OREANDA-NEWS. Fitch views the planned merger of DZ BANK, the main central bank of the German cooperative banks, with the last remaining other central bank, WGZ BANK, as positive for GFG. The combined bank will start its operations on 1 August 2016 but the full integration process will only be completed by end-2018. By 2020 the strategy and steering functions will be combined in a holding company while the business activities of DZ BANK and WGZ BANK will be in a separate unit and organisationally located with other specialised service providers of the group, including Bausparkasse Schwaebisch Hall (building society), R+V Versicherung (insurance), Union Investment (asset management) and TeamBank (consumer finance).

As both banks have similar business models, the merger will avoid duplicate investments, especially in IT and for regulatory requirements, and it should provide opportunities for revenue and cost synergies. We understand that the merger will support DZ BANK's improving regulatory capitalisation ratios, mainly from no longer recognising minority interests that are currently deducted.

The merger should strengthen further the strategic alignment of the German cooperative banks with its central institution, which will increase the group's cohesiveness. The consolidation in the cooperative sector highlights the contrast with the public sector banks in Germany under the umbrella of Sparkassen-Finanzgruppe (SFG; 'A+'/Stable), which also share an institutional support mechanism. SFG has still seven Landesbanken (central banks) that compete with each other and nine building societies and 11 insurance companies.

Despite a 14% drop from its record results in 2014, DZ BANK's strong 2015 pre-tax profits reflect its diversified recurring income sources, with especially strong results from its asset management and consumer finance subsidiaries, and low loan impairment charges thanks to the benign operating environment in Germany. This year's result was less driven by one-off effects than the stronger EUR2.87bn 2014 pre-tax profit. We expect NII to suffer in the medium term if interest rates remain low and loan impairment charges increase after hitting a cyclical peak in 2015. As a result we estimate that DZ BANK's pre-tax profits will decline to more sustainable levels.

DZ BANK strengthened its capitalisation thanks to retaining earnings and additional Tier 1 issues (in total EUR750m) placed with the local cooperative banks. At end-2015, its fully-loaded Common Equity Tier 1 (CET1) ratio improved to 13.0% from 11.4% at end-2014 and its fully-loaded leverage ratio to 4.0% from 3.2%.