Fix it, or close it.”

Dresdner’s problems clearly frustrate Diekmann. The bank is “almost negligible” compared with the rest of the group, he gripes in an interview, but it sucks up half the time he spends with investors and analysts. “People can’t stand the idea that an insurance company has bought a bank,” he says.

Allianz executives say they are committed to controlling German retail distribution rather than relying on intermediaries. “We have a strong interest in strengthening distribution wherever we can,” says Allianz’s Achleitner. “We have built the operations to a certain level of profitability that now we can start growing again.”

Dresdner is not Diekmann’s only challenge. The group’s U.S. life insurance business, Allianz Life Insurance Co. of North America, has been hit by several class-action lawsuits alleging it misled investors in selling fixed annuity products. In February, Allianz agreed to pay $10 million to settle allegations by California’s insurance commissioner that it tried to sell unsuitable annuities to senior citizens. Slumping sales of such annuities contributed to an 11 percent decline in premiums in the U.S. life business last year, to €6.9 billion.

At the end of 2006, Diekmann replaced the head of the U.S. business with Gary Bhojwani, former chief of the commercial division at Allianz’s U.S. property/casualty subsidiary, Fireman’s Fund Insurance Co. Bhojwani has made changes to make it easier for investors to withdraw funds from some fixed annuities without paying high penalties, which was a factor in some of the lawsuits. He is also looking to expand in variable annuities, an area where Allianz trails badly, with sales of $3.3 billion last year, far behind market leader AXA’s $15.5 billion. He says he wants to get the U.S. life business “back on its feet” within three years. He had better hurry. As Diekmann puts it bluntly, “There is no reason for us to carry underperforming businesses.”

The problems at Dresdner and in the U.S. are daunting, to be sure. But with Allianz’s main insurance operations humming along nicely, many investors and analysts are giving Diekmann the benefit of the doubt.

“Diekmann has performed in line with my high expectations,” says J. Christopher Flowers, head of private equity firm J.C. Flowers, which helped buttress Allianz’s capital in 2003 by subscribing to a €4.4 billion rights issue. (Flowers won’t confirm whether he still holds Allianz shares.) “He’s very focused on the share price and driving Allianz forward.”

Allianz was established in Berlin in 1890 by Carl Thieme, the founder of Munich Reinsurance Co., and Wilhelm Finck, a banker who sat on Munich Re’s board. After World War II the company moved slowly to develop an international presence, opening a Paris office in the late 1950s and adding other small outposts in Europe and the Americas over the next two decades. It started flexing its muscles by buying a stake in Italy’s Riunione Adriatica di Sicurtá in 1984 and acquiring London-based Cornhill Insurance in 1986. But Allianz remained an overwhelmingly German company until Diekmann’s predecessor, Henning Schulte-Noelle, took over as CEO in 1991 and set about building a global powerhouse.

Schulte-Noelle made a series of bold acquisitions, beginning with the $3.1 billion purchase of Fireman’s Fund in 1991. He pushed into emerging markets in 1999 by setting up offices in China and Vietnam. That same year he snapped up South Korea’s First Life Insurance Co. for $270 million.

With the insurance business bulked up, Schulte-Noelle turned his attention to asset management. In 2000, Allianz paid $3.3 billion to acquire U.S. fixed-income asset manager Pacific Investment Management Co. The following year the company bought growth equity specialist Nicholas-Applegate Capital Management.

By contrast, the insurer’s efforts to expand into banking appeared ill-fated from the start. Schulte-Noelle initially attempted to engineer an ambitious merger between Deutsche Bank and Dresdner Bank, in which Allianz had stakes of 5 percent and 22 percent, respectively. That 2000 deal collapsed, however, largely because of the strenuous opposition of Deutsche’s investment bankers. Tellingly, they saw no reason to combine their fast-growing business with Dresdner’s much smaller investment banking franchise. The failure of the deal, which would have created a stronger retail distribution channel, was a high-profile embarrassment for Allianz and its boss.

Schulte-Noelle salvaged part of the plan with the help of Achleitner, the star banker and former head of Goldman, Sachs & Co. in Germany whom he had recruited earlier in 2000. The following year Allianz bought Dresdner on its own, gaining the third-largest retail banking network in Germany and the second-largest retail fund manager. As part of the deal, it also took on an expanded investment banking business: In the wake of the failed Deutsche merger, Dresdner paid $1.56 billion in 2000 to acquire U.S. investment banking boutique Wasserstein Perella & Co. The new Dresdner Kleinwort Wasserstein had a bit more heft but even higher costs.

