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Deutsche Bank Merger Looks Real, and It’s Scary

Elisa Martinuzzi

(Bloomberg Opinion) -- It’s one of the most talked-about mergers, and one most think only works on paper: marrying Deutsche Bank AG with its smaller competitor Commerzbank AG to create a German champion. If it’s actually happening, investors should worry.

Both lenders’ stock fell on Thursday after Bloomberg News reported that the government-brokered combination could happen by mid-year. That negative reaction shouldn’t be a surprise. The deal looks like the option of last resort. Combining two of Europe’s most inefficient banks to create an even bigger supertanker would require tens of thousands of job cuts and a risky (read costly) integration to stand a chance of working.

The apparent rush to pursue what could be seen as a bailout via state-backed Commerzbank only raises questions about Deutsche Bank’s near-term viability.

Shares of Europe’s largest investment bank have fallen by almost 50 percent over the past 12 months, dragged lower by a loss of confidence that not even an entire new management team could arrest. Both banks now trade at the steepest discount to the book value of their assets in their European peer group, according to Bloomberg Intelligence. Deutsche Bank has been plagued by a seemingly endless erosion of revenue and more regulatory scandals.

So why get together now without the prospect of gaining much competitive advantage? Even with a leaner domestic retail business, the combined entity would still be exposed to pressure from Germany’s numerous local lenders. The securities business would be no better off.

Deutsche Bank reports fourth-quarter earnings tomorrow. It’s a chance for the financial community to push executives hard on what’s really behind the tie-up. Here are three key questions.

How toxic is Deutsche Bank’s balance sheet?

In Deutsche Bank’s investment banking heyday, it would compete in some of the most complex areas of derivatives structuring. Buttressed by an implied state guarantee, in the words of a former CFO, it was able to “build up a sheer endless balance sheet.”

As the lender’s cost of funding tripled in the last year, long-dated assets would have become more expensive to own. Its five-year euro credit-default swap, a proxy measure, jumped from about 65 basis points to about 220 basis points in December.

What’s more, according to Bloomberg News, Deutsche Bank has one of the largest concentration of Level 3 assets – the most illiquid securities that are priced based on internal models.

The European Central Bank, Deutsche Bank’s principal regulator, reviewed the trading books of the euro zone’s biggest lenders. It will know more about what’s in there than ever before. Shareholders need to have a similar level of detail.

How has liquidity held up during the latest confidence crisis?

The fourth quarter was a torrid one. Fixed-income trading, which remains Deutsche Bank’s securities engine, slumped across the industry, and wave of headlines on new and old scandals will only have deterred customers.

Notwithstanding the chairman and CFO’s confident tone in their year-end interviews, we know little about how well liquidity held up during the turbulent months – and the track record isn’t great.

During the bank’s 2016 crisis of confidence, clients were pulling billions every day. And though it was sitting on about 200 billion euros ($230 billion) in cash and liquid assets, its computer system was so slow it could not report to regulators exactly how much the bank held on a daily basis.

The end of the quarter may have been particularly brutal because that’s when clients re-balance their positions.

Have U.S. regulators run out of patience?

The bank faces deeper scrutiny on the other side of the Atlantic. The Federal Reserve is examining how Deutsche Bank handled billions of dollars in suspicious transactions from Denmark’s Danske Bank A/S in what could be one of the biggest money-laundering scandals ever.

It comes at a delicate time for the lender. It failed the agency’s annual stress tests in 2018 and was faulted for “widespread and critical deficiencies” in its capital-planning abilities. In March, it was scolded for relying on dysfunctional technology, and Deutsche Bank’s U.S. business was added to a group of troubled lenders monitored by the deposit insurance regulator.

Clearing up fundamental questions about Deutsche Bank’s balance sheet, liquidity and its ability to operate in the U.S. would go some way to reassure long-suffering shareholders. Rushing headlong into a shotgun merger will only do the opposite.

To contact the author of this story: Elisa Martinuzzi at emartinuzzi@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@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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