EMEA Credit Comment 18 March 2019
European Banks: Deutsche Bank / Commerzbank merger impact on debtholders
A merger between Deutsche Bank and Commerzbank would be at best neutral for debtholders Israel Da Costa, CFA in the short to medium term, although potentially positive in the long term. Credit Analyst +44 20 7597 8355 The hurdles for an actual merger are still significant, meaning execution of the deal is still far [email protected] from clear.
Comment The merger talks between Deutsche Bank (DB) and Commerzbank (CBK) are finally official, as announced by both parties yesterday afternoon. We see the merger as neutral, at best, for debtholders in the short to medium term, although potentially positive in the long term. The structure of the deal remains open and speculative, but we see significant execution risks and other factors that could weaken the merged entity’s credit profile, including:
Unsolved problems. DB’s and CBK’s main current problem is the lack of revenue generation, with reductions in the cost base being matched by reductions in revenue. Both banks have seen declining revenues and have struggled to maintain a sustainable business model amid the new regulatory environment and low interest rates. Although there are potentially significant costs synergies to be achieved, it is unclear how the merger would lead to improved revenue generation. In fact, as SMEs and large corporates often have several banking product providers, those which are served by both DB and CBK, would seek alternative providers to maintain the diversification of their supply base. Material charges. Restructuring charges will be significant. In addition to a large number of branch closures and layoffs, the integration of IT and risk systems will also lead to significant charges. In addition, in a deal where DB is the acquirer, and CBK the acquired, CBK’s assets would be revalued at market or fair value, as per the accounting rules of an acquisition. This could lead to significant devaluation of CBK’s assets (i.e. losses) which could eat into the merged bank’s capital base. Among the assets with significant potential for devaluation are the €8.4bn of Italian sovereign exposure held by CBK as of end-September 2018. Significant additional costs to DB would also arise if it were to pay a premium for CBK. The latter has a current market value of €9.5bn, which translates into a P/B of 0.32, meaning DB would have to raise at least around €3bn for a 30% premium on CBK’s share for instance. Diminished profitability. Capital could be raised through the sale of DB’s asset management arm DWS, which Allianz has reportedly showed interest in, and/or the sale of CBK’s Polish operations. However, these two divisions are positive drivers of the banks’ profitability. At DB, the Asset Management division reported a pre-tax RoE of 7.8% in 2018, whilst the private and commercial banking division reported a 5.6% pre-tax RoE, and the CIB 1.2%. At CBK, the Polish operations reported a pre-tax RoE of 16.6%, materially above the 5.3% reported by the group as a whole. Reduced focus on revenue generation. The merger would divert management attention from business and balance sheet optimization. In light of the new regulatory environment, low interest rates, and weakening economic growth, European banks are focused on optimizing business models and balance sheets, avidly looking for ways to increase earnings in a sustainable manner, with low capital consumption. Meanwhile, management of the merged group will be distracted by the many significant challenges of the merger, noting also that both banks have a poor track record on integration (e.g. Dresdner by CBK and Postbank by DB). Not the right consolidation. Justifying the merger on the basis that the German banking sector needs consolidation is somewhat shallow. Although correct per se, the consolidation needed in Germany is of the thousands of Sparkassen (savings banks) and Volksbanken (cooperative banks), which do not seek profit maximization and drag down margins. Consolidation of the two largest privately owned groups will have little impact, if any, on margins in Germany. Higher capital buffers. The larger size of the merged entity could also lead to higher systemic buffer requirements. Although this would mean higher protection for senior debtholders, it would further restrict the merged entity’s capital utilization.
There are also positive credit factors that could arise from the merger, yet these are only likely to materialize in the long term:
Government support. It is being reported that the German government would convert its 15.45% ownership of CBK into a stake of the merged entity, with these shares being transferred to the state-owned KFW, which, in turn, would act as anchor shareholder and could inject additional capital if required. This means that the implicit government support to DB’s bondholders would strengthen significantly. In addition, given the size of the merged entity and relevance for the German economy and financial sector, the German government could also easily circumvent the EU’s bail-out rules in a stressed scenario by -correctly- arguing that a default by the bank would destabilize the local financial system. Renewed franchise. In an optimistic scenario, in which the merger and restructuring are executed successfully, we see a renewed and increased confidence from investors and clients in dealing with a government-supported “German champion”. DB’s franchise has been hit significantly since spring 2016, when it incurred a significant outflow of deposits and clients. The lender has since failed to recover many of the clients lost, whilst a continuous flood of negative headlines and disappointing earnings led the bank to become the sick man among the large European global trading banks. A new, merged group would allow for a fresh start on strengthening of the bank’s franchise.