The Dresdner deal proved remarkably ill timed, as the euphoria spawned by the late-’90s stock market boom and launch of the euro, which had inspired Allianz’s banking ambitions, gave way to crisis and a sharp market downturn. Like other insurers, the once-proud group was battered by the plunge in global stock markets, which hammered investment returns. It also took several big hits; the company paid out some €1.5 billion to cover claims from the September 11, 2001, attack on New York’s World Trade Center, and €710 million for damage from European floods in 2002. Dresdner, meanwhile, suffered from a spike in loan defaults by companies in Germany, Latin America and the U.S.

In 2002, Allianz had a record €2.5 billion loss in the third quarter, including €972 million at Dresdner. At the end of the year, Schulte-Noelle announced he would step down as CEO the following May and become chairman. He nominated as his successor Diekmann, a 14-year company veteran who had grown Allianz’s Asian presence and turned around operations in Australia and the U.S.

Diekmann grew up in Bad Salzuflen, a small town in the German industrial heartland of North Rhine–Westphalia, where his father owned a construction company specializing in building bridges. His father told the teenage Diekmann and his twin brother that he could have only one successor. “I can’t take both of you because you will fight, and the business can’t take fighting,” Diekmann recalls his father saying. His brother studied engineering and eventually took over the family business; Michael left for Georg-August University in Göttingen, where he studied law and philosophy between 1973 and 1982. There he met fellow student Florian Thieme, a member of the Pelikan-Füller ink and cartridge dynasty. The two set up a company that published adventure-travel books such as Wildnis Privat — Der Ratgeber für Kanutouren in Kanada (Private Wilderness — The Guide to Canoe Tours in Canada), which features a bearded Diekmann on the cover.

But eventually, Diekmann’s wife tired of his long safaris in Africa and late nights writing, as he tells it. In 1988 she handed him an advertisement for a job as executive assistant to the head of Allianz’s Hamburg regional office and asked him to go for an interview. Diekmann landed the job, although as he recalls, “I was 34 years old and didn’t know much about insurance.”

He quickly demonstrated his skills, though, winning promotion to head of sales for the Hamburg office within two years. A few years later he was tapped by Schulte-Noelle to head sales for North Rhine–Westphalia.

Looking for an entrepreneurial manager to grow Allianz’s small Asia-Pacific business, Schulte-Noelle sent Diekmann to establish a regional headquarters in Singapore in 1996. Within six years he had opened 18 offices in the region. He also made his name as a turnaround artist by reviving Sydney-based Manufacturers Mutual Insurance Group. In a move that Diekmann would later apply elsewhere, he acquired the shares of Manufacturers Mutual that Allianz didn’t own, merged back offices and overhauled pricing.

In 2002, Schulte-Noelle dispatched Diekmann to the U.S. to take on an even bigger task. Allianz had been struggling there ever since its 1991 acquisition of Fireman’s Fund, a p/c insurer with a record of poor profitability. In 2002 the subsidiary had a pretax loss of $1.3 billion because of bad investments and increased reserves for asbestos and environmental claims. “It was clear that Fireman’s would not be able to withstand that kind of loss,” says Peter Huehne, the former CFO of Manufacturers Mutual whom Diekmann appointed as CFO of Fireman’s in 2002.

Diekmann flew to Munich and got the board to inject $1 billion of capital into Fireman’s. He then set about overhauling the unit’s management team, naming Charles Kavitsky, a former president of Allianz Life, as CEO in 2004 and replacing the rest of Fireman’s top 12 executives. Kavitsky is now president and CEO of Allianz of America, the parent of Allianz Life and Fireman’s; Huehne serves as his chief administrative officer.

Diekmann also shifted Fireman’s business to areas like marine insurance, where it was more competitive, tightened underwriting standards, and cut costs in marketing and technology. The aim was to reduce Fireman’s combined ratio, a key profitability gauge that compares underwriting expenses to revenues, from 128 percent to 100 percent by the end of 2003. “Fireman’s had never contemplated being at 100 percent before,” says Huehne. Helped by the general hardening of insurance rates in the aftermath of the September 11 terrorist attacks, Fireman’s reached that goal by the end of 2003 and has kept the ratio at about 90 percent since then.

Upon becoming CEO, Diekmann applied the same drive for efficiency to the group’s worldwide operations. He was determined to get back to basics and restore the underlying profitability of Allianz’s insurance operations.

His push started at home. Under a major restructuring launched in 2006, Allianz is merging its German health care, p/c and life insurance units; shuttering 11 of its 21 offices, including those in Cologne, Dortmund and Hamburg; and cutting 5,700 of its 31,000 jobs. The move sparked demonstrations by trade unions, which questioned why the company was cutting jobs just a few months after announcing 2005 earnings of €4.4 billion, but Diekmann argued that the plan, intended to cut costs by €600 million a year, was vital to the company’s competitiveness. At the same time, Allianz axed 2,480 mainly back-office jobs at Dresdner Bank.

