Can Cerberus Break Out of Germany's Bank Graveyard?

(Bloomberg Opinion) -- Since buying minority stakes in Commerzbank AG and Deutsche Bank AG in 2017, Cerberus Capital Management LP's 1.7 billion-euro ($1.9 billion) investment has lost more a than a third of its value. Simply recouping that money may require more than patience and fine-tuning.

The $35 billion private equity manager’s appetite for lenders in Europe’s largest economy appears to be insatiable. Last year, a Cerberus-led consortium snapped up former state lender, HSH Nordbank. It is also bidding for a minority stake in another regional bank, NordLB, along with another fund.

In keeping with its secretive nature, Cerberus has said very little about its broader plan so far. In an interview with the Financial Times, the fund’s co-head, Frank Bruno, described the strategy to turn around the lenders as “basic blocking and tackling,” suggesting that, with easy fixes, the banks should be able to earn their cost of capital.

Self-help based on clearing out the balance sheet, exiting businesses and cutting costs has worked in bank turnarounds the world over. It will in over-banked Germany, too – not least when inefficient state lenders are involved. And there’s little doubt that there have been opportunities to buy companies at rock-bottom prices.

But restoring the valuations of the bigger and unwieldy Deutsche Bank and Commerzbank is looking increasingly like a reach. The two trade at the steepest discount to the book value of their assets of any big European lender, according to Bloomberg Intelligence.

A friendly merger between the two may not be what Cerberus says it wants – but it’s probably what it needs.

The viability of the two lenders isn’t under immediate threat after years of restructuring and capital raising. In betting the two banks can now achieve sustainable profitability, Cerberus will have calculated that its small holdings would give it the ear of management and that the adjustments required would probably not need to be too radical.

It appears to be scoring on one point. Deutsche Bank has appointed Cerberus's advisory arm to consult on implementing its strategic plan. As part of that engagement, Cerberus has helped sway Deutsche Bank to deploy funds to higher-yielding assets, Bloomberg News has reported.

Meantime, Cerberus representatives have met with German finance ministry officials at least four times in the past six months. The government remains Commerzbank's biggest shareholder with a stake of about 15 percent.

But since the fund’s 2017 wagers, the outlook for both the industry and German banks in particular has worsened markedly. Deutsche Bank has been dragged into yet another money laundering scandal. It is being scrutinized like no other lender in the U.S. for its dealings with President Trump. And police raids at home in November weighed on revenue in what was already torrid fourth quarter for many banks.

Over at Commerzbank, its core business of serving mid-sized corporate clients – the backbone of the German economy – is struggling as trade wars dent exports and competition from foreign rivals intensifies.

But both banks' recovery has become fundamentally more complicated. While the European Central Bank has suspended QE, record-low rates are unlikely to move higher any time soon as economic growth sputters, prolonging the squeeze on net interest margins. At Deutsche Bank, cutting costs has so far proved tricky, eroding revenue more than desired, while funding has become more expensive.

The German government isn’t ignoring this loss of confidence – what Deutsche Bank’s CFO, James von Moltke, has described as a vicious cycle – and has been intensifying discussions for a potential merger of the two banks.

The obstacles to creating more value through a combination are significant – deep cost cuts to eliminate overlaps and a risky combination of their technology platforms would be required. But if there’s one stakeholder that could help to broker the creation of a German national champion, and benefit from it, it would be Cerberus.

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.

©2019 Bloomberg L.P.