EMC deal gives Commerzbank glimmer of hope

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By:
Dominic O’Neill
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Sale offers relief from share price dip.

Commerzbank’s deal with Société Générale to sell its equity markets and commodities business (EMC) marks an important step in its strategic plan after a tough few months for the bank’s shares. The German lender lost more than a third of its value between February and early July, when it announced the EMC deal; by the end of July it had risen about 3%.

The talk in Frankfurt is still whether or not this pillar of Germany’s financial world – its second biggest bank – can maintain a place in the blue-chip DAX index of the top 30 German stocks. Although the index lost about 8% of its value between February and July, younger online firms are catching up rapidly. Delivery Hero, for example, has risen by almost 50% in that period and now has a similar market capitalization to Commerz.

Management board member for corporate clients, Michael Reuther, says four issues lie behind pressure on its stock.

Firstly, the bank had previously been subject to unrealistic speculation both over earlier-than-realistic ECB rate rises – which would benefit Commerz more than most – and, secondly, over an imminent merger with another large European lender, possibly Deutsche Bank.

Thirdly, fears about US trade policy towards Germany have hit Commerz hard, as its model revolves so much around financing German exports. Finally, there was contagion from Deutsche’s problems, as investors tend, rightly or wrongly, to view Commerz in the same light.

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Michael Reuther, Commerzbank

But while fears over a trade war increased last month, Deutsche bounced back; its shares rose about 10% compared with a 2% rise in the DAX in July. Deutsche’s second-quarter results, announced in mid-July, showed a €700 million pre-tax profit, about twice the market consensus, according to UBS.

The relief on Deutsche has helped, while the Société Générale deal marks a milestone for Commerz in its four-year transformation plan, announced in late 2016 and designed to boost its poor underlying profitability. It has taken time to disentangle the various EMC business lines from Commerz, to make sure it could all function separately and to find a suitable buyer.

SocGen is taking EMC’s trading books, client franchise, staff and parts of the IT infrastructure. The business is made up of manufacturing and market making of flow and structured trading, investment products and its exchange-traded funds unit, Comstage, including its ETF market-making platform. Commerz will retain its cash equity brokerage and commodities hedging business.

Chief executive Martin Zielke took the decision to sell EMC and refocus even more closely on the bank’s core franchise, shortly after the departure of predecessor Martin Blessing in mid 2016. The markets businesses would only be kept if they were useful to German or Germany-related corporate clients, rather than “faceless institutions”, as an insider puts it.

Capital requirements

Reuther says the bank took the idea to sell the ECM unit in part due to expected increased capital requirements from the Basel review of the trading book, as well as the general effort to reduce complexity at the bank. Less than 10% of its revenues come from Commerz’s private clients.

More generally, Reuther says investors have confidence in Commerz’s management, beyond the external factors impacting its share price performance.

“I haven’t heard doubts among investors about the strategic direction and our aim to digitalize the bank,” says Reuther.

The firm has gained more than 6,500 corporate clients since October 2016, according to Reuther. He says the bank has been particularly successful in winning clients with turnovers between €15 million and €100 million, where its market share was previously weak due to the lead of savings banks and cooperatives in that segment.

Its growth in this middle segment partly lies behind its decision to add corporate loan growth as an indicator of its strategic execution in its reporting. Reuther says volumes in that segment more directly translate into higher net interest income, partly because there is less competition and because the ECB’s asset purchase programme does not extend to it, so there is a higher return on risk-weighted assets.

Approaches

In the EMC sale, the bank had more than 30 approaches for the ETF unit, although it wanted to offload the whole EMC operational infrastructure, which several banks were willing to take – some, apparently, to gain an EU sales and trading operation in Frankfurt after Brexit. Commerz shortlisted initially four and finally two banks; the other one was rumoured to be Goldman Sachs.

Commerz had considered an IPO but decided against that as it became clear the business needed another investment grade-rated parent to back the certificates and warrants.

The deal is also relevant to SocGen’s wider derivatives and investment products business and especially its German and ETF franchise. It will allow SocGen’s Lyxor Asset Management to overtake Deutsche-owned DWS’s Xtrackers as the second biggest ETF provider in Europe after BlackRock’s iShares, according to research provider ETFGI.

Commerz’s EMC business had €381 million in revenues in 2017. Not all of that is German – it also operates from London, Hong Kong, Paris, Luxembourg and Zurich – but SocGen’s Germany head, Guido Zoeller, says Germany is the largest European market for the biggest part of EMC, flow products.