Commerzbank: Awaiting ECB Rate Hike to Tangible Pound 0.33 (OTCMKTS: CRZBF)

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Investment thesis

Commerzbank (OTCPK:CRZBF) is off to a good start in its first year post-restructuring, with a comfortable buffer against larger peer Deutsche Bank (DB) in terms of absolute CET1 capital level, as well as distance beyond the Maximum Distributable Amount (MDA) requirement:

Commerzbank German Bank Comparison Commerzbank/DB
Capital CET1 13.54% 12.8% 0.74%
MDA requirement 9.42% 10.43% -1.01%
MDA buffer 4.12% 2.37% 1.75%

Source: Author’s calculations based on company statements

While both companies are currently accumulating dividends at the 30% level, Commerzbank is in a more comfortable position to increase distributions to shareholders once the war in Ukraine becomes clearer. During the first quarter of 2022, however, Commerzbank lagged DB in terms of tangible book growth given lower RoTE (4% vs. 8.1%) and the lower benefit of a strong american dollar. And while DB benefits from the occasional uptick in trading activity with its large exposure to investment banks, Commerzbank seems more suited to the current rate hike environment, especially if the ECB initiates rate hikes. in July.

Company presentation

Commerzbank operates in two main divisions – Private and Small Business Customers (PSBC) at 54% of Q1 2022 underlying revenue, of which Polish majority-owned subsidiary (Commerzbank’s 69.3% stake) mBank accounted for 15% of revenue underlyings for the first quarter of 2022, and Corporate Clients (CC) around 33.7% of Q1 2022 underlying revenue.

Operational overview

Commerzbank was able to absorb the initial impact of its exposure to Russia thanks to higher revenues and limited restructuring expenses, leading to a stable year-on-year operating result despite a significantly higher cost of risk:

Key performance indicators

Key performance indicators (Commerzbank Q1 2022 Earnings Press Release)

In total, net income amounted to EUR 298m, i.e. a RoTE of 4%, and management reconfirmed the 2022 net income target above EUR 1bn. The remaining net exposure of 1.19 billion euros to Russia is expected to continue to decrease in the coming months via a combination of roll-offs and write-offs.

On the provisioning side, the High Level Adjustments (TLA) that banks use to provision what is currently only recommended by risk models, increased by 36% Q/Q to EUR 713m. 27.5% of COVID TLAs were used/released in the quarter, and an additional EUR 334m of Russia TLAs were added:

TLA Overview

TLA Overview (Commerzbank Q1 2022 Analyst Presentation)

Sensitivity to interest rates

With interest rates appearing to have stabilized somewhat and the market looking confident that the ECB’s deposit facility rate will reach 1% to 1.5% over the medium term, Commerzbank stands to benefit significantly if events are unfolding as currently predicted by forward rates:

Net interest income benefits from a yield change of 100 bps

Net interest income benefits from a yield change of 100 bps (Commerzbank Q1 2022 Analyst Presentation)

In the scenario above, the profit of 700 million euros for 2023 is net of the loss of income due to the charging of deposits, prioritization at the ECB, etc. Given that the underlying NII for 2021 was €4.62 billion, the €700 million represents a 15% increase. For context, NII accounted for approximately 57% of 2021 revenue, with net commission income accounting for the remaining 43%.

mBank’s NII was also discussed on the conference call given that interest rates in Poland are at 5.25% and there have been political reactions against the banks:

mBank also had strong transaction activity in the quarter, supported by one-time fees. This brings us to the NII on slide 11. The underlying NII was up EUR 151 million from the prior quarter. This is driven by mBank, which benefited from rising interest rates in Poland. The benchmark rate is currently at 525 basis points and is expected to continue to rise. Deposit beta so far has been modest as the vast majority of customer deposits are below or up to 100 basis points for retail customers.

With further rate hikes, expect an increase in beta. Higher rates will remain beneficial and mBank’s Q1 NII will likely be a good indicator for the coming quarters. However, the Polish Prime Minister made some proposals in response to the rate hikes and their impact on consumers. The legislative process has been launched, but it is too early to give a concrete assessment of the potential impacts.

Source: Commerzbank Q1 2022 Analyst Call Transcript

Key takeaway for investors

Despite strong operational performance, the tangible book value per share remained broadly stable at EUR 19.56/share, with other comprehensive income losses weighing on net income. Nevertheless, the bank is in a very strong position to absorb any adverse events given the strength of its capital.

Commerzbank reserves 30% of net income for distributions to shareholders. I think as we move forward into 2023, the strong capital position will allow the bank to transition to a more normal 50% payout given the focus on retail business. Operating results are expected to improve further as deferred restructuring benefits materialize in 2023 and 2024, coupled with NII benefits through higher rates.

The valuation remains at very degraded levels, with a P/Tangible book at around 0.33. Even if there are adverse events along the way, or if rates don’t rise as much as currently expected, the current valuation provides a very large margin of safety. Personally, I will continue to roll my options position with an upward bias.

Thanks for the reading.

Angela C. Hale