After Deal Talks Collapse, German Banks Struggle to Set Course

(Bloomberg) --

The rehabilitation of Europe's financial industry will have to wait.

Deutsche Bank AG and Commerzbank AG, the two biggest listed banks in the continent's dominant economy, pulled the plug on government-brokered merger talks designed to forge one strong institution out of two struggling firms. The collapse of their talks sets the stage for an era of matchmaking for the region's financiers.

The failure to agree on a deal may now force Deutsche Bank to come up with its fifth turnaround plan since 2015 and allay investor concern about how it will revive growth and boost shareholders returns. For Commerzbank, still 15 percent-owned by the federal government, a foreign takeover may be in the cards, with lenders including ING Groep NV and UniCredit SpA said to be interested in an acquisition.

“There's an urgent need now to refine their strategy,” said Ingo Speich, chief of sustainability and corporate governance at Deka Investment. “Calling off a national merger is opening the door for consolidation on a European level.”

Deutsche Bank fell 2 percent in Frankfurt trading. The bank's riskiest bonds slumped and the cost to insure notes against default surged to the highest in a month. Commerzbank declined as much as 3.7 percent.

The companies decided that attempting to integrate the two banks would be too difficult to execute and also cited the restructuring costs and additional capital requirements, according to a statement on Thursday. Deutsche Bank said it would continue to review “all alternatives to improve long-term profitability and shareholder returns.”

“We do envisage that, over time, consolidation will happen and Deutsche Bank wants to be a part of that,” Chief Financial Officer James von Moltke said in an interview.

Christian Sewing, chief executive officer of Deutsche Bank, and his counterpart at Commerzbank, Martin Zielke, had been in talks about a takeover since mid-March but soon encountered massive opposition from labor representatives and strong criticism from key shareholders.

The talks were a desperate effort to strengthen two lenders whose shares had lost more than 90 percent of their value from their peak, and to shore up a domestic banking industry that has fallen far behind Wall Street.

Part of the rationale for a deal was to lower Deutsche Bank's high funding costs, which have made it hard for its key securities unit to compete. With that option off the table, pressure could be mounting on Sewing to announce even steeper cuts to the investment bank, further weakening its position.

Sewing had already scaled back Deutsche Bank's global ambitions when he took over a year ago, announcing cuts to U.S. rates sales and trading, the corporate finance business in the U.S. and Asia. Von Moltke said Thursday that the U.S. Operations weren't part of the Commerzbank talks, and the business remains key to the lender.

“The U.S. market is a core market to us and, frankly, the clients we serve and some kind of wholesale decision about the U.S. was never part of our considerations,'' he said.

Deutsche Bank, which is scheduled to report first-quarter earnings Friday, signaled that the long slide in its franchise continued at the start of the year, with the investment bank driving another drop in revenue. Market conditions improved toward the end of the quarter and the bank is moving in the right direction, Sewing told staff in a memo.

“After thorough analysis, we have concluded that this transaction would not have created sufficient benefits to offset the additional execution risks, restructuring costs and capital requirements associated with such a large-scale integration,” the CEOs of both banks said in statements using identical wording, and thanking each other for constructive talks.

Regulators rushed to assure investors, with the Bundesbank saying both banks “fulfill supervisory expectations for solid and stable banks” and their restructuring efforts are “showing first positive results.”

Deutsche Bank remains one of the most systemically critical banks in the world -- with assets of about $1.5 trillion -- underscoring German Finance Minister Olaf Scholz's desire to reverse the erosion of its franchise. But labor unions vehemently opposed the loss of jobs from a takeover of Commerzbank and lawmakers across the spectrum distanced themselves from Scholz. Large shareholders such as Qatari investors and BlackRock Inc. had questioned the logic of a deal.

Both lenders are still struggling with the fallout from an aggressive expansion that ended with the financial crisis. While Deutsche Bank survived that crash without direct aid, it paid more than $18 billion in misconduct fines in the last decade. Commerzbank was bailed out after it bought Dresdner Bank from insurer Allianz SE in 2008, two weeks before the collapse of Lehman Brothers Holdings Inc. Continued negative interest rates, a fragmented European banking market, and cutthroat competition at home added to their woes.

“A merger would have been an enormously complex and long endeavor,” said Speich. “In the end, it's a victory of reason.”

--With assistance from Nicholas Comfort, Birgit Jennen and Ross Larsen.

To contact the reporter on this story: Steven Arons in Frankfurt at sarons@bloomberg.net

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, James Hertling, Sree Vidya Bhaktavatsalam

©2019 Bloomberg L.P.