Explainer: Why Germany wants a merger to underpin Deutsche Bank

FRANKFURT (Reuters) – Deutsche Bank and Commerzbank confirmed on Sunday they were in talks about a merger, prompting labor union concerns about possible job losses and questions from analysts about the merits of a combination.

FRANKFURT (Reuters) – Deutsche Bank and Commerzbank confirmed on Sunday they were in talks about a merger, prompting labor union concerns about possible job losses and questions from analysts about the merits of a combination.

Germany’s two largest banks issued short statements after separate meetings of their management boards, a person with knowledge of the matter said, indicating a quickening of pace in the merger process, although both also warned that a deal was far from certain.

Deutsche, the largest bank in Germany, Europe’s biggest economy, emerged unscathed from the financial crash but later lost its footing.

In 2016, the International Monetary Fund called the bank the world’s biggest potential risk among peers to the financial system because of its links to other banks.

German officials fear that a recession or big fine, for example, could derail the bank’s fragile recovery.

Berlin wants a reliable national banking champion to support its export-led economy, known for cars and machine tools.

Deutsche and other European banks have taken longer to recover from the financial crisis, losing ground to stronger rivals from the United States.

Other than Deutsche, Commerzbank is Germany’s only remaining big bank, after a series of mergers. The government holds a 15 percent stake after bailing it out during the crisis, giving it an important voice.

Commerzbank, like Deutsche, has struggled to rebound, and German officials say it is vulnerable to a foreign takeover. If an international rival snapped it up, that would increase competition for Deutsche on its home turf.

Berlin also wants to keep Commerzbank’s speciality – the funding of medium-sized companies, the backbone of the economy – in German hands.

The merged bank would have roughly 1.8 trillion euros in assets, such as loans and investments, and a market value of about 25 billion euros ($28 billion). It would have one fifth of the German retail banking market.

Together, Deutsche and Commerzbank employ 140,000 people worldwide. A merger would put tens of thousands of jobs at risk, according to unions.

Proponents of a merger include the German government and U.S. investor Cerberus, which is a shareholder in both banks. Opponents include some other shareholders in Deutsche Bank and labor unions.

Deutsche’s chief executive officer Christian Sewing would prefer to have more time to stabilize the bank before taking on a merger, people familiar with the matter have said.

On March 17, both banks held management board meetings and confirmed they were in talks about a merger, though both warned that a deal was far from certain.

In February, Deutsche’s management board gave Sewing the go-ahead for exploratory talks with Commerzbank, a person with knowledge of the matter said. There had been contacts among a small circle of executives.

With the talks now out in the open, and Berlin still pushing for a deal, the companies are under pressure to figure out the mechanics of a fusion and decide whether or not it is workable. That decision is seen within weeks.

One of the biggest risks is how to fill what one German official has told Reuters will be a multi-billion-euro financial hole because a merger could trigger an adjustment to the valuation of some bank investments.

Commerzbank, for example, has about 30.8 billion euros of debt securities such as Italian bonds that now have a value of 27.7 billion euros – a drop of 3.1 billion euros. A tie-up could crystallize this loss. Deutsche has such securities at market value in its accounts.

The deal would make the German government a shareholder in the country’s largest bank and executives would want to curb its influence.

The two banks could also get bogged down with restructuring, such as integrating different technology systems, losing ground to rivals.

German officials have held exploratory talks about merging Deutsche and UBS but there was little interest in Switzerland, people familiar with the matter have said.

These officials believe that sticking with Deutsche’s current course of cutting back costs and scaling back high-risk banking offers scant hope of a turnaround.

The continued pressure from Berlin makes it harder for Deutsche to go it alone. Merging with a state-owned lender, in the officials’ view, offers a safe harbor.

If talks do unravel, however, Deutsche could respond to pressure from some investors to make further cuts to the investment bank, especially in the United States.

Deutsche has long been unpopular with ordinary Germans because it was seen by many as a symbol of capitalist excess.

Its image has been tarnished by numerous lawsuits and billions of dollars in fines.

These included an alleged “conspiracy” to rig the price of financial market bets and sham trades between Moscow and London that moved money from Russia abroad.

In its latest financial report, Deutsche has set aside 1.2 billion euros for litigation. That is a fraction of earlier years but nonetheless more than three times its 2018 profit.

The bank has dealt with the bulk of legal action going back to the economic crash and has improved its finances.

Announcing the first profit since 2014 last year, CEO Sewing said the group was “on the right track”. But German officials are not convinced and have continued to push for talks with Commerzbank. Sewing has now bowed to that pressure.