Commerzbank AG (CBK) Earnings Call Transcript & Summary

First of all, good morning from my side, and welcome back to our European Financials Conference, but more importantly, welcome to our next session, which is a session on Commerzbank. And I'm delighted to be joined here by Martin Zielke, who's the Chief Executive Officer of Commerzbank. Martin truly is a veteran of European banking and of German banking, having joined the industry in 1983 at Deutsche Bank. He then switched between various roles, but joined Commerzbank in 2002. So Martin, I think it's fair to say that you're now experiencing your third systemic crisis from a position of being a senior executive at Commerzbank. But before we go any further, and I am genuinely looking forward to this discussion, let me pause here for a second and just say, Martin, thank you very much for finding the time to join us here today, even though it's virtually. Thank you for spending time with us and with our clients. And I certainly hope that we make you feel welcome over the course of this conversation.

So Martin, let me get right to it. So the first quarter of 2020 for European banks was a very unusual quarter. So banks had to make some sort of a scenario and estimate losses and book loan loss provision in that way. We had a range of 9 basis points at one end of the extreme to 269 basis points on the other end of the extreme. And German banks, in general, Commerzbank also, more specifically, were towards the lower end of this range at around 50 basis points. And I wanted to ask you, so what kind of a macro scenario underpins your loan loss provisioning? Why is 50 basis points the right number? And how confident are you that it will remain the right number as time goes on?

Thank you, Jernej. First of all, I'm happy to be here with you today. And I wondered whether it is a good start if you call me a veteran. I'm not sure about it, but honestly, I think you're right. So -- but coming to your question, I think the question is clearly one of the key questions on everybody's minds. In relative terms, the German economy has performed better than average. I think this is thanks to several factors: one is, of course, its structure; another is the softer lockdown, more businesses were able to continue in March and April than in most other countries; and last but not least, of course, decisive government actions. So our economist view on the development of the economy reflects this. For Germany, we expect GDP to fall by around about 5.5% this year before recovering by 4.5% next year. The unemployment rate, for example, is expected to climb from 5% before the crisis to around 7% this year and then fall to around about 6% towards the end of 2021. The impact of the overall Eurozone is expected to be larger, with GDP dropping by 7% this year and unemployment going up to around 10%. So our guidance of a risk result of EUR 1 billion to EUR 1.4 billion in 2020 is based on the analysis. The key assumptions are a 2-month lockdown and then a step-by-step reopening of the economy. And this is what we are seeing right now. The 2 key questions are, first, will there be a second lockdown? We assume this will not happen. And second, will the economies see this step-by-step reopening gaining traction? Key factors that influence the strength of the recovery are the support and stimulus packages of the government. Everybody acknowledges that the actions of the German government are very strong and decisive. The income support, short time work and loan guarantee schemes have been very effective. An economic stimulus package to support the restart of the economy has just been launched last week. I've already publicly endorsed this. It sends a clear and a positive message to companies and consumers. It has also been very well received by the public. I think the strength of the stimulus comes not only from its size of EUR 130 billion, but also its composition. It contains measures on the demand side as well as the supply side of the economy. And I'm very confident that it will yield results. So our assessment on which our risk result guidance is based has so far been consistent with the development we see in the economy.

So Martin, just going back to the overall assessment of credit quality and also going back to the introduction. So you were in German banking at the time of the German real estate crisis, so to speak, which kind of kicked off in 2003. So the key risk asset that the banks didn't want to have on their books at that time, obviously, was everything related to particularly mortgage -- commercial mortgage lending. Then you were around for the global financial crisis when the key source of losses were structured credit portfolios, and then for the European sovereign crisis in 2012 where the key risk asset, all of a sudden, became sovereign paper of certain countries. So when you think about the loan loss provisioning cycle now, what are the specific assets on Commerzbank's balance sheet that you're most concerned about and that you could view as a disproportionate source of losses?

