Why Deutsche Bank won’t lead European bank consolidation

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Deutsche Bank has long hoped to become a global banking powerhouse. Its parochial valuation defeats it.

The German lender is one of the world’s cheapest banks, trading at five times forward earnings and under 40 per cent of its tangible book value. This makes market chatter about Deutsche buying another bank, such as local peer Commerzbank or ABN Amro of the Netherlands, a distinctly dubious prospect.

True, the fragmented European bank sector could use some consolidation. But that has long been the case. While the ECB oversees eurozone banks, local regulation such as national deposit schemes complicates deals. Then there is politics: a German bank takeover of ABN feels unlikely, given the Dutch government’s shareholding.

Investor mistrust about the fair value of European bank assets, and their resulting knockdown valuations, is the other problem. Stoxx 600 banks trade under 7 times forward earnings. Even US laggards such as Citi get a higher rating at 9 times and 0.6 times tangible book.

That means European lenders’ cost of equity is high at over 15 per cent when many of them earn less than that on their capital.

Deutsche’s shares aren’t valued highly enough to create value if it wants to pay for one of its regional rivals with stock rather than cash. Spending its hard-earned common equity tier one capital buffer of 13.9 per cent, meanwhile, would rankle with shareholders if it impinged on payouts.

Yes, Commerzbank and ABN also trade well below their tangible book value. For example, the former has a gap of some €16bn. Buying cheaply enough, and revaluing the equity, can bring accounting benefits. When the equity is so submerged under the market price this is known as “negative goodwill”.

UBS used this to good effect when acquiring Credit Suisse last year to absorb the losses required to mark assets and liabilities to their market price. The Credit Suisse adjustment of about €14bn is probably too high for Commerzbank, thinks Mediobanca’s Adam Terelak, despite their similar sized balance sheets. But a deal could involve offsets in the same ballpark, eating up much of the negative goodwill benefit. The German state still owns 15 per cent of Commerzbank and might not wish to sell too cheaply.

Ultimately, Deutsche does not have the valuation required for these all-share transactions, even after a rebound in the stock. What’s needed is a return on tangible equity in the teens, not its “adjusted” 9 per cent as of September. Its cost/income ratio at 73 per cent remains relatively high.

Investor hopes for a round of cost-cutting consolidation among beleaguered European banks have been repeatedly dashed. There is no reason to think that Deutsche is going to change that now.