We’ve previously commented on the now failed merger saga between Commerzbank and Deutsche Bank; there are now fresh new press rumours this week linking Commerzbank with both UniCredit and ING Groep. We struggle to see either strategic rationale or real-world practicality in any of these purported combinations. What’s clear is that Commerzbank is in a need of a radical solution. What is less clear is that either of these combinations can deliver it. Not only that, but we are wary that any theoretical tie-up would be detrimental to the investment theses of the cross-border suitors without solving the underlying structural issues for the German lender.
From UniCredit’s point of view, the appeal could be any and all of the following:
1) Increase presence in Germany and consolidate its local unit HVB with Commerzbank to achieve cost synergies.
2) Reduce funding costs long term if it manages to move headquarters to Frankfurt.
3) Gain access to the excess deposits at the Commerzbank level that would, in spreadsheet land, be revenue-accretive.
However, there are many more obstacles than opportunities in our view. To name just a few:
1) The lack of a single Deposit Guarantee Fund in the EU (and unlikely to get there anytime soon, if ever) will nullify Revenue synergies from the heavy deposit overhang at Commerzbank.
2) There is severe political opposition to exposing German taxpayers’ savings to purportedly inferior-quality assets in the periphery.
3) It will be very hard, if not impossible, to achieve cost synergies (“a lot of blood will spill before we merge with the Italians” – Verdi Union official and labour representative on Commerzbank’s board.)
Looking at a potential combination from the perspective of ING – the other rumoured “suitor” – it makes even less sense. The most obvious reason for a merger would be some sort of regulatory “arbitrage”. Dutch banks currently face a 3% core capital surcharge requirement imposed by the local regulator due to the size of ING in the financial sector compared to the Dutch economy. So, in theory, a move to being domiciled in Frankfurt and a reduction in the combined ING/Commerzbank entity relative to the size of the German economy would remove this Dutch requirement, creating a one-time windfall – freeing up excess capital. Furthermore, there continues to be a 20% bonus cap on the compensation of financial services professionals in the Netherlands, which is much stricter than the general European Banking Authority’s (EBA) guideline that applies for the rest of Europe. One could therefore argue that moving the headquarters to Frankfurt would financially benefit shareholders and employees alike, at least in the first instance. The main problem here is that this relationship would be a marked departure from ING’s current strategy of being a digital/innovation leader, with a branch-light and branch-less network across many countries. Interestingly, this includes its current operations in Germany, where it is among the few banks that actually generates return on equity (RoE) near its cost of equity, precisely due to its cost-light, branch-network-light approach. The secondary issue is that any merger will be ROE negative, hardly in the long term interests of shareholders and creditors beyond a one-time theoretical gain.
Let’s not forget that Commerzbank is a structurally challenged business rather than a prized asset that everyone is fighting to acquire. Hence, if there is any deal impetus, it is driven by Commerzbank itself rather than anyone else. Its less enviable capital and revenue position is partly due to past decisions of its own (curable organically), and partly due to the structural state of the German banking landscape (not curable organically).
The main appeal of a potential transaction, according to market pundits, therefore lies in the price. Many say that Commerzbank’s 0.4x price to net asset value (NAV) is very cheap. However, expected returns on “tangible” equity of below 5% (using market consensus figures) do not make Commerzbank “cheap”.
Further accountants’ tricks around goodwill may sweeten the deal from a potential suitor’s perspective, but the European Central Bank may take a dim view of such shenanigans.
Overall, Commerzbank does have a problem to solve, and so does the EU banking system. The lack of a common Deposit Guarantee Mechanism (a.k.a. deposit fungibility) across the European Union prohibits the creation of a true single banking market – crippling the EU banking sector. Inability to eliminate excess capacity and reduce costs via cross border mergers puts the sector in a permanently lagging position compared to US banks. On top of that, there is the incredibly fragmented banking sector in Germany. This fragmentation challenges revenue growth and the cost base of thousands of branches creating an unsustainable cost base. These factors, along with a union vehemently opposed to any significant rationalisation adds further complexity. Without solving at least one of these factors, it will be extremely difficult for any German bank, including Commerzbank, to look competitive at a Pan-EU level. No type of M&A will supplant this fundamental truth.