I mentioned unemployment and GDP growth, which are, of course, key elements. You then have indicators like consumer and business confidence, PMIs, number of people in short-term work schemes, et cetera. We are watching all of these carefully as well as the business going through our books as indicators. And there is, I must admit, also the anecdotal evidence. So when I go shopping, by the way, I see a big improvement of activity, which is very encouraging. I also speak to customers, and they are, together with us, handling the situation really professionally. To give you an example, one of our Mittelstand customers with about 2,500 employees is active in hospitality, restaurants and food production. Obviously, they are strongly affected by the corona crisis, but they already started to prepare in February. So while some activities like their online shop and takeaway services continued, a significant portion of their activities needed to shut down. We could quickly arrange bridge financing and a KfW-guaranteed loan for them. They are now restarting activity with the loosening of the lockdown. So overall, the trajectory is clearly positive, but we will have to see how much traction we have during the next month. So the sectors most exposed, that was your question, are well known. These are retail, travel and oil and gas. Our exposure to these more vulnerable sectors is limited and really diversified. So in retail, food retailing represents the largest sub-portfolio and is one of the few beneficiaries of the crisis. The smaller part of our portfolio consists, among others, of fashion, which is most severely affected. But overall, stringent customer selection and emphasis on sustainable business models in combination with 88% of the portfolio being rated investment-grade, is paying off. So 83% of our travel-related sub-portfolios are rated investment grade and, therefore, benefits from guarantees. On this basis and with governance support available, we see a good chance to come through the crisis with limited damages. On oil and gas, I would like to highlight that we are hardly engaging in any upstream business and that more than 50% of the exposures is to integrated oil and gas majors. Furthermore, we are not engaged in fracking and oil servicing, and we do not have any project finance exposures. So maybe to add a bit on customer behavior at this point, we still have a low volume of loan deferrals. Since March, our private and small business customers segment has granted deferrals for less than 2.5% of our exposure. There are hardly any deferral requests from our corporate customers. So I think this is a good indicator of overall financial strength.

That's very interesting. So one thing that the market is struggling with, so we do a stress test in Europe every 2 years, and the last one was run obviously in 2018. And there are banks which are currently guiding for loan losses, which more or less reflect the adverse scenario in the stress test. But there's quite a large group of banks, and Commerzbank is one of them, which are guiding their peak losses to be much lower to what the European Banking Authority estimated. And I just look at this discrepancy between Commerzbank's guidance, which is up to 50 basis points, and then European Bank Authority (sic) [ European Banking Authority ] estimate, which is up to 120. What makes you confident that your guidance is correct? And how do we explain the substantial difference between the 2?

Well, the EBA stress test is a technical scenario and not a good guide to what is actually happening right now. Just to give you one example, the stress test does not assume any support by the government or the ECB. So let's look at how we have come to our conclusions. We have updated our macro scenario along the lines of a stressed ECB base scenario. Based on this, we have applied adjustments to cover corona. This has resulted in a significant downturn scenario. So we have covered our assumptions for GDP and unemployment earlier, sorry. We apply -- looked through the crisis approach to rating of corporate customers to avoid unwarranted stagings under IFRS 9. Instead, we reflect expectations of higher PDs and defaults in the top level adjustment we booked in the first quarter. So obviously this will be reviewed in the second quarter. We also consider the mitigation effects of German and international support programs as well as forbearance schemes, for example. This is the macro and model-driven approach that gives us an expected risk result of EUR 1 billion to EUR 1.4 billion in 2020. And additionally, complementary, we have a bottom-up approach. We have gone through our portfolio and analyzed each sector. I have been with our colleagues there in a workshop. We have looked at relevant individual exposures in detail. This is an ongoing process within the risk function and the Board is also closely engaged, as I said. This bottom-up approach has confirmed the expected risk result of EUR 1 billion to EUR 1.4 billion in 2020. So also, when looking at the experience of the first 2 months in Q2, the risk result has developed in line with our expectations. So we, therefore, believe our estimates have a solid foundation based on our assumption of a step-by-step restart of the economy and no second lockdown. But as you know, things can change quickly, and we continue to closely monitor developments.

So Martin, let me just go back to what you mentioned before. So the government guarantee programs in this crisis is something that is unique, that wasn't there in any of the previous iterations of various crises over the past years. And I think you certainly make a point that it is an important contributor to what are -- what is your loan loss guidance. And I just wanted to ask you, so can you help us quantify this? So how important is it? What do you think the loan loss experience would have been had it not been for these government programs? Can your corporates get the cash sufficiently quickly so it precludes them from being pushed into bankruptcy, from being pushed into insolvency, et cetera? So how do we think about quantifying the scope and effectiveness of the government programs?

