German bank consolidation: Deutschmerz
A mash-up of Deutsche Bank and Commerzbank makes a lot of sense on paper
Freddie Mercury’s vocals helped make “We are the Champions” one of the catchiest songs of all time, according to an academic study. German politicians echo his theme when describing their country’s industries — except for banking. German lenders are dispiritingly weak. Hence the recurrent idea of merging the two largest, Deutsche Bank and Commerzbank.
The main aim is to put the fallen titan that is Deutsche back on its feet. Overheads are stubbornly high, with a cost-to-income ratio of 93 per cent. A dire return on equity, under 1 per cent, means the bank cannot plough enough profit back into its balance sheet each year to bolster the capital base. Chief executive Christian Sewing’s target of a 10 per cent return on equity over the medium term looks challenging. Cost cutting helps. But hefty restructuring would bring big cash charges, eroding thin capital.
A mash-up — with the penitential code name Deutschmerz — makes a lot of sense on paper. Deutsche probably could not pay cash for Commerzbank, which has a market value of €8.7bn, roughly half its own worth. The weird physics of accounting means an all-share deal would lift capital. Commerz trades below book value. If Deutsche acquired it, any goodwill — the difference between the price paid and net asset value — would be negative. Even on a bid premium of 30 per cent, Citi thinks the boost could be €11bn, a fifth of Deutsche’s top tier capital, assuming no big writedowns.
That backdoor capital raising would not be enough to reassure shareholders. Management would still need to raise profitability. Assume Deutschmerz cut total overheads by 10 per cent. That would produce €3bn in savings. Taxed and capitalised, those are worth about €22bn, nearly equal to the banks’ combined market values. Hallelujah!
So much for fantasy M&A. Doing the deal would be tough politically, given the job cuts. Profits in German lending would remain miserably thin without structural reform. Yet the banks of the EU’s largest economy are slowly imploding. Freddie had no time for losers. In banking, Germany should follow his example.