Commerzbank AG (CBK) Earnings Call Transcript & Summary

Hello. Good morning all and thank you all for joining us for the session. My name is Vishal and I'm part of the Morgan Stanley Bank's Research Team. Today, it is my pleasure to welcome the CFO of Commerzbank Dr. Bettina Orlopp, a role she has been in since the March of 2020. Bettina, welcome, and thank you so much for being here. Look, I have a long list of questions for you. But before we head there, I have a polling question for the audience, and we'll get about 10 seconds to answer the question using the headsets -- handsets at your table. Can we have the polling question, please? What do you think will drive Commerzbank's share price the most over the next 12 months? First, better NII delivery versus management guidance; two, capital returns and faster time line and buyback application; three resolution of Swiss franc mortgage provisioning issue; four, resilient asset; quality at Commerzbank and in Germany; fifth, continent cost control. [Voting]

All right. We have 41% for NII and 34% for capital returns. I wouldn't say I'm surprised.

We are not surprised, are we?

That is true.

Yes.

So, Bettina, we obviously talk about these 2 topics, very key topics for Commerzbank. But I just want to start with a big picture question first. Look, 3 very difficult year you started during COVID and oversaw a successful restructuring with stabilize bank profile now. So can you provide us a quick recap of the key targets? How is the ongoing progress been? And what will be the key goals to achieve in 2024?

Yes, certainly. So I mean, first of all, we had a very successful '23, important to state. I know we never are backward looking but I think we had a good starting point also for 2024 with a EUR 2.2 billion of net income and a cost income ratio of 61%, very near to the targets, which we have set for originally 2024. So for 2024 targets also are pretty clear. We want to achieve more net income than last year. Important message. Second is we want to achieve an CET1 ratio above 14% but have a very decent capital return of 70% plus. And we will target a cost income ratio of 60% and clearly also in RTE, and above the RTE, which we have had last year. So -- and that should bring us in a nice trajectory towards our target for 2027, which we have laid out, which is really getting into cost of equity returning and getting a return of tangible equity of 11% or more than 11% on a 55% cost to income ratio and then also bringing our target capital ratio in -- into to direction of 13.5%, which clearly also requires some capital return in the coming years.

Of course, that is very helpful. So I think let's dive into the first big answer on the polling question, NII. Look, it continues to be the dominating driver for Commerzbank story and management has given us EUR 7.9 billion NII guidance for 2024 and then slightly below '24 levels into 2025. So I think the first question is around deposit betas. It is a key element driving this guidance. And can you touch upon what you're assuming for 2024 and '25, and how has the deposit beta tracking so far? And how are you seeing customers and competition behaving in the year?

Yes. So we haven't changed our guidance. It's still EUR 7.9 billion for 2024, and we feel pretty good on that. And then also on '25, we still see and it all depends clearly on where we end this year and then start next year with respect to the interest rate level but also the guidance for 2025, we still feel very comfortable on it. And it's -- I mean there are several driving factors. One is clearly deposit better but the other one is also volume and clearly also the level of the interest rate. And you have a close look on the forward rates, and we do that now not on a daily basis but at least on a weekly basis, you basically see that there is also some movements and they have come up. They are now much more, again, in the direction of our economic scenario, which our economists have laid out. And -- so we'll see where we really end the year and when it starts and with all the assumptions, which we have put in place, the EUR 7.9 billion are absolutely achievable. And deposit beta is a very important driving factor because in the measurement, 1 percentage point up or down means EUR 90 million up or down. But it's also -- it's clearly also a result of the volumes we take in. And be in the moment, one with much higher volumes than we originally thought. But they come at a price, which means at a little bit higher deposit betas, and now the art is to also manage it the right moment, the offerings down and we do that. We have just lowered also our offerings for Commerzbank or comdirect. We do that very different for the 2 brands, because the client base is very different, also in their reaction behavior and we observed that the competitors are doing very similar things. So in the moment, the offerings for core money clearly have come down and have been shortened also how long they are basically fixed and offered.

Okay. I think just to follow up on the deposit beta point because that is interesting in the sense, Germany has seen a lot of competition pick up at least in the latter half of the last year on the call deposits, especially. So what gives you the confidence on this 35% deposit beta number that you have guided for? What -- and if you can touch upon the levers that are in your control, that gives you confidence on that number.

I mean the offerings are in our control and we have a very good liquidity situation and a very good benchmarking also of our competitors. And we simply also adjust and -- adjust the offerings. And yes, I also said that before, we will most likely also see some movements in the deposit beta because it's also clear that whenever there will be an interest rate lowering of the ECB, you can't direct in the very same moment and adjust offerings, et cetera. So automatically, the deposit beta will go up just by the developments. And then we will manage it down by adjusting our offerings. And -- so therefore, we feel comfortable with the 35% average but I'm pretty clear that we would see also some up and downs over the year. And then it's also clear that if we come out with our end with higher volumes and then a slightly higher deposit beta, it would be also not a problem because at the very end, for us, top line and then net income is the one, which accounts for us.