Well, I think I don't want to speculate about hypothetical scenarios. We shouldn't do that. But surely the shock to the economy would be significantly higher with the corresponding impact of the risk result. I would like to stress that we have worked very constructively with the German government in the development of the programs. The clear aim is to help corporates and households in a targeted and an appropriate manner. So I have to say the programs are very effective. And this is not just the programs directly but also the confidence that they're given to both borrowers and lenders. Many borrowers actually did not need to support programs but were able to get funding from the bank or in the market. So please also keep in mind that there are several support programs. They range from direct grants and government-guaranteed loans to capital injections. This allows for a tailored approach most suited in the individual situation. So we are at the side of our customers with advice and help them find the right instruments for them. Concerning speeds, borrowers can apply and can get approval quite quickly. In addition, if required, we can and do offer bridge finance.

Okay. Martin, I want to switch tack a little bit now from what is the expected loan loss experience to what is the ability of Commerzbank to deal, to absorb those loan losses. So if I look at the first quarter, both large German listed banks, Deutsche Bank and Commerzbank, were loss-making, marginally loss-making, but loss-making, on what was a reasonably or comparatively low loan loss experience. And again in a European context, and I think you've explained well why that is still the right relative ranking. And I was just wondering from your perspective as a Chief Executive and when you think about the loss absorption capacity of Commerzbank, how confident are you that Commerz can continue to absorb these losses organically and deal with them organically? And what the options are at your disposal if against the predictions of Commerzbank loan loss experience does rise and obviously puts even more pressure on the profitability of the institution?

Yes, thank you for this question. I think let's first look at the actual drivers of our Q1 results. Our operating loss of EUR 277 million includes corona effects amounting to EUR 479 million. Of these, EUR 295 million were valuation effects, which are likely to reverse with market normalization. We've already seen a partial reversal, by the way, in the last 2 months. So underlying customer business in Q1 was strong, which is reflected in the 10% growth of net interest and commission income. So we managed our costs down by 4% and fee potential for further reduction. So when adjusting for the corona impact, we had a positive quarter. So what we can do in case the headwinds from corona are significantly worse than anticipated, that's the question. So first of all, we have a strong CET1 ratio of 13.2%, which is well above regulatory requirements. This gives us a good starting point. Second, as mentioned, we continue to work on cost management where we see additional potential beyond current plan. And we are, of course also further optimizing our business, be it by working on pricing, RWA optimization and other metrics.

As a follow-on to that, so what typically happened in the past is that if the losses were too much to bear, not just losses from the credit portfolios, but also losses associated with restructuring and so on, Commerzbank tended to revert to raising capital in the markets. And I don't think there's anything wrong with that, but what now becomes problematic is if we look at the valuations, I don't think European banks in general but also Commerzbank, I think they are at lows probably compared to any historical yardstick the market capitalizations allow. It seems to be that the message from the market is if there is a capital need, we're not willing to provide it to a large number of European banks. How do you think about that? What happens if needs to raise capital externally materializes, but the valuations remain as depressed as they are?

Well, excellent question. Let me start with the status quo. Our balance sheet is very solid and healthy with strong risk and capital ratios. In this crisis, we will clearly benefit from all the efforts we have put into our risk profile and the quality of our loan book over the last year. So our CET1 ratio stands, as mentioned, at a high 13.2% with a significant buffer of 240 basis points over MDA, which has been reduced by the ECB to 10.8%. So we have plenty of headroom to cushion the eventuality. Furthermore, we still use CET1 to cover requirements that can be fulfilled by AT1 and T2. This is where we can free capital for growth or to cover other potential capital requirements. So we have, therefore, fully filled the Tier 2 layer in May and established an AT1-issuing program. Fully filling the AT1 layer would free more than 100 basis points or EUR 2 billion of CET1. And there are, of course, further measures we can take to free up CET1, if required.

Let's switch tack a little bit. So taking a step back from the first quarter and all the immediate pressures, and talk about the strategic outlook, a slightly longer-term picture instead. So it wasn't so long ago that Commerzbank communicated the new strategic plan, and that included a 4% return on tangible equity ambition that in turn was underpinned by substantial cost cutting. I think we both agree that since that communication, the environment worsened materially. And I was just wondering, so how do you think about the targets at this point? How do you think about the capacity of Commerzbank to generate a certain return? How has that changed? But most notably when a restructuring plan is underpinned on cost cutting, and we're looking at a public health crisis which affects everybody with spiking unemployment across the board, how realistic is it to expect that a bank like Commerzbank can continue with those cost cuts as planned?

