Much better than expected third quarter results at Commerzbank don’t change the harsh truth: Germany’s second biggest bank is going nowhere. Chief executive Martin Zielke’s new three-year strategy falls well short of what is necessary to revive it.
There are spots of brightness in what Zielke wants to do ‒ like integrating digital bank Comdirect, which could avoid cannibalization and bring together the group’s digital investment. But, overall, the plan is more like an admission of weakness than a recovery strategy, mainly involving paying for redundancy settlements with the sale of one of its best assets (mBank, in Poland).
It is, of course, understandable that Zielke is lowering his medium-term profitability targets: because the last ones turned out to be so unrealistic. He previously targeted a return on equity of more than 6% next year. He is struggling even to get to 3% this year. The extent of his ambition is now to reach 4% by 2023.
These targets, ultimately, are irrelevant, as the bank’s position is miserable either way. The bank is not losing money, but that is not sufficient to make it attractive for long-term investors, who will always look for decent income from a firm of this age and size.
Commerz reckons it will be able to resume dividend payments once it reaches a 4% return on equity, yet this may not be much of a consolation. According to Bank of America, once a bank reaches 4% ROE it can no longer pay any dividends, because of the capital required to grow lending. That’s also excluding the current inflation in capital requirements.
No wonder Germany’s government, belatedly, is looking more favourably on the idea of deeper eurozone banking integration
Bear in mind that much of Commerz’s hope – and its pleasant third-quarter surprise – is predicated on its ability to grow customers and assets. That’s again understandable, given its lack of alternatives, but there’s a big risk that future credit losses don’t justify the upfront reprieve to interest income.
Even if Commerz can pay some dividends, it won’t be much, as the closer it gets to 4% ROE, the smaller the proportion of profit it will be able to pay. A bank with 6% ROE can pay out half the rate a bank with 8% ROE can pay, according to Bank of America. In Commerz’s case, its absolute earnings may fall too as negative rates persist.
There is only one other big bank with similarly poor medium-term profitability: Deutsche Bank, which at least has the lever of reducing its international investment banking operations. According to UBS, two mid-tier eurozone banks, Spain’s Bankia and Italy’s Banco BPM, are in a similar predicament ‒ or worse, as their cost of equity is higher.
Yet German banks’ cost of equity, while much lower than Italian peers, is still about 10%, according to Kepler Cheuvreux, so a percentage point or two of ROE won’t make a difference. Commerz, like Deutsche, simply needs much higher profitability.
Now these two Germans have rejected a merger, a foreign takeover is the only possible catalyst for a turnaround by Commerz. It’s something that might have happened long ago, had vested interests not clung so tightly to the idea of banking as a prestigious national strategic asset.
As the fundamental unprofitability of Commerz has now become obvious, while potential acquirers have their own problems to solve, it is probably too late. No wonder Germany’s government, belatedly, is looking more favourably on the idea of deeper eurozone banking integration.