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Deutsche Bank and Commerzbank Confirm Merger Talks

Wall St’s oldest secret, the merger of two of the world’s most over-levered financial institutions came out of the closet today. Deutsche Bank and Commerzbank faced concerns from workers unions, Chancellor Angela Merkel’s office and top shareholders on Monday after confirming merger talks. How much capital would the German taxpayers have to put up is the question on everyone’s mind?

The concerns underline the obstacles to combining the banks, which confirmed talks about a tie-up on Sunday following months of pressure from Berlin, which has pushed for a deal amid concerns about the health of Deutsche Bank, which has struggled to sustain profits since the 2008 financial crisis.

Combined Entity

Commerzbank

Debt: $54B
Equity: $10B
+

Deutsche Bank

Debt: $174B
Equity: $18B

=

Post Merger

Debt: $228B
Equity: $28B

German GDP: $3.6T

*Enterprise value of the combined entity is equal to 7.1% of the country’s GDP. This deal has been lingering around for months, for one reason, who’s going to come up with the $30B? With levered banks, you MUST look at “enterprise value” (Debt + Equity), NOT the meaningless stock price or equity market capitalization. See the data above.

Need for Equity

The deal has yet to go through due to the political pushback given the lack of equity relative to the massive amount of debt in the combined entity.  In our view, the merger needs to get to at least $50B in equity for regulators to accept it. This would mean a near $30B capital injection from the German Government. Keep in mind Germany is the one holding fellow EU members’ feet to the fire on fiscal spending, putting them in a further precarious position.

Leverage vs. US Banks

JP Morgan:
Debt: $230B
Equity: $350B
D/E: .66x

Morgan Stanley:
Debt: $160B
Equity: $74B
D/E: 2.16x

The New (Merged) Deutsche / Commerzbank:
Equity: $28B
Debt: $228B***
D/E: 8.14x

In Q4, Deutsche Bank’s common equity tier-one capital ratio (CET1), a key measure of financial strength, came in near 8% in the European Union-wide test of banking resilience. The bank’s CET1 ratio will compare to 7.8% in the previous round in 2016, per Reuters. In contrast,  Barclays’ CET1 ratio ended 2019 at 13.2% (December 2017: 13.3%).

Debt to Equity Ratios
The German government will probably (must) inject some state capital into the merged bank and retain an equity stake, but it would have to be substantial. We would assume the merged entity needs to at least double its equity capital. 

Employees

Deutsche Bank AG: 92k
Commerzbank AG: 50k

Another obstacle for the acceptance of a deal is the jobs it would need to destroy. The merger takes out 20-30k here, unfortunately. After a decade of downsizing, financials are still downsizing.

Global Bank CDS
Credit risk in Europe has tightened substantially since the beginning of the year. However, the CDS in Deutsche and Commerzbank remains well above the banks in the US. Pick up our latest report here.