I can assure you, cost management is a key issue for the bank and an integral part of our strategy. So we continue with the implementation of our strategy. And of course, we'll be incorporating learnings from the corona crisis, such as the accelerated usage of digital channels in our strategy going forward. So due to the effectiveness of introduced efficiency measures, we've already improved our 2020 outlook on costs. We now expect costs at the level of 2019. This includes up to EUR 200 million additional IT investments as well as increased compulsatory contributions. This is about EUR 150 million less than originally guided. And furthermore, as already communicated, we have an additional cost management project running. We'll update you and all your colleagues on additional savings potential with the disclosure of our Q2 figures in August. And I can assure you that our update will answer your last question as well. It is our clear aim to improve our profitability, and that goes beyond cost measures.

So I think from a pragmatic perspective, so somebody observing the behavior of Commerzbank and your actions as a management team from the outside, right, so the pragmatic dilemma seems to be the following. Here, we have a bank that is part owned by the government. We are looking at what might be a very sharp increase in unemployment overall. So purely from a pragmatic perspective, does reducing the number of employees, which is part of cost cutting, whilst being part owned by the government, is that still a realistic proposition in the current operating outlook -- or macro outlook rather? Or do you expect any interference perhaps from the political side of the equation to hold back on the reduction of full-time employees and the reduction of costs?

Well, I understand your question, but as said, cost management is an integral part of our strategy. The crisis has made this both more necessary, but also in some sense easier. Customer behavior is changing faster than originally anticipated, allowing us to also move faster. And the government knows that the banking industry must improve profitability and has already supported our measures to increase profitability. You also must keep in mind that in Germany, the approach is to negotiate with workers' representatives and agree on measures that are socially responsible and that will help.

Right, right. And just changing tack but staying with the restructuring plan. Obviously, there was -- one of the key pillars of the restructuring -- of the new strategy, back at a time when it was announced, was the disposal of Commerzbank's Polish unit. You've changed your mind on that as an institution. And I was just wondering why was that U-turn on the disposal of your Polish business the right thing to do?

Well, mBank has a proven and successful business model, and this is a very valuable asset within Commerzbank Group. At the time of the decision to sell mBank, the main objective was to realize the value of mBank, significantly reduce risk-weighted assets and release capital within the group for faster implementation of the Commerzbank 5.0 strategy. In the meantime, Commerzbank has achieved enough flexibility with regards to a CET1 ratio of 13.2%. So let me spend a few words on our plan for mBank. In the current environment, the achievable terms and conditions for deals are simply not attractive enough to pursue an M&A process. As we do operate with a strong CET1 ratio, this does not limit any of our strategic initiatives going forward. So it rather adds back high-yielding operations to our business model. So we will continue to exchange our deals and concepts with mBank, of course, and cooperate on several levels. But the banking markets in Poland and Germany are still quite different, so there is -- there are not many operational synergies in this business.

Yes. And I wanted to ask you, so just the final point on this strategic plan. So one of the changes that this crisis introduced was the response of the regulators. They've reduced the capital hurdles for all institutions. Commerzbank was no exception. Commerzbank reduced their own communicated capital hurdle marginally, I think, by 25 basis points. And you've made the point very clearly that you see Commerzbank as having an ample capital buffer. So I was just wondering, capital evolution, how are you thinking about that? I think you gave us some partial insight already before. And the second thing I wanted to ask you, how do you think about these changing regulatory hurdles? Is that something that you think is here to stay? Is that something that reverses as time goes on?

So you're right. Our balance sheet is very solid and healthy with strong risk and capital ratios. In this crisis, we clearly benefit from all the efforts we have put into our risk profile and quality of our loan book over the last years. Our CET1 ratio stands, as mentioned before, at a high 13.2%. To make sure we contribute as much as we can to the real economy through this crisis, we followed the ECB's strong recommendation not to make dividend payments for the time being. We welcome the regulatory leeway provided to increase the banking system's ability to support the economy. So with our decision to set a CET1 target of at least 12.5%, we have enough capacity to support our customers. At the same time, we will be well above our regulatory requirements, of course.

