(Bloomberg Opinion) -- Amid all the European banking merger chatter of recent months, one potential deal stands out for its industrial logic. UBS Group AG and Deutsche Bank AG briefly explored a combination, a deal that on paper would bring together highly complementary businesses to create a leading regional lender. Too bad the transformational deal doesn’t stand much of a chance.
Discussions to marry Switzerland's and Germany's biggest banks stemmed from talks the two were having about combining just their asset management units, Bloomberg News reported. But the company-wide merger talks never proceeded beyond the initial stage.
It could be a missed opportunity. Deutsche Bank needs to arrest an erosion of confidence that has seen its share price drop to a record low. After exploring a deal with domestic rival Commerzbank AG, a combination that would have left the joined-up firms with unaddressed weaknesses, it hasn't set out a convincing path to revive revenue and restore profitability. Meantime, UBS has seen its shares drop to a seven-year low as investors question whether the bank will be able to deliver on returning profits as growth in managing money for the wealthy begins to slow.
More importantly, the strategic rationale of a deal are compelling, even if it wouldn’t do much to address the industry’s overcapacity. UBS has a market capitalization of $43.8 billion compared to Deutsche's $13.6 billion. The Swiss bank would be taking advantage of a drop in the latter’s valuation to just 23 percent of book value. UBS’s is almost four times that.
In investment banking, a deal would combine UBS's global top-five equities business with Deutsche Bank's fixed-income trading activities, which ranks fourth globally. The German company is a bit player in stock trading, a business that firms ranking outside the leading five struggle to make money in.
Overlaps in currency trading may not be too difficult to manage as most of the dealings are now electronic; cost-cutting would involve eliminating mostly platforms, not jobs. And in the U.S., where both firms lag Wall Street peers, they would have a real opportunity to take market share.
While UBS, the world's largest wealth manager, doesn't need to add scale and would have to preserve its superior brand, it would benefit from Deutsche's access to clients in Europe’s largest economy. The asset management combination would create a $1.6 trillion player, better equipped to compete with global rivals. An agreement over the money management units was reportedly complicated by who would have control, an issue that could be resolved if the parent companies were to merge.
At home, the combined entity would own commercial banks in Germany and Switzerland. While cost synergies across borders wouldn't be significant, pressure on returns would ease as the firm would be a leader in global investment banking, wealth and asset management. It's little wonder that when Deutsche Bank assessed hypothetical merger scenarios last year, UBS emerged as the most compelling cross-border candidate.
While it's not clear what led to the breakdown in talks, the complexities of undertaking a combination of this scale are at present nearly insurmountable. Even after due diligence, it would take a significant leap of faith to combine two large-ish investment banks that are overseen by two different regulators. It's unlikely the Swiss would roll out the red carpet for an even bigger investment bank after bailing out UBS in the financial crisis, yet its "Swissness" is what makes the wealth business so attractive to clients.
Separating the investment bank into a German business could be one way around it, but it would require political and regulatory will. That would leave the complication of bringing together two distinct corporate cultures, and deciding on the one that would dominate. There’s also a question over who would lead the reorganization. In the job for little over a year, Deutsche Bank Chief Executive Officer Christian Sewing has yet to prove himself, and UBS CEO Sergio Ermotti has been losing confidence of investors. There are no obvious successors at either firm.
The industry’s weaknesses are also a hindrance to such deals. Deutsche is still sitting on Level 3 assets – hard -to-value securities priced off internal models – that represent about half of its Common Equity Tier 1 capital. UBS shareholders may not want to pay for reducing Deutsche’s toxic holdings. Creating continental Europe’s biggest bank, a behemoth with $2.6 trillion in assets, will make watchdogs uncomfortable, as they still cannot be sure what’s in those books.
While regulators say consolidation is just what the industry needs, some of the best mergers on paper won’t work in practice. Unless, of course, a crisis were to focus minds.
To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.
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