Minimal Upside From Potential Merger Of Two Struggling German Banks

by Trefis Team
-17.12%
Downside
8.49
Market
7.04
Trefis
DB
Deutsche Bank
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Rumors of a potential merger between Germany’s two largest banks have now begun to materialize. Deutsche Bank and Commerzbank have now officially engaged in merger talks. Trefis believes the merger seems to be more driven by political urges rather than financial appeal, and there would not be significant upside to completing the merger of this size. A merger would be unlikely to substantially strengthen the bank, while prompting job cuts. Considerable synergies would have to be found to deliver the cost savings needed for robust profitability in the future. However, there would exist a lot of potential to cut overlapping activities between the two banks and improve efficiency.

One of the biggest hurdles in the merger of the two banks would be massive job cut program that is expected to follow. If a merger goes ahead, about 30,000 positions are possibly at risk in a future combined entity. Moreover, any potential tie-up would have to overcome numerous hurdles — including the merging of two IT systems, working through different corporate cultures, liaising with unions, and the huge task of recapitalizing the new lender. We remain skeptical about the benefits of a Deutsche Bank-Commerzbank merger as both banks have struggled to restructure their businesses materially in recent years.

Financial Suitability

Both banks have struggled a bit over recent years to deliver significant returns for its shareholders. Although Deutsche Bank has now put behind it most of its litigation and conduct issues, the business still has some structural problems. It has a very high cost/income ratio (efficiency ratio), large debts and low-profitability businesses. Since 2010, its share price has sunk from over $76.00 to $8.00, and its market cap is now around $18 billion, the lowest it has been since the 2008 financial crisis. Commerzbank is also struggling to deliver much in the way of returns to shareholders: return on tangible equity for 2018 was just 3.4% and earnings per share of less than $1, while return on tangible equity for Deutsche Bank was a mere 0.5% in 2018. This is well below the average of other large banks, such as Citigroup, which had a ROTE of 10.9% in 2018, and HSBC, which delivered a ROTE of 8.6% in 2018.

However, a merger would help the new consolidated entity achieve significant cost reductions. Deutsche Bank had some 92,000 employees at the end of 2018, and Commerzbank around 50,000; if the new entity is able to cut down 30,000 jobs, this would mean that about 21% of total overhead may be reduced. In addition, if the entity were able to cut other general expenses by combining IT systems, cutting branches, optimizing real estate, in addition to other measures, the entity would be able to bring down its elevated efficiency ratio of approximately 91% (before cost cutting measures). We have summarized our post-merger outlook for the new entity on our interactive dashboard Post-Merger Outlook For Deutsche Bank And Commerzbank. You can modify any of our key drivers to gauge the impact changes would have on its valuation.

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