Diekmann has also tightened his grip on Allianz’s global operations. He has bought out minority shareholdings at subsidiaries in France, Russia and Taiwan, including spending €9.8 billion in 2007 to acquire the 41.4 percent of France’s AGF that Allianz didn’t own. In April he paid €373.2 million to gain majority control of two Turkish subsidiaries, p/c insurer Koç Allianz Sigorta and life insurance and pensions company Koç Allianz Hayat ve Emeklilik. And Diekmann has given Allianz’s board an international accent, appointing members like Jean-Philippe Thierry, chairman and CEO of AGF, and Enrico Cucchiani, head of Allianz in Italy.

“We have been trying to turn a confederation of national insurance companies into one global actor,” says Achleitner. “What hindered Allianz in the past were constant excuses about what couldn’t be done on a local level.”

Diekmann has tightened the integration of the global insurance business by adopting the Allianz brand in most markets, replacing a variety of national names, such as Cornhill in the U.K. The CEO says he was inspired by a conversation with Louis Gerstner, former CEO of IBM Corp., who asked him why Allianz used so many different brands. Diekmann said the company sought to respect local identities, to which Gerstner replied: “I think that’s rubbish. Sounds like you’re just shying away from a tough decision.”

Diekmann is currently rebranding AGF in France, putting it into direct competition with archrival AXA. He expects about 80 percent of the group to be operating under the Allianz name by the end of the year. One potential exception is in the U.S. “We may keep Fireman’s in the U.S. as a product because it’s such a great brand,” he says.

The efforts have certainly reenergized Allianz’s insurance lines, but Diekmann believes the best is yet to come. In a bid to drive a new wave of efficiency, he hired Oliver Bäte, a former head of European insurance and asset management at consulting firm McKinsey & Co., as Allianz’s first chief operating officer. His task is to revamp all of Allianz’s operations in 70 countries.

Bäte, who started in January, had advised Diekmann in 2003 on improving Allianz’s German auto insurance business by adopting best practices across the group. “It turned out that the best operators were not in our largest units,” says Bäte. “Seguros in Spain and Lloyd Adriatico in Italy had the best underwriting and pricing policies for claims.”

Bäte wants to find similar improvements by comparing the costs of processing claims across Europe and promoting global standards for human resources managers or back-office staff. “We will measure how we are organized and how productive we are,” he says. “We want to be the most productive group in the industry.”

The COO is also exporting the kind of cost-cutting measures that Allianz used in Germany. A key early test is France, where AGF has been losing market share for more than a decade, slipping from No. 4 to No. 7. In February, AGF announced plans to close offices in Grenoble, Montpellier, Nice and Reims, which will eliminate 200 of the company’s 9,000 jobs. Allianz is planning similar cost-cutting in the U.S., but executives decline to give a target for savings or job cuts. Bäte says he expects to have all countries adopt the target operating model by 2010.

Diekmann finds “unconventional solutions to problems,” Jürgen Hambrecht, chief executive of German chemicals group BASF, says in an e-mail reply to questions. He is a leader who is “straightforward but who can think outside the box and take bold decisions.” Diekmann sits on BASF’s board.

The Allianz CEO will need all of his boldness to tackle the problems at Dresdner. The bank boasts a strong retail brand in Germany but suffers from poor profitability compared with European rivals, in large part because of competition from public sector banks. Dresdner had an aftertax return on equity of just 4 percent in 2007, compared with 18 percent at Deutsche Bank, 16.7 percent at Postbank and 15.4 percent at Commerzbank, according to analysts at Landesbank Baden-Württemberg in Mainz. Dresdner and the other big private banks — Commerzbank, Deutsche, HVB Group and Postbank — have combined assets of €1.4 trillion, or just 19 percent of German banking assets, according to consulting firm Ernst & Young. Public sector banks such as the Landesbanks and the Sparkassen, which don’t face the same pressure to make profits, control a massive 80 percent market share.

Many investors regard Dresdner Kleinwort as a particularly poor fit with an insurance group because of its risk-taking culture and small scale. Although the bull market in capital raising and mergers helped boost profits in the middle of this decade, the sharp downturn over the past year has exposed the bank’s weakness.

“I would prefer Allianz to sell the whole of the investment bank,” says Reiner Klöcker, portfolio manager at Union Investment in Frankfurt, which holds Allianz shares among its €172 billion in assets under management. “They could secure distribution with a joint venture and stake in a bank instead.” Diekmann underscored that potential last month when he told shareholders that Allianz had concluded a deal to sell its products through HSBC Holdings’ branches in Europe, the Middle East and Asia-Pacific.

