Our Call: On March 14, 2019, Capstone hosted a series of meetings for clients in Frankfurt to discuss the outlook for the German big bank M&A with regulatory and industry stakeholders. Our conversations focused heavily on banking consolidation and the broad sense of skepticism around the merits of creating a “national champion” given the merger talks between Germany’s Deutsche Bank and Commerzbank. We argued a merger was unlikely to happen in a note published on April 3, 2019.

Background: On March 17, 2019, Deutsche and Commerzbank announced that they had begun exploratory merger talks, confirming prior media reports. In our meetings in Germany three days earlier, our contacts expressed concern as to whether a long and difficult integration would leave bank regulators with a larger problem to confront. The prospective deal was orchestrated by two of Commerzbank’s larger shareholders (with help from Deutsche’s chairman): the German government (16%), and Cerberus (5%), with the US private equity firm also holding a 3% stake in Deutsche. German Finance Minister Olaf Scholz publicly reiterated his call for a banking national champion.

Our Rationale: In our view, any merger had to be justified on the basis of cost synergies. A reoccurring theme from our meetings was the powerful labour unions. The German principle of “codetermination” enhances workers’ representation and participation rights in corporate governance. As such, we argued that the job cuts supporters of the merger touted were unrealistic. The repeated focus on prudential requirements expressed during our meetings suggested to us that a larger, more complex bank is unlikely to win any concessions from bank regulators—with a higher CET1 requirement more likely, in our view. We argued that the focus of regulators would be on prudential standards, not on political motivations behind proposed deals. A key question was how the government could lower the risk in executing this complex deal (for example, through a tax break). Our conversations in Germany did not give us a sense that this was likely. In our view, European Union member state aid rules and a shaky domestic coalition made any perceived transfer of value from taxpayers to private shareholders politically unpalatable. Overall, we argued that Deutsche faced significant challenges as a standalone entity, including litigation risk, capital pressure from risk-weighted asset (RWA) inflation, and structural profitability concerns. We believed a complex merger with Commerzbank would further contribute to these challenges rather than alleviate them.

Our Process: We conducted a rigorous review of the public record of existing and proposed regulation and legislation. We combined our proprietary research with targeted conversations with relevant regulators, policymakers, and other stakeholders to assess the risks and opportunities the companies faced and the regulatory perception of the proposed merger.

The Outcome: On April 25, 2019, Deutsche Bank and Commerzbank ended talks. The banks said a deal would not justify the “additional execution risks, restructuring costs, and capital requirements associated with such a large-scale integration.”