German banks’ flirtation stirs debate

Posted on September 1, 2016

Commerzbank and Deutsche Bank's shares have tumbled in the wake of the stress tests©Getty

It may turn out to have been no more than a summer fling. But the news that top executives at Deutsche Bank and Commerzbank discussed the prospect of a union last month sent shares in both banks up sharply on Wednesday.

    Germany’s two biggest lenders broke off talks after just a couple of weeks, having decided that it was the wrong moment for such a complex undertaking. But the chief executives of both banks insisted on Wednesday that the German banking sector still needed consolidation.

    On the face of it, it is not surprising that the duo have considered throwing in their lot with each other. Both have long struggled to make money in their domestic market, which, thanks to the dominance of the army of local savings and co-operative banks, is the most fragmented in the eurozone.

    And both are under intense pressure from shareholders who worry about how the duo will make money in a banking world transformed by tightening regulation and the distorting effect of negative interest rates. Deutsche’s shares have almost halved over the past year, while Commerzbank’s have shed a third of their value.

    Against this backdrop, some investors gave a cautious welcome to the idea of a tie-up. “Organic growth is not really conceivable at the moment. Investors would welcome a convincing growth strategy, and that could mean buying a business or part of another banking group,” said one of Deutsche’s top 10 shareholders.

    Other observers, however, are more sceptical. One question is whether the branch closures and job cuts necessary to make the tie-up worthwhile would be politically feasible in a country where unions still hold considerable sway.

    Chart: Banking consolidation across Europe

    “You could make an economic case for it, but I’m not sure if anyone would have the courage to do what would need to be done to make it work. You would have to shut hundreds of branches, and make maybe 20,000 redundancies,” said one adviser.

    “Then there is the question of whether they could finance such a big restructuring. You would need billions of euros.”

    Others question whether the pair are a good fit. “It wouldn’t be the first combination you would think of for consolidation in Germany. At the moment they are two banks pointing in very different directions,” said Neil Smith, an analyst at Bankhaus Lampe. “Deutsche is there to give European companies access to global capital markets, and Commerzbank is much more focused on supporting German SMEs.”

    Chart: Profits at Germany's leading banks

    More fundamentally, not all analysts and investors are convinced that a merger would actually resolve the raft of problems facing Deutsche and Commerzbank.

    While a combination would boost the two banks’ market power, they would still lag far behind the Sparkassen and co-operative banks that dominate German lending and deposit taking. Between them Deutsche and Commerzbank would have a share of about 12 per cent of total domestic deposits and about 8 per cent of total loans.

    Chart: Deutsche Bank and Commerzbank

    By contrast the savings banks have a 23 per cent share of lending, and 24 per cent of deposit taking, while the co-operative banks have shares of 16 and 18 per cent respectively, meaning that Deutsche and Commerzbank’s pricing power would be unlikely to jump much as a result of a merger.

    The other big question is capital. Analysts already think both banks are short on capital — and a tie-up could make things worse. Between them, the duo would have a balance sheet of about €2.3tn. “Regulators would probably want a bank as big as Deutsche and Commerzbank to hold a lot more capital than they do at the moment,” said Helmut Hipper, a portfolio manager at Union Investment, one of Deutsche’s 20 biggest shareholders. “I can’t see that happening.”

    Jeremy Sigee, an analyst at Barclays, takes a similar line. “Deutsche have three problems: they are a bit short of capital, their return on equity is too low, and they are overexposed to investment banking,” he said. “Combining with Commerzbank might help with the business mix, but it is less clear whether it would do much for their capital position or their profitability.”

    Chart: European banks' return on equity

    Felix Hufeld, head of BaFin, Germany’s financial watchdog, warned on Thursday that mergers were not a “panacea”. But it is a sign of the intensity of the pressure on Germany’s two biggest banks that some observers think a tie-up could still happen despite the hurdles — especially if markets remain weak.

    “It could be a situation where normal logic doesn’t apply,” said one analyst. “Plan A hasn’t worked for either bank, so they could decide that even if there are doubts about it, it’s worth trying plan B.”

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