Confirmation that Deutsche Bank AG and Commerzbank AG are exploring a potential merger was welcomed by the stock market, but also raised concerns about future risks, most notably to financial stability.
Shares in Germany's two largest private banks surged March 18 on the back of a statement by Deutsche CEO Christian Sewing the day before, with Deutsche's stock up 4.53% at market close, and Commerzbank's up 7.21%.
The move comes after several months of media speculation about a potential deal. The German government is said to be a strong proponent of a merger as it wants to strengthen Deutsche and protect Commerzbank from a foreign buyer. Having a strong national bank has been one of the key messages of Finance Minister Olaf Scholz since he took office in March 2018.
Poor track record
Despite returning to profit in 2018 after four consecutive loss-making years, Deutsche is far from done with its long-term restructuring. Commerzbank lost more than half of its market value last year and is yet to complete its own multiyear revamp.
A tie-up, especially in the near term, would push the two groups into a new large-scale restructuring which many doubt they could successfully complete, given their track record with mergers so far. Deutsche is still struggling to make a profit from retail arm Postbank almost nine years after its €6.5 billion takeover in 2010, and Commerzbank's €9 billion takeover of Dresdner Bank deepened its losses ahead of a government bailout.
"[A] merger of this size would be a huge undertaking. Right now, it might stretch the banks' capacity to manage change," S&P Global Ratings said in an analysis March 18.
If it comes to a merger, the banks might delay their operational integration until the restructuring of Deutsche Bank's retail arm, including Postbank, has been completed, the credit analysts said. This would also mean a delay in any merger-related synergies, they added.
The fact that the state is still Commerzbank's largest shareholder, with a 15% stake, is seen as an obstacle by politicians across all parties in the German parliament.
Representatives of the ruling Christian Democratic party, the CDU, have called for a stake sale before a potential merger with Deutsche. The Free Democratic Party, the Greens, and the Left Party factions in parliament have all warned about a conflict of interest in any merger where a state stake is involved.
Meanwhile, the leader of the Free Democratic Party, Christian Lindner, warned that greater concentration in the private banking sector could disrupt domestic competition, broadcaster N-TV reported March 17.
But the systemic risks from a merger between Deutsche and Commerzbank are far bigger than any potential antitrust issues, according to Achim Wambach, head of the German Monopolies Commission, an independent expert committee that advises the German government on competition policy.
Given that the two groups complement each other to some extent in many business areas and will face considerable competition even after a merger, antitrust approval could be achieved, he told Rheinische Post on March 18. But the risks to the whole financial system could be significant, because the resolution of big banks is still problematic and a state rescue could not be ruled out completely, Wambach said.
A minority government stake in a newly merged institution might raise investor confidence, but government solvency support for systemic commercial banks in Germany is "uncertain," S&P Global Ratings said.
The expected large number of job cuts is another area of political friction, as Deutsche and Commerzbank both have large retail banking arms in Germany and most cuts will be on a national level. Germany's second-largest trade union Verdi has estimated the potential job cuts at around 10,000 in the short term and 30,000 in the long term.
Regardless of how difficult a headcount reduction in Germany would be, a deal is unlikely without an agreement on job cuts, Lisa Kwasnowski, senior vice president in the Global Financial Institutions Group at rating agency DBRS, said in an emailed comment.
Minister Scholz is said to have agreed not to oppose the job cuts necessary to complete a potential merger, Bloomberg reported March 17.
And despite any misgivings in the future, the fact that Scholz gave the green light to potential job cuts increases the likelihood of a merger "to the highest level," Tom Kinmonth, a fixed-income strategist at Dutch bank ABN AMRO, said in a March 18 note to clients.
But creating a new profitable bank out of the two will be a "monumental task," given the group's current low return on equity, he noted. Deutsche Bank's return on average tangible shareholders equity stood at 0.5% in 2018 and Commerzbank reported a net return on tangible equity of 3.4% for 2018.
DBRS also noted that a merger would be "a major distraction" for managers at a time when the focus should be on improving profitability. Fitch Ratings, S&P and DBRS have all warned of potential downgrades if the group fails to execute its strategic restructuring.
No better alternatives
Nevertheless, a merger with Commerzbank, "if well executed," is a better alternative for Deutsche than continuing on its own or merging with a foreign partner, according to Scope Ratings.
A lot of market participants, especially on the equity side, are not in favor of a merger.
"But I wonder what solution they propose in exchange, as they rightly don't like the status quo either," Sam Theodore, head of Scope's financial institutions ratings, told S&P Global Market Intelligence on March 18.
Given that the business models of the two German banks fit well together, combining their operations would not be a mere "cost-reduction play" but would create a "national champion" with a strong small-business lending franchise and less dependence on global markets trading, Scope said in an analysis Feb. 1.
Deutsche's prospects for improved profitability, which investors are most hoping for, are especially slim if the bank remains on its own, according to Scope.