European Banks: Deutsche Bank / Commerzbank merger EMEA 18 March 2019 impact on debtholders
Ratings. DB’s Senior Non-Preferred (SNP) debt is rated Baa3/Negative by Moody’s and BBB-/Stable by S&P, whilst CBK is rated Baa1/Stable and BBB/Negative. That is, DB’s SNP debt currently has a high likelihood of a downgrade to sub- investment grade, which would increase the bank’s wholesale funding costs even more, further impacting profitability. The rating of the merged entity is naturally yet to be confirmed, with the rating agencies yet to publish a view on the matter, but with CBK’s 1-2 notches higher than DB’s, the merged entity could end up with a higher rating for its bonds, including the SNP.
It remains highly uncertain whether the deal will indeed go ahead. German unions and key shareholders are reportedly against the deal, whilst the likely high number of job cuts would put pressure on the government. In all, we would need to see the details of the merger to better assess the impact on bondholders. At the moment, based purely on credit metrics, we see significant negative pressure. Nonetheless, debtholders were initially positive on the news this morning, driven partly by the potentially strengthened government support, with spreads on DB senior bonds tightening up to 20bps, whilst CBK’s spreads widened marginally.
Key Metrics Pro-Rata DB/CBK Data as of YE18 Deutsche Bank Commerzbank Barclays BNP Paribas merged Total Assets €1,384bn €462bn €1,846bn £1,113bn €2,040bn Total Deposits €565bn €228bn €793bn £395bn €797bn CET1 Capital €52bn €23bn €75bn €41bn €76bn CET 1 Ratio 13.6% 12.9% 13.3% 13.2% 11.8% LR Ratio1 4.1% 4.8% 4.2% 5.1%3 4.5% Wholesale Funding €133bn €67bn €200bn £154bn €159bn Net Income €267m €865m €1,132m £1,394m €7,526m RoE 0.4% 3.1% 1.2% 2.7% 8.2% FTE in Germany 41,700 36,400 78,100 - - Branches in Germany 1,400 1,000 2,400 - - Moody’s SP/SNP2 rating A3/Baa3 Negative A1/Baa1 Stable - A2/Baa3 Stable Aa3/Baa1 Stable S&P SP/SNP2 rating BBB+/BBB- Stable A-/BBB Negative - A/BBB Stable A/A- Positive Source: Deutsche Bank, Commerzbank, Barclays, BNP Paribas, Bloomberg. 1CBK data used for pro-rata calculation as of end-3Q18 2OpCo/HolCo ratings for Barclays. 3UK Leverage Ratio.
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European Banks: Deutsche Bank / Commerzbank merger EMEA 18 March 2019 impact on debtholders
Key contacts
London Head of Research Grant Lewis +44 20 7597 8334 Financials, Supras/Sovereigns & Agencies Israel Da Costa, CFA +44 20 7597 8355
Research Assistant Manager Jodene Adjei +44 20 7597 8332
Tokyo Domestic Credit Chief Credit Analyst Toshiyasu Ohashi +81 3 5555 8753 Electronics, Automobiles, Non-Banks, Real Estate, REIT Takao Matsuzaka +81 3 5555 8763 Chemicals, Iron & Steel Kazuaki Fujita +81 3 5555 8765
International Credit Non-Japanese/Samurai, European Sovereigns Hiroaki Fujioka +81 3 5555 8761 Non-Japanese/Samurai Fumio Taki +81 3 5555 8787 Non-Japanese Jiang Jiang +81 3 5555 8755
London Translation Head of Translation, Economic and Credit Mariko Humphris +44 20 7597 8327
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