Of course. And I think you touched upon an important point. Obviously, the liquidity is a strong suite for Commerzbank, where you can manage deposit beta but you touched upon volumes as well. Can you talk a bit about volumes and lending growth? Clearly, 2023, '22 as well because the rate hike has been quite -- put a lot of pressure on the lending growth. How are you seeing those trends developing right now? What is your outlook there?

I mean still -- it's still kind of depressed. This is also how we planned it. It's very much as we have embedded in our plans and our guidance. You see in the [indiscernible] first take note that really -- and I'm not talking about Corporate Clients that corporate clients start to reach out to discuss certain plans they have. And they are the early indicators that things are moving. I mean we always had and it's a pool debate, which we have in Europe that there is a large, huge investment need because of the digital and sustainable transformation, this has to start at a certain point in time. The only question is when it really kicks off and that also have a lot to do with the macro and the geopolitical environment. But then the moment we see basically that there are more discussions ongoing. And that's -- yes, that will most likely we will only see over the summer, which is really ending up in real business or not. So we have been very cautious in our guidance for this year. We can only have a positive surprise there. And on the mortgage side, I mean volumes have recovered to a certain level after the very low levels at end of 2022, beginning of '23, but they have not reached the levels which we have seen in the years '20, '21. And there, we probably would need to see a significant lower interest rate environment that you really see a change there. So that will take some time on the mortgage side.

Okay. That was very helpful. And then I think just to stick on NII topic for a bit more. I think replicating portfolio, the structural hedge, there are many names for it. But that is a key driver for NII as well to stabilize the margins and reduce the volatility. Can you share the details on the portfolio size, average time to maturity, current yields? What kind of tailwinds do you expect over '24, '25, '26?

Yes. Yes. So the -- and I said as already mid-February, we have lowered the volume a little bit and it's now EUR 123 billion approximately, which has a lot to do with the fact that we have seen some shifts in the deposits and how clients react that might change again over the year. But in the moment, it's EUR 123 billion. The average duration is something around 3.6 years, and the average yield is a little bit less than 1%.

Okay. And in terms of tailwinds, if you can touch upon how much contribution do you see from the...

So for the EUR 7.9 billion number for this year, there's approximately a benefit out there something around EUR 400 million. Then in '25, you will see basically the dip because also of our model changes, et cetera, and then it will raise again or increase again over the coming years, clearly also depend a little bit on the interest rate development as we all know, and in '25, it will be a smaller triple-digit number.

Okay. I think so let's move on to the next big topic, capital returns. Clearly, a key pillar for the management strategy came up with a new policy last year in November. So I think the first point is you have got it for EUR 3 billion payouts over 2022 to 2024 and then 50% to 100% payouts post AT1s thereafter, right? So far, you have already paid EUR 1.4 billion. It implies EUR 1.6 billion is left, which it seems like you're very confident on delivering, then why the delay in applying for the buyback? Could you give us a sense of what is the logic behind that decision?

Well, the simple logic is that we tie the next capital return and this is a 70% plus we have talked about very much to the 2024 results. And therefore, it's probably a valid assumption to first see the -- first minimum 2 quarters and to know that we are ending where we want to end. And in the moment, we are very confident that we will then start the whole request process based on the H1 results in summer, and that has not changed. And clearly, we then want to start earlier. The program will be most likely higher than what we have seen in the past 2 share buybacks and that requires that ideally we start by the end of the year. But at least on the share buyback, a little reminder, we are always dependent on the approvals by the ECB and in our case also by the financial agency of the government.

Okay. And do you expect the time line on future applications for the buybacks to be a similar process, i.e., of application with the first half results?

Yes. I mean, we think it's a good model. We have always our AGM in April -- end of April or in May. And the thing is that, we have the 10 percentage approval, which we have to renew, which you also now we'll renew for this year because we have done the share buyback. So therefore, the [indiscernible] is a good one to not miss out a window. And then clearly, however, it requires that we also deliver results. But I have to say that we had also a very -- we had a very good start into 2024. First 2 months are absolutely leading us towards our guided results.

Okay. That is very good to hear. And then just to stick on the capital returns, can you talk a bit about the mix between buybacks and dividends going forward? How do you think about that? Clearly, given where the valuations are, but just even in the longer term about the mix?

