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Deutsche Bank has long hoped to become a global banking powerhouse. Her narrow assessment defeats her.
The German bank is one of the cheapest banks in the world, trading at five times its forward earnings and less than 40 percent of its tangible book value. This makes market talk about Deutsche Bank buying another bank, such as its local counterpart Commerzbank or the Dutch ABN AMRO, a clearly questionable prospect.
It is true that the fragmented European banking sector may need some consolidation. But this has been the case for a long time. While the European Central Bank supervises eurozone banks, domestic regulation, such as national deposit schemes, complicates deals. Then there are the politics: a takeover of ABN by the German bank seems unlikely, given the Dutch government’s contribution.
Another problem is investors’ lack of confidence in the fair value of European banks’ assets, and the resulting very low valuations. Stoxx 600 banks trade at less than 7 times forward earnings. Even US laggards, like Citi, receive a rating 9x higher and 0.6x higher for tangible book.
This means that European lenders’ equity is more than 15 per cent expensive, while many of them earn less than that on their capital.
Deutsche shares are not valued highly enough to create value if it wanted to pay for one of its regional rivals with shares rather than cash. At the same time, expending its hard-earned common stock from Tier 1 capital of 13.9 percent would anger shareholders if it affected the payout.
Yes, Commerzbank and ABN shares are also trading well below their tangible book value. For example, the former has a gap of about 16 billion euros. Buying cheaply enough, and revaluing the stock, can yield accounting benefits. When shares are submerged below their market price, this is known as “negative goodwill.”
UBS put this to good use when it acquired Credit Suisse last year to absorb losses needed to mark assets and liabilities at market price. Credit Suisse’s adjustment, of about €14 billion, may be too high for Commerzbank, believes Mediobanca’s Adam Terelak, despite their similarly sized balance sheets. But the deal could involve compensation in the same ballpark, eating up much of the benefit of negative goodwill. The German state still owns 15 percent of Commerzbank, and may not want to sell it too cheaply.
Ultimately, Deutsche does not have the valuation required for these all-stock transactions, even after the stock rebounds. What is needed is a return on tangible equity in the teens, not the “revised” 9 per cent from September. The cost-to-income ratio of 73 percent remains relatively high.
Investors’ hopes for a round of cost-cutting among beleaguered European banks have been repeatedly dashed. There is no reason to believe Deutsche will change that now.
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