So now changing the topic of the discussion altogether to the very, very long term, I want to talk to you about the competitive dynamics that you see in Germany and more broadly. And I've started looking at German banks a very long time ago. And on day 1 of my process of becoming a banks analyst, I've heard that the competitive dynamic in Germany is changing, the Sparkassen are starting to act more rationally, and the same for all the public sector institutions. And it seems to be a theme that keeps going, but the output hasn't really changed up until this point. You made a reference before that there has been changes in customer behavior, but now I want to ask you about changes in competitive behavior. How do you observe them? Do you think that this time, it's for real, that we will have more rational behavior in German banking? What are the trends on pricing of products? And what is this longer-term competitive outlook?

I think this is a really good question, and I'm observing this, as you mentioned, for a very long time. For sure, the savings banks, including the Landesbanken, have the largest market share in Germany, followed by the cooperative sector. Deutsche Bank is a competitor in corporate banking and wealth management and UniCredit in the southern part of Germany. And there are foreign banks operating in focused areas or businesses in our home markets. All in all, we are working in the most competitive market in Europe. The number of banks, the number of branches have been reduced by minus, I think, 6% in each of the last 2 years. This has lowered the cost base, but not the level of competition. The low negative rates continue to increase the pressure, particularly on smaller banks as they operate only locally. This limits their opportunities while we have a countrywide presence. So the effects of the corona crisis will surely add to the pressure. How far behavior of competitors is changing is, as you said, hard to predict. But it would also be surprising if there is no change in behavior following the corona crisis. What I can see so far is that not all competitors are there for their customers as well are in this crisis -- as we are in this crisis. So I believe corporate customers realize that they need a strong banking partner like Commerzbank, especially in a crisis. So I'm optimistic that our customers understand that they must pay for services in good times to have them also available in challenging times like now. I think this is a chance, not just for Commerzbank, but for the whole system. So in any case, our strategy is based on the things we can change to improve profitability and does not rely on a change in the competitive landscape. Our answer is to grow efficiency and profitability and to improve our cost base.

Okay. And then the final topic, and again this is eternal topic with German banking, which is one of consolidation. I was surprised that at the time of an AGM of one of your competitors, the M&A cycle for Germany and for Europe was described as "inevitable". And I just wanted your opinion on this topic, both in the context of Commerzbank, in the context of German banking, in the context of European banking. How do you think about consolidation? Is there appetite for consolidation? Does it make sense? How can we think about consolidation when even a merger of 2 domestic competitors, which was considered last year very publicly and involved Commerzbank, when the financials even on a domestic merger don't work? So consolidation as a topic in the context of Commerz German and European banking, what is your view?

First of all, we are strong and I personally am a strong believer in consolidation in European banking. We need less but stronger banks to serve our economy. But as you know, the obstacles have so far been high, limiting actual consolidation. And if we talk about our talks last week -- last year, after a thorough analysis, both banks, both German banks have concluded that this transaction would not have created sufficient benefits to offset the additional execution risk, restructuring costs and capital requirements associated with such a large-scale integration. And to be honest, as long as current circumstances will not change, I don't see this. And as you know, we are fully focused on our customers and the implementation of our actual strategy.

And consolidation in a European aspect more broadly, do you see that taking place? Not necessarily involving Commerzbank, but just the rationalization of the sector.

Yes, this is also a good question. Not a new one, by the way, but it is still good. But a domestic merger clearly benefits from potentially huge cost synergies. And there is a broad understanding in the industry that cross-border mergers will not generate this size of cost savings. So the likelihood is limited. And in addition, the execution risk for such a deal is also much higher, and not to forget additionally -- additional regulatory requirements. So we need a clear regulatory framework for cross-border consolidation backed by the regulators, otherwise I don't see this in this -- in the moment.

Excellent. Well, look, I think we've come to the end of our conversation. We managed to cover everything that we agreed to cover in the time that was available to us, which is an achievement in its own right. But can I just say again, Martin, thank you for joining us here today. And I certainly hope to see you in person soon and to have a discussion on these topics, which I'm sure are going to dominate the European bank discussion for the next year with you in a different live setting. But thank you very much.

Well, thank you, and stay healthy.

Thank you.