Deutsche-Commerzbank merger plans dealt a major blow

IFR 2267 19 January to 25 January 2019
6 min read
EMEA
Gareth Gore

Banners of Deutsche Bank and Commerzbank

The shotgun marriage might be off. Berlin’s favoured solution to the problem child that is Deutsche Bank – a merger with smaller rival Commerzbank – has been dealt a heavy blow, after European regulators indicated they would disapprove of the union and appealed for a better suitor.

The proposed merger of Germany’s two largest banks, which would have created Europe’s third-largest bank behind HSBC and BNP Paribas with almost €2trn in assets, had been gaining momentum in recent weeks, with regular meetings between both chief executives and the German Finance Ministry.

Berlin had been supportive of the tie-up as the best solution to two issues: first, as a way to revive an ailing Deutsche, which has been haemorrhaging revenues and clients over the past few years; and secondly as a way to create a national champion capable of supporting German industry on a world stage.

Although Deutsche seems stable from a capital and liquidity perspective, Berlin has become increasingly concerned about the bank over recent months. A share price in freefall, ongoing criminal probes and doubts about its strategy seem to have pushed Germany’s political elite into finding a solution.

“Deutsche Bank is a state ward in the way that every major bank is a ward of the state,” said one senior financial institutions banker. “But it’s a bank that isn’t terribly stable or profitable and the government is clearly worried about it becoming a more difficult problem.”

Commerzbank seemed to some like the ideal partner: the government owns a 15% stake in the bank - the legacy of a bailout during the crisis - which would make a tie-up easier to orchestrate; it too is struggling with low profitability; and overlap, especially in the retail market, which could lead to big cost savings.

“Both banks have been getting along with their own turnaround plans, but it is quite clear that, for both of them, it isn’t working,” said one analyst. “Some might see the finance ministry as being overly aggressive in trying to orchestrate this, but you might argue it is just doing prudential planning.”

QUESTIONABLE RATIONALE

But even before European regulators weighed in, the merits of a merger were in doubt. Synergies of €2bn were talked about, but analysts saw few prospects of a big jump in profitability – especially in Germany’s retail market, where state-owned savings banks dominate, and where returns are next to nothing.

“Savings banks can charge below the cost of capital because they have no shareholders,” said a second analyst. “Nobody can compete with that.”

The financials of the deal were another major stumbling block. Commerzbank, which trades at 0.3 times book, looks relatively cheap on paper at €5bn. But, under badwill accounting rules, its equity base might also need to be written down post-acquisition, leaving a potential €15bn capital shortfall.

While regulators might choose to waive the badwill writedown requirement, that is far from certain. The worry is that Deutsche, which has already asked shareholders to stump up more than €30bn of fresh capital since the financial crisis, might not be able to convince them to put more cash in for such an uncertain deal.

“It would all be about the combined equity story – about the formation of a national champion, the synergies, the potential for a deep restructuring – about creating a narrative that people could really buy into,” said the banker. “You can see how it might be possible. But it is far from certain.”

Fall from grace for Germany’s biggest banks

The biggest stumbling block for European regulators appears to be that a deal wouldn’t necessarily address Deutsche’s fundamental problems. One regulatory source told Reuters that Commerzbank was too small to make a difference to Deutsche’s health, and added that both need to focus on increasing profitability and stabilising their businesses rather than merge.

Annual revenues have fallen by about €10bn since 2011, mostly in investment banking; it has booked almost €10bn of losses in three years; return-on-equity is just 1%. “For a bank of that size to be delivering those returns this late in the cycle is just a joke,” said the first analyst.

Regulators also seem to be worried about making Deutsche even bigger. Last year, the European Central Bank, which is the ultimate regulator for the bank, asked it to simulate the cost of winding down its investment bank. That was widely seen as indicative that the ECB was concerned about Deutsche’s size.

The bank is implementing the fifth iteration of a strategy overhaul since the crisis, and is busy reintegrating Postbank, the retail unit it disentangled from the wider group ahead of an IPO it later ditched. That process is expected to last until 2022. Adding another bank four times greater than Postbank is seen as too much.

WHAT TO DO?

Still, that all leaves the question of what to do with Deutsche. Most analysts think that it is unlikely a larger European rival will buy it – at least while questions still remain about its €30bn of legacy assets, many of which are difficult to value and require a sizeable amount of capital and liquidity.

The first analyst thinks that the Deutsche-Commerzbank deal might not necessarily be dead. It might possibly remain as the least bad option – at least from a political perspective.

“The problem they have is that nobody wants to buy Deutsche,” he said. “And if someone comes along to buy just Commerzbank – a foreign player like BNP Paribas, for example – then the German government is left with the problem child. They don’t want that, so this seems like a neat solution to them.”

“If the German government blessed the deal, then it would be difficult for the Europeans to stop it. They are good at bullying smaller countries, but it would be a whole different deal with Germany.”

Banners of Deutsche Bank and Commerzbank
Fall from grace for Germany’s biggest banks