FILE PHOTO: Outside view of the Deutsche Bank and the Commerzbank headquarters in Frankfurt
By Andreas Framke, Arno Schuetze and Tom Sims
FRANKFURT (Reuters) - German hopes of creating a national banking champion able to challenge global competitors were dashed on Thursday when Deutsche Bank and Commerzbank ended merger talks due to the risks of doing a deal, restructuring costs and capital demands.
Germany's two largest banks announced that nearly six weeks of high-level negotiations about a tie-up had ended in failure, confirming an earlier Reuters report and immediately raising questions about the future of the Frankfurt-based rivals.
The decision to ditch the talks followed a final early morning meeting between Deutsche Bank Chief Executive Christian Sewing and his Commerzbank counterpart Martin Zielke, two sources told Reuters.
Both CEOs said a deal would not have created sufficient benefits to offset the risks and costs of a merger, which had been opposed by unions fearing 30,000 job losses, and raised concerns among investors and regulators.
While the talks are over, investors doubt either bank can go it alone for long under their current strategies given their low levels of profitability.
German government officials, led by Finance Minister Olaf Scholz, had pushed for a tie-up to create a national banking champion and end questions over the future of both banks, which have struggled to recover since the financial crisis.
Deutsche Bank's 2018 return on equity was just 0.4 percent, trailing far behind rival U.S., and increasingly other European, investment banks, while Zielke said this month that Commerzbank does not have the market share for costly investments, fuelling speculation of an alternative tie-up if talks fell through.
Shares in Commerzbank were 2.1 percent lower at 1235 GMT. Deutsche Bank traded 0.3 percent lower, erasing earlier gains.
Deutsche Bank will now face pressure to make more radical changes, such as cuts to its U.S. investment bank as advocated by regulators and some major investors. It is already looking at a deal for its asset management unit DWS.
"Deutsche Bank will continue to review all alternatives," Germany's largest bank said.
BIDDERS IN THE WINGS
Employees of both banks immediately welcomed the news, although a senior Commerzbank manager acknowledged it opened the door to further uncertainty as foreign competitors circle.
"It is clear that others will now come out of the woodwork with offers and ideas," the manager told Reuters.
Doing nothing is "not an option", Zielke has told his staff, 82 percent of whom were against a merger in an internal survey.
Both UniCredit and ING Groep have expressed interest in Commerzbank, which is Germany's No. 2 lender and 15 percent owned by the government, sources have said.
UniCredit and ING declined to comment after news that talks between Deutsche Bank and Commerzbank had failed.
Some major Deutsche Bank investors had questioned the deal's logic and were unwilling to stump up any extra cash to get it done, while credit ratings agencies had warned of risks.
The European Central Bank would have asked Deutsche Bank to raise fresh funds before it gave the go-ahead for a merger, a person with direct knowledge of the matter said. .
The German central bank, which helps oversee the banks, stressed their individual health, calling them sound and stable.
"This was the case prior to discussions, during discussions and now – without qualification," Bundesbank executive board member Joachim Wuermeling said.
Deutsche Bank also published preliminary earnings in which it said it expects to post a first-quarter net profit of about 200 million euros ($223 million), beating analysts' expectations of 29 million.
"A merger would have been an enormously complicated and protracted undertaking. In the end, reason has won," said Ingo Speich, head of sustainability and corporate governance at Deka Investment, a shareholder in both banks, adding they urgently need to address their strategies.
Alexandra Annecke, portfolio manager at Union Investment, which also holds shares in Deutsche Bank, said it needs to focus on increasing profitability, especially at its investment bank.
Deutsche Bank's finance chief James von Moltke told CNBC that the U.S. investment bank is "a core part of our strategy".
Gerhard Schick, finance activist at Finanzwende and a former member of the German parliament, welcomed the end of talks but cautioned that Deutsche Bank remains "too great a risk".
"The bank is still far too large and would probably have to be rescued in an emergency," he said, with reference to the likelihood of Deutsche Bank needing to turn to the state to keep it afloat if it ran into difficulty.
(Reporting by Hans Seidenstuecker, Andreas Framke, Arno Schuetze, Tom Sims, Francesco Canepa, Frank Siebelt; Additional reporting by Toby Sterling in Amsterdam and Gianluca Semeraro in Milan; Editing by Sabine Wollrab, Tassilo Hummel, Michelle Martin and Alexander Smith)