Germany's Top Banks Weigh Unpalatable Options as Talks Fail

(Bloomberg) -- A merger of Deutsche Bank AG and Commerzbank AG was supposed to be the path to recovery after years of failed attempts to turn the institutions around. Now that’s off the table, where do they go from here?

The prospects are unattractive: Deutsche Bank may have to keep shrinking, and either lender could yet be acquired. There are broader risks, too, for Germany’s export-oriented economy should restructuring curtail access to international financial markets.

“Neither bank has been able to move forward in the last months,” said Ingo Speich, head of sustainability and corporate governance at Deka Investment GmbH, which holds shares in both companies. “A further development of the strategy is sorely needed. The rejection of a national merger has opened the door for consolidation on the European level.”

The proposed merger faced intense skepticism from the outset. Major investors said they weren’t convinced it would solve the banks’ problems; labor unions railed against the necessary job cuts; and regulators questioned the logic of a tie-up.

The banks will struggle to restore credibility if they merely revert to old plans that failed to boost their profitability and stock prices. Deutsche Bank said Thursday it will continue to review all alternatives to improve long-term profitability and shareholder returns. Commerzbank said it will “continue our strategy, grow together with our clients and invest in our future.”

Germany's Top Banks Weigh Unpalatable Options as Talks Fail

Deutsche Bank Chief Executive Officer Christian Sewing is said to have considered two scenarios -- a small strategy update that would hinge on more (and accelerated) cost cuts, including at the investment bank; and a broader shift that would create upfront costs.

The options could look like this:

More of the same

Deutsche Bank has been exiting and scaling back trading businesses for about five years. Deepening those cuts would help reduce costs, but the restructuring has also crimped revenue. Sewing has consistently said Deutsche Bank won’t pull out of the U.S., home to the world’s deepest capital markets. Still, proponents of an exit may now feel emboldened to call on him to retrench to Europe.

Germany's Top Banks Weigh Unpalatable Options as Talks Fail

Other mergers

Deutsche Bank also has the option of a merger with another European bank. People close to its leadership have floated names like UBS Group AG, BNP Paribas SA and ING Groep NV. These options are seen as remote, however. Deutsche Bank’s stock decline means it would probably be a junior partner, and the German government is unlikely to surrender its banking champion.

"Plan B is more likely to be implemented on a standalone basis of restructuring the equity business and further asset reduction” rather than broader strategic changes, JPMorgan analysts led by Kian Abouhossein wrote in a note on Thursday.

Partnerships

Deutsche Bank’s DWS fund-management unit is a more likely candidate for a tie-up. The preferred partner is UBS’s asset-management division, people familiar with the matter said this week. No decision has been reached and other options are still possible, the people said. Combining DWS and the fund unit of UBS would create an entity with about $1.5 trillion in assets under management, making it the second-biggest money manager in Europe after Amundi SA.

The pressure on Commerzbank is also acute after CEO Martin Zielke scrapped several financial goals this year, partly because interest rates in Europe are likely to be lower for longer, eating into lending revenue. The bank faces similarly unattractive options.

Takeover

Commerzbank has attracted interest from Netherlands-based ING and Italy’s UniCredit SpA, according to people familiar with the matter. Commerzbank is smaller than Deutsche Bank, giving a competitor an easier path to gaining a chunk of the German market.

It’s also possible a foreign bank wouldn’t have to eliminate as many jobs at Commerzbank to make the deal work. Still, the German government owns about 15 percent of the bank and may be keen to avoid giving any foreign institution yet another edge over a weakened Deutsche Bank.

Stay the course

While Commerzbank has scrapped several goals, it’s been able to increase both profits and client numbers in recent quarters. That could support a bid to remain independent, though Zielke may have trouble selling that line after telling employees this month that a deal could be a faster way to add scale and gain market share.

A takeover is “the more likely outcome at this point” for Commerzbank, the JPMorgan analysts wrote in their note.

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