Yes. You think that the mix -- it must be a healthy mix between dividends and share buybacks and specifically on the dividend side. I think it's very important to show a very constant trajectory and also not up and downs but rather a very reliable path, which people can take into account. I mean we had started low with the EUR 0.20 and then actually now with the EUR 0.35, which we will propose to the AGM. It's also for a long time, the first time that Commerzbank pays in a row, so second time in a row because since the financial crisis, there has been 2 times beforehand where we had a dividend, it was always EUR 0.20. Now we had EUR 0.20 in 2022. We will hopefully have a EUR 0.35. For sure, AGM will give us the approval for '23 and then we clearly want to see a further increase of the dividend but be cautious so that we can also have a reliable dividend, people can calculate with. So I suspect a decent increase for '24, probably dependent a little bit on the final results and do this increase, not have this up and downs in the dividend, that would be our target.

Okay. That's very helpful. And then at some point in the past, I think around the Capital Markets, you've also mentioned that a 90% payout ratio is not out of question. Assuming everything goes as planned, how soon do you think Commerzbank can get to that level?

Well, it depends that we deliver. But I mean we have said it clearly what our target is until 2027, and that is 13.5%. And if we deliver the results, which we have laid out also during our strategic plan update in November, people can do the math and can know that we need to have a decent payout ratio to achieve that. So it's basically kind of a mathematic thing if you take on the results and you take our current CET1 ratio clearly have to take into effect basal and things like that. But then you have our target ratio of 13.5%, which we think gives us also a very decent buffer to MDA. I think it's a good approach but that means that we have the flexibility and probably even the necessity to do a decent a capital return.

Okay. That is very helpful. I think I'll move from the capital side a bit to the asset quality and commercial real estate is a big topic. But just for Commerzbank, you have guided to less than EUR 800 million of provisions, assuming usage overlays in 2024. Firstly, can you highlight the exposure you have to commercial real estate, how worried are you about the situation with the German regional banks? And how do you think that could impact you?

So I mean, our commercial real estate exposure is still restricted because it's only in Germany, very important to our message, nothing in the U.S., which gives us already some comfort. Then it's -- volume-wise, its asset base is approximately EUR 9 billion. Very good quality from our standpoint, very good coverage ratio. And therefore, I think we have had our lessons learned out of the financial crisis. We had a really, really big commercial real estate exposure, and we have -- states are very cautious since then and have not changed the strategy and that proves to be a very wise decision nowadays. So we are not really worried about this exposure. And overall, with respect to the risk results, I mean the less than EUR 800 million is already still a little bit of an elevated level where we take into account that, at least for German economy, our own research believes that there will be, again, very mild but there will be a recession so while there is GDP development of minus 0.3%, market is a little bit more positive on that but we stay conservative. And on should not forget that we have the top level adjustment still out there of EUR 453 million. And if you took that one in combination, you see that we are very nicely covered if there are more movements and if there is a deterioration of the asset quality, which some fear, we don't see it actually yet not so far. You always have single cases and that's normal. And the moment we brought that see a very normal level of default but that might change over the next coming months. And then we are well prepared through the combination of what we have guided plus on the top level adjustment which we still have out there.

Okay. That was very helpful. And then just if you could -- because you touched that your portfolio is still performing well, you're not seeing anything out of ordinary yet. Can you give us a bit of -- a bit further color on what your conversations are like with your corporate customers, your mid-cap SME customers, what are they saying on the ground is happening? And how are they generally feeling about the trends for the year ahead?

I mean I said it earlier, they are still very much in a cautious mood. I mean, they're waiting also for politics in Berlin and Brussels to take some decisions. It's clear that there is really the ask for stability, also stability in regulations and probably also a reduction of [indiscernible] and the easing of the conditions -- the investment conditions in Germany and Europe. But overall, as I said, they start thinking about their investment programs, the large corps and MNCs anyhow do that. I mean we see that. Unfortunately, they do a lot outside of Germany and Europe. But for us, as a bank, we are still in the game because of that, we also support them outside of Germany and Europe.

Okay. That's very helpful. And I'm going to just quickly look at the audience to see if there is any questions. Any questions? Okay, we have one in front.

I have 1 question about the structural hedge portfolio and the liability management risk. Are you seeing some scrutiny from the regulator about the modeling of banks?

I mean we see the normal interaction with the regulator on the different topics and they clearly have laid out their priorities also for this year, what they concentrate on but we do not feel anything specific on that. I think given also our overall liquidity and capital situation, it's a normal dialogue, which we have with them. And they clearly are concentrating and they will concentrate and focus on asset quality, I'm pretty sure this year, and they will concentrate on the whole cybersecurity environment and how we are protected but there is nothing specific.

This is -- I had this question just to know if there was a risk that banks are pushed to change their modeling by the regulator?

Their what, sorry, I didn't get that.

I had this question just to know if there was some risk that you are pushed to change the deposit modeling?

No. We are not.