One of Schulte-Noelle’s last moves as CEO was to recruit Herbert Walter, who helped turn around Deutsche Bank’s retail business earlier this decade, to become chief executive of Dresdner. Walter set about cutting costs — the bank had 350 people in the communications department alone. Over the past five years, Walter has slashed staff by 14,000, or 35 percent, to 26,000. The pruning helped the bank move from an operating loss of €2.2 billion in 2002 to an operating profit of €1.35 billion in 2006. Profits fell 46 percent last year, to €730 million, after €1.3 billion in subprime-related write-downs.

But cost-cutting alone will go only so far, says Walter, even for a bank with a cost-income ratio of 89 percent, double Royal Bank of Scotland’s 43.9 percent. Dresdner needs greater scale as well as efficiency, he argues. A merger with another retail bank, like Postbank, would give it that scale. “There is a window of opportunity now, and we would like to play a proactive role in the consolidation process,” Walter says.

The potential benefits of linking up with Postbank are compelling. Roughly half of Dresdner Bank’s 6.5 million German customers have bought an Allianz insurance product, and 25 percent of the company’s new German life insurance business is sold through Dresdner’s branches. Postbank would significantly broaden Allianz’s reach: It boasts 14.5 million customers, the most of any German bank.

“Scale is gaining importance in retail banking and in German retail banking in particular,” says Achleitner. “Now there are talks that Citigroup’s bank in Germany might be available and that Postbank will come up for sale. The consolidation has happened in other markets, like the U.K., Italy and France, and is starting to happen in Germany. We need to act in a competitively shifting landscape.”

It is unclear how quickly a deal could be reached, though. The German government, by virtue of its stake in Deutsche Post, which owns 50 percent plus one share of Postbank, has a veto over any sale of the bank until January 2009. The Finance Ministry has not had discussions yet with interested parties, according to a ministry spokesman in Berlin, suggesting that any merger talks are at an early stage. Such efforts could also be complicated by existing distribution agreements that Commerzbank has with Generali and Postbank has with Hanover-based insurer Talanx. A spokesman for Commerzbank declined to comment.

The fallout from the credit crunch makes it difficult to sell Dresdner Kleinwort, bankers and analysts say.

Dresdner made its first serious foray into investment banking by acquiring U.K. merchant bank Kleinwort Benson for $1.5 billion in 1995, boosting the bank’s equities and M&A advisory capabilities. Looking to add a U.S. presence to its arsenal, Dresdner snapped up New York–based Wasserstein Perella in September 2000 and briefly installed star banker Bruce Wasserstein as chairman of its investment bank. But the pieces never added up to a coherent whole, and the sharp downturn in global stock markets in 2001 and 2002 depressed revenues.

Andrew Pisker, the former head of debt and equity markets, was made CEO of Dresdner Kleinwort Wasserstein in October 2002. The British executive pared the head count by 26 percent and ramped up fixed-income trading, which helped put the bank back in the black, with a pretax profit of €306 million in 2003, compared with a year-earlier loss of €608 million.

Ironically, the recovery would prove costly. During this period Allianz had at least one offer for Dresdner Kleinwort, according to people familiar with the matter, but Diekmann decided to commit fresh capital to the business in hopes of a continued turnaround and to review the situation in two years’ time. Asked to explain that decision today, he says, “We wanted a retail bank and got a universal bank. It was also a pretty troubled bank when we bought it. We had to put in a lot of work to get that sorted out.”

In 2004, the Allianz board reviewed Dresdner Kleinwort again and considered spinning it off or merging it with Dresdner’s German corporate banking business. Achleitner was one of the investment bank’s chief defenders, arguing that it could meet Allianz’s considerable needs for capital markets and advisory services. Dresdner CEO Walter also favored keeping the subsidiary. “Spinning off derivatives books from Dresdner Bank’s balance sheet would have been a risky and difficult effort,” he explains.

After months of discussions Allianz decided to keep Dresdner Kleinwort and merge it with a division of 850 corporate bankers servicing 1,800 large companies. In effect, Diekmann was pulling back from much of Dresdner Kleinwort’s global and European ambitions and placing a sharper focus on Germany.

Frustrated by the narrower strategy, Pisker resigned in November 2005 and went off to co-found a London-based investment firm, Richmond Park Capital. In his place, Diekmann appointed Stefan Jentzsch, who had worked at Goldman Sachs in Frankfurt with Achleitner and before joining Dresdner had been head of investment banking at HypoVereinsbank in Munich. The depth of his experience in Germany made him a natural candidate to refocus Dresdner Kleinwort on the domestic market.

