SHARE THIS ARTICLE Share Tweet Post Email

Want the lowdown on European markets? In your inbox before the open, every day. Sign up here.

Deutsche Bank AG, Europe’s once-dominant financial institution, threw in the towel on years of failed turnaround efforts and agreed to begin government-backed merger talks with Commerzbank AG.

By bowing to officials’ desire to forge a durable German lender with global reach out of two troubled firms, Deutsche Bank’s leaders are hardly putting their woes behind them: massive job cuts, political turbulence, a weakening European economy, U.S. probes into its dealings with Donald Trump and a herculean integration – not to mention skeptical clients and investors -- lie ahead if they reach a deal.

“I have consistently stressed that consolidation in the German and European banking sector is an important topic for us,” Deutsche Bank Chief Executive Officer Christian Sewing said in a letter to employees. “We have to assess how we want to play a part in shaping it.”

The companies confirmed the move to deeper discussions in statements on Sunday, capping months of speculation and behind-the-scenes talks with the Finance Ministry. Both firms have struggled to restore revenue growth after deep cuts to their investment banking units. An economic slowdown that has pushed back expectations for higher interest rates has added urgency to the situation.

Christian Sewing Photographer: Krisztian Bocsi/Bloomberg

The Finance Ministry said in an emailed statement it “notes” the decision of the banks to start open-ended talks and that it’s in “regular contact” with all parties involved. Finance Minister Olaf Scholz and his deputy Joerg Kukies have been favoring a deal to ensure the country has a lender to support the export-driven economy, people familiar with the matter have said. The country still owns a large stake in Commerzbank after a bailout.

The trade union for bank employees opposes a merger “in view of the risk to tens of thousands of jobs,” Jan Duscheck, who sits on Deutsche Bank’s supervisory board as labor representative, said in an emailed statement. As many as 30,000 positions could be at risk in a merger, according to people familiar with the matter.

Shares of both lenders rose Monday, with Deutsche Bank gaining 2.9 percent at 9:04 a.m. in Frankfurt trading and Commerzbank adding 4.3 percent.

The banks agreed to start formal talks after the government signaled it wouldn’t stand in the way of necessary job and cost cuts, people familiar with the matter said. Deutsche Bank expects to spend the next month in negotiations, according to a person briefed on the talks.

A tie-up of the two 149-year-old firms would create Europe’s fourth-largest lender with assets of about 1.81 trillion euros ($2.05 trillion). The banks have a combined market value of about 25 billion euros, comparatively small because of the long slide in the shares. Both companies have lost more than 90 percent of their value from their peaks.

While it’s not clear how a merger would be structured, Deutsche Bank is the larger of the two and would probably be the acquirer. If a deal goes ahead, it may need to raise about 8 billion euros from shareholders or through sales of holdings such as its DWS Group asset management business, according to an estimate by Christian Koch, a DZ Bank analyst.

Allianz SE has shown interest in DWS and is exploring the possibility of combining it with its own asset management arm, according to people familiar with the matter. DWS, which was taken public a year ago, rose 6.9 percent.

Martin Zielke Photographer: Alex Kraus/Bloomberg

“We will only pursue options that make economic sense, building on the progress we made in 2018,” Sewing said in his letter. “Our stated aim remains to be a global bank with a strong capital markets business –- based on a leading position in our home market in Germany and in Europe, and with a global network.”

The two companies previously discussed a merger in the summer of 2016. Both Commerzbank CEO Martin Zielke and Sewing were part of those discussions, though Sewing was head of the retail division at the time. The talks fell apart and the lenders embarked on their respective restructurings.

Bolder Steps

Almost three years later, their turnaround plans are sputtering. Commerzbank has dropped most of its 2020 financial targets after cutting its revenue outlook. Within Deutsche Bank, doubts are growing that it will be able to reach its goals. Sewing, tapped a year ago as CEO with a mandate to accelerate restructuring efforts, has recently given up his resistance to pursuing bolder steps, people familiar with the matter have said.

Deutsche Bank in February reaffirmed its 2019 profitability target but also made clear that it would need to implement tougher measures if markets don’t play along and revenue continues to decline. January was a terrible month for the trading business though February has seen improving conditions, the people have said.

Just a Notch Over Junk Deutsche Bank's senior non-preferred rating is close to sub-investment grade Source: Company filings

For Deutsche Bank, the urgency to address the situation is exacerbated by high funding costs and the risk of a credit rating cut. Chairman Paul Achleitner is said to see an expansion of Deutsche Bank’s retail deposit base -- which Commerzbank would bring -- as one way to lower funding costs.

The recent decision by the European Central Bank to push out the expected first interest rate increase has exacerbated the situation as both banks have said that they will struggle to meet their long-term profitability target in the current low interest rate environment.

2016 Talks

The idea back during the banks’ talks in 2016 was to merge Commerzbank with a subsidiary of Deutsche Bank that would also contain its retail and some of its corporate banking operations, and then float that business on a stock exchange, a person involved in the talk has said. Deutsche Bank’s trading operations would have remained separate, perhaps with a view to selling or merging them with another bank at some point.

Proponents of a deal have said it will help the firms cut cost by eliminating branches and thousands of jobs, while pooling investment in information technology. Critics have said a merger would lock both companies into several more years of restructuring, with high execution risks, and doesn’t fix the real problems at Deutsche Bank’s securities unit. Several influential Deutsche Bank investors have said they’re wary of a merger as it will dilute their stakes at a low valuation.

If a deal goes ahead, the new bank will be “busy with itself for years to come,” said Stefan Mueller at DGWA, an investment advisory boutique based in Frankfurt. “We continue to prefer a big European solution to counter the dominance” of U.S. banks.

— With assistance by Birgit Jennen, Ruth David, Dinesh Nair, Nicholas Comfort, and James Hertling

( Updates with share reaction from seventh paragraph. )