UNCRY - Commerzbank: As Good As It Gets?

2023-05-23 05:40:16 ET

Summary

• Commerzbank announced Q1 results on May 17, and they were better than expected.
• Shares were down 7% on the day of the announcement.
• While results were good, Commerzbank is still years behind other banks regarding its profitability – and it is getting hard to see how the bank will catch up.
• With a forward-looking P/E of around 6 and a P/B ratio below 0.5, the bank is cheap, but for a reason.
• Shares have limited headroom upwards from here, and there are probably better opportunities in the financial sector for investors.

(Note: all amounts in the article are in EUR. At the current exchange rate 1 EUR is around 1.08 USD.)

Investment Thesis

Commerzbank (CRZBF) (CRZBY) presented its Q1 2023 results on May 17 and the bank had a lot of good news.

Profit before taxes was 875mn, clearly exceeding expectations. The same goes for net profit, which was 580mn and up almost 95% YoY from 298mn in Q1 2022. Cost increased only by 2% YoY. Given the inflationary environment this is an achievement, and better than many other banks did. Even more, Commerzbank had already reduced cost in 2022 in absolute terms.

With 68mn, risk provisions were on the low side, and a core capital ratio of 14.2% means that the bank is now well capitalized. Accordingly, Commerzbank has received ECB approval for share buybacks. The amount is only 122mn (just around 1% of the market cap), but we should take this as a good sign. Last year, Commerzbank managed a second consecutive year of profit after several years of losses, and the bank rejoined the DAX index (which it had to leave previously due to the low share price).

But as a result of all the good news, shares went down around 7% on the day of the announcement (they almost recovered the loss on the next day though).

So, what is going on here?

I think there are two reasons why the market reacted badly. One - behind the good results, some surprising problems were apparent in the Private and Small Business customer segment and at the Polish subsidiary mBank. The Private and Small customer segment surprised with a lower QoQ profit, and especially the net interest income disappointed. And in Poland there is no end in sight for the money drain from the legal problems due to CHF loans in the past.

Second, Commerzbank is still well behind other banks regarding its profitability and not really catching up. A RoTE of 8.3% is an improvement from just 4% a year ago, but certainly not great by itself.

The same goes for efficiency, where Commerzbank is still behind other banks - and by a lot. The cost/income ratio was around 65%. The bank wants to be at an unambitious C/I ratio of 60% in the mid-term, still far behind competitors. For example, UniCredit (UNCFF) (UNCRY) was at 39.2% in Q1 2023 . UniCredit has significant business in Germany similar to Commerzbank through its HypoVereinsbank subsidiary. Even ING Groep (NYSE: ING ) with its German ING DiBa subsidiary has a C/I ratio of 58%, but at least targets a ratio of 50-52% in the future. And I could go on with more examples.

If the bank cannot do better when times are good, what is it going to be like when the going gets tough in a recession? For Commerzbank this could be as good as it gets for a while and shares seem to have limited headroom upwards, at least in the mid-term.

A detailed look into Q1 2023 results

Commerzbank generated an operating result of 875mn in Q1 2023 - a good 61% more than in the same period of the previous year. The bank also significantly exceeded the consensus estimate of 481mn for net profit with 580mn, nearly doubling the number YoY.

As expected, net interest income was the key profit driver. NII increased 39% compared to the same quarter of the previous year.

Total income was still 5% lower than in the previous year. Last year Commerzbank benefited from a one-time effect of more than 300mn. In addition there was no income anymore from the ECB's TLTRO program. But costs increased only by 2% despite inflation, and the risk provisions were very low at only -68mn. Risk provisions were -464mn in Q1 2022. So, this was enough therefore to achieve the mentioned increase in the operating result and net profit.

While all this is good, some problems were apparent and clearly visible too.

NII was lower QoQ everywhere except the Corporate Centre and guidance for FY 2023 disappointed

While NII was higher YoY across all divisions, it was lower QoQ everywhere except the Corporate Centre (Note - in the below graph O&C stands for Others & Consolidation, which is basically the Corporate Centre, PSBC Germany is the German Private and Small Business Customer segment and CC stands for Corporate Clients).

This was clearly a negative surprise, and Commerzbank forecasts an NII of 7bn for FY 2023. This is disappointing as it means Q1 was the peak quarter for net interest income, and it is not going to get better anymore despite rising interest rates. The reason: the bank expects that it will have to pay more for customer deposits going forward.

During the earnings call the CFO, Bettina Orlopp, said that the bank expects the deposit beta to significantly increase over the year. In Q1 the bank only passed on an average of 15 percent of the central bank interest rates to its private and corporate customers, but it forecasts the number to rise to 35 percent for the rest of the year. We can already see this, for example, with its online subsidiary Comdirect which is now trying to attract new customers with a 3.05 percent interest rate for deposits. This is barely below the ECB rate.

Private and Small Business Customer segment came in below expectations

A clear deviation from expectations can be seen in the segment results: The unit for Private and Small Business customers remained well below the analyst consensus of 499mn with an operating profit of just 390mn, and also 3% below the previous year's result. The main drivers were a decrease in the consumer finance book and lower deposits.

Meanwhile, the Corporate customer division saved the day and performed well, with a pre-tax profit of 539mn million, beating expectations by more than 200mn.

The Private and Small Business customer division also increased its cost versus the previous year. My view is that the cost base in general is still too high. I agree with the bank's management that keeping costs almost flat YoY on the group level in the current inflationary environment counts as a success. But the problem is that staying flat is not good enough.

The larger part of the operating expenses are personnel expenses, absolutely not unusual for a bank. Most of the cost reduction efforts seem to go towards general administrative expenses, which went down YoY, but personnel expenses increased. In Q1 2022 the ratio between personnel and administrative expenses was 60:40, in Q1 2023 it was 61:39. I would expect this trend to continue, unless management takes more drastic measures, which I do not see coming.

Polish subsidiary mBank increased risk provisions again

Another disappointment was that Commerzbank again had to increase provisions for the controversial Swiss franc loans in Poland to 173mn, and said that further cost cannot be ruled out.

Because of low interest rates in Switzerland in the past, many Polish customers had taken out loans (mostly mortgages) in Swiss francs. And a lot of banks were happy to comply. When the Polish currency, the zloty, lost value against the Swiss franc, customers started taking legal action against Polish financial institutions because of possibly unlawful clauses - and were usually getting their way as the Polish government and courts were also quite supportive.

In total mBank has now already raised 1.75 billion euros for provisions, settlements and court decisions in connection with its Swiss franc portfolio. Commerzbank has tried to sell its stake in the Polish bank ( it holds 69.3 percent ) in 2019, but had been unable to find a buyer, at least at a reasonable price. So, the money drain will likely continue, and it is no consolation to shareholders that mBank is not alone here. The Austrian Raiffeisen Bank International (RAIFF) (RAIFY) even does not do any new business in Poland because of this problem, but still has to keep paying.

Conclusion

There is no doubt that Commerzbank has made good progress in its transformation over the last years. Shares are up more than 200% from their lows in 2020 when they were really cheap.

But this could be as good as it gets for a while, unless Commerzbank management gets more ambitious regarding profitability especially on the cost side, which I cannot see currently. In my view the air looks quite thin for new investments to reap a decent reward and I recommend that new investors stay on the sidelines.

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