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Deutsche merger chatter spooks markets

It’s been less than a year since Christian Sewing took over from John Cryan as CEO of Germany’s biggest bank over growing dissatisfaction with respect to the progress of a turnaround plan that began way back in 2016 and which was showing little sign of returning the bank to sustainable levels of profitability.

John Cryan did manage to avert a government bailout by securing €8bn of new funding back in April 2017, something that looked very unlikely towards the middle of 2016, however the problems for Deutsche showed no signs of receding, and while we did get a minor recovery the gains proved to be somewhat short lived.

Since then the share price has continued to come under pressure, hitting record lows of €6.68 in December, before rebounding over the course of the past few weeks.

Over the last few months we’ve heard multiple rumours of a potential merger with Commerzbank, a bank that is also struggling and which the German government owns a 15% stake. It is no secret that the German banking sector is extraordinarily competitive, with a significant number of regional banks, which means that the main profit centres for the bigger banks have tended to come from their international operations.

As most banks have been discovering in recent years, investment banking has also become significantly less lucrative as a result of lower rates, as well as much stricter regulatory scrutiny. We’ve already seen in the past few months both BNP Paribas and Societe Generale announce significant numbers of job losses in their investment banking divisions, in an attempt to hit performance targets.

With Deutsche Bank’s latest quarterly numbers out at the end of this week the talk of a merger with Commerzbank has once again hit the headlines with reports that senior executives are concerned that they are running out of road in their attempts to turn around the struggling lender, and that they may be forced to merge by the middle of this year if all else fails.

News of yet more scandals haven’t helped in terms of projecting an image of a bank that is in control of its own destiny, with pictures of German police raids at its head office, over the Panama Papers, as well as getting drawn into the investigation into money laundering at Danske Bank, in the past 12 months.

Unsurprisingly this has caused some investors to become a little restless, and while Sewing seems to have their support for now, that doesn’t mean they aren’t worried. The bank has managed to secure some additional pledges of investment from Qatar, which is encouraging but this seems more a case of doubling down, than a vote of confidence.

High level talks between the German government and senior management have been reported to have increased over the past few weeks, which suggests that senior German officials are growing increasingly concerned about the financial health of its biggest global bank, though quite how merging it with Commerzbank, whose problems are similarly acute, will help is beyond a lot of people’s comprehension.

If we’ve learnt anything over the last few years you don’t resolve a problem of a struggling bank by merging it with a rival who is also struggling. If anything it makes the problem even bigger, though it may prolong the eventual denouement.

What won’t be helping German government officials or Deutsche management sleep at night is the fact that interest rates remain anchored to the floor, with the potential to go even lower, while growth flat lined in the second half of 2018.

The German consumer doesn’t appear to be in any mood to splash out either if this week’s December retail sales numbers are any guide, cratering 4.3% in December, and down 2.1% year on year.

Compound that with a slowing global economy, and Germany’s key export markets under pressure and there is rising concern that Deutsche Bank might struggle to weather a prolonged economic slowdown in Europe.

Add in the possibility of a disruptive Brexit which could adversely impact Germany’s industrial heartland and it’s no wonder that German officials are worried about how the German economy might fare in a worst case scenario.

Both Deutsche Bank’s share price and Commerzbank’s share price have dived sharply lower on these merger reports which probably tells you all you need to know about what investors think of this story.

In April last year we were talking about moving the deckchairs on a sinking ship when Cryan was replaced, today’s reaction from the markets would suggest that some investors are heading to the lifeboats as investors worry that this week’s numbers from Deutsche could leave a nasty aftertaste.

Expectations are for annual revenues to come in at €25.46bn, a decline of 16% and net income to come in at €710m.

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