When he arrived, Jentzsch, a marathoner, told employees that “thousands of changes” were needed to get the investment bank into shape. These ranged from reducing the 92 percent cost-income ratio to revising the bonus formula. As he put it, the three years from 2003 to 2005 “were the best bull market ever seen, but revenue at Dresdner Kleinwort Wasserstein was down or flat every year.” To mark a new start, Jentzsch ditched the Wasserstein name to coincide with the bank’s move into new offices in London.

He then set about downsizing. He reduced head count in the U.S. from about 850 to 600 and shut offices in Chicago and San Francisco. Dresdner Kleinwort would no longer try to compete in purely U.S. M&A deals, focusing instead on transactions with a European connection. He also closed the bank’s equity proprietary trading desk in London.

Overall, Jentzsch reduced staff at the investment bank by 11 percent, to 3,700 at the end of last year. He expects to bring that figure down to 3,200 by the end of 2008. He is also trying to squeeze more revenue out of each banker by tying bonuses to the successful cross-selling of products.

The efforts were starting to bear fruit before the subprime crisis broke out last summer, with revenue per banker up almost 40 percent since the end of 2005 and the cost-income ratio dropping to 75 percent. But credit losses over the past nine months effectively wiped out those gains. Dresdner Kleinwort posted a €659 million operating loss in 2007, compared with a €548 million profit a year earlier. Even after its first-quarter write-down, it had €877 million in exposure to U.S. mortgage-backed securities and €961 million in collateralized debt obligations. The unwinding of the K2 vehicle could force further write-downs. “There will likely be more provisions from banks in the future from these kind of investment vehicles,” says Kian Abouhossein, a banking analyst at JPMorgan in London. Amid mounting losses, Dresdner Bank was forced to fund the investment bank’s bonus pool last year to prevent a mass exodus of staff. Jentzsch probably has a year to show he can make Dresdner Kleinwort into a viable stand-alone business, sources say.

For Diekmann as well, the pressure is on to find a permanent solution to Allianz’s banking problems and satisfy disgruntled investors.

Dresdner’s Silver Lining

Allianz executives have plenty of reasons to regret the company’s €23.5 billion (then worth about $22.4 billion) acquisition of Dresdner Bank in 2001, but at least one to rejoice about. Dresdner’s fund management arm, the €250 billion-in-assets Deutscher Investment Trust, has given a big boost to Allianz’s asset management business.

“It’s then that we got real scale in the German market,” says Joachim Faber, CEO of the insurance giant’s Allianz Global Investors subsidiary, which manages €970 billion in assets, including €725 billion for third-party clients. DIT gave Allianz entrée into Germany’s big mutual fund market. Allianz is currently the country’s fourth-biggest mutual fund manager, with an 11.2 percent share. Allianz also picked up San Francisco–based equity specialist RCM Capital Management in the Dresdner deal. RCM was suffering from poor performance — only 20 percent of its funds were outperforming their benchmarks over a three-year period — and high staff turnover. In 2002, Faber recruited Andreas Utermann, then head of global equities at London-based Mercury Asset Management, to take charge of global equities at Allianz, which today manages €140 billion for third parties. Utermann introduced greater transparency by making all fund managers’ performance figures available throughout the company; he also set a target of having 70 percent of equity funds outperform their benchmarks. By the end of 2007, 79 percent of funds were doing so.

Faber’s division has also benefited from astute bets by Allianz’s $800 billion-in-assets U.S. bond fund manager, Pacific Investment Management Co. Pimco’s renowned fund manager, Bill Gross, called a downturn in the U.S. housing market in 2005 after sending out credit analysts to pose as home buyers and sound out the market by meeting with real estate agents. That early call, which led Gross to hold a big cash position and avoid subprime-mortgage-backed securities, hurt the performance of Pimco’s flagship Total Return Bond Fund in the first half of 2007, when markets were still buoyant. Largely reflecting Pimco’s weakness, Allianz Global Investors’ fixed-income funds suffered net outflows of

€7.2 billion in the third quarter of 2007. But Gross’s conservative position paid off in a big way after the subprime mortgage crisis erupted last summer. The Total Return fund outperformed the Lehman aggregate bond index by 160 basis points last year. Fixed-income inflows returned to positive territory in the fourth quarter, to €1.3 billion.

Gross’s latest call, made in his monthly “Investment Outlook” in late May, predicted that U.S. Treasuries would underperform because of rising inflation and advised investors to look for higher returns in emerging markets. — J.W.