Any further questions? Okay. In that case, I'll continue with a few more questions, and we'll come back to the audience. So I think what I want to touch next upon is mBank. Clearly, the Swiss franc mortgage issue has been a big earnings drag over the last 1 or 2 years, especially 2023, which had much larger-than-expected provisions. How much provisions do you expect for 2024? And when do you think the situation ends?

Yes. That's a good question. So I mean, first of all, whenever we would have had the feeling that we would know what would be to be expected in '24 or something in addition to what we have already booked, we would have booked it. That's for sure. The booking always depends also on the erections of the client portfolio. So how many of the passive or active population is going to occur, how are the settlements development developing? I mean, mBank is clearly following up with the strategy to settle as much as possible. And we have a certain average costs for the settlement booked. And if we see that this one is increasing, then you have to do booking. I honestly expect more bookings this year, clearly. And it's also very clear that we have a focus to get much done this year as possible because we clearly also want to put that one to an end, but to also just get it out of our heads, and we should not forget that it's also quite important for the organization because doing 1,000 settlements per month, someone needs to do that. And therefore, the more we can get done, the better. And we do not rely that there might be at a certain point in time, per Supreme Court that we'll be able to have a final decision or something like that. So we will concentrate to end the whole thing by our own and then it would be very helpful if they would build a final judgment but it's not short term to be expected. And then clearly, I think we should be also open that there are further burdens, which we also know from Poland on the scenery, they have just decided another program or another round of credit holidays that will clearly also have an impact on mBank as for the other banks. And that one, you will also see in '24. But the important message on mBank is that they have a very strong profitability. They also had a very good start in the year. So they can really basically absorb that luckily very nicely. And I should not forget they're up to EUR 1.1 billion, last year. We do not expect a number like that for this year, clearly not. So it's -- '24 will be clearly a year where we want to make as much progress as possible to not only see light at the end of the tunnel but probably be very much at the end of the tunnel in this aspect, yes.

Okay. And can you share your view -- further view outside of the mBank provisions? You obviously spoke about strong profitability at mBank. We have a new government in Poland. There's a lot of optimism about the Polish economy. How should we read that to mBank in terms of their own business lending growth?

Yes. I mean, they have a very efficient business model, which has helped them also in the past 2 years. And if you look on the cost/income ratio, et cetera, very, very efficient. They're very digital -- very digital customer base, which is helpful from an efficiency standpoint. On the Private Client side, they have the customer profile, which is the most -- the best educated and also a very young one. And that's a perfect mix for upcoming growth trajectory because automatically, this client base becomes more wealthy and one can also see that Poland is getting much more into society where I will say it's not only about savings and having a mortgage but it's also more getting into asset management, wealth management and their mBank once and will clearly play a role given their attractive customer base. And also on the Corporate Client side, they have a very nice position and they also digitize the Corporate Client offering in the moment to a significant effect. So very innovative, very quickly moving bank, and therefore, we think they have a very nice growth and profitability path ahead of them.

Okay. That's very helpful. So that brings me to the next question on mBank is, this has been -- a topic that has been discussed in the past, management has considered a sale of mBank at some point and then you did not. Is that still on the cards?

No. I mean, the reasons why we considered on the sale back in 2019 were completely different ones. We thought that we need to do the sale to finance the transformation of Commerzbank itself that has proven to be not necessary, a, and also by the time it was not very smart to any sale because it was very clear that by the time the regulator would have forced us to keep 100% of the Swiss franc portfolio. And let's imagine For a moment, we would have been successful in the sales process. We would now sit on in total EUR 2.5 billion of provisions, which we have booked so far and we would have observed 100% of it without having the benefits anymore of the P&L of mBank. So I think we can be all very lucky that we haven't been successful. And we have no reason why we should consider a sale. We are very happy with the bank and it also fits very nicely in our digital profile.

Okay. That is very helpful. I'm just going to go back to the audience to see if there is any questions in the room. There's one here.

Evan Morris from Bell Rock Capital. You mentioned that you had a good start to the year. Is that just volatile items in markets generally being helpful? Or are you seeing any positive trends emerging that you think might carry on forward?

Well, I mean, traditionally, the first quarter is anyhow should be always a strong quarter and it is, but it's also strong if you compare it to previous quarters, and that's in both areas, Private Clients and Corporate Clients, and it's across product lines. So it's not only NII but also MCI, they have a very solid development of the risk regard so far and high cost discipline because also our cost base is developing exactly as we have forecasted that. So it's basically the combination of both things, which nicely come together in the moment.

One more question from [indiscernible]?

Maybe if you could talk about fee income. Recently, you did a small acquisition to support this item. So do you need more? How do you see developing? [indiscernible]

Yes. So we have announced that on 2. One was the joint venture with Global Payments in the payments area and that will help us with respect to the fee income, specifically in the SME segment of Private Clients. And then we have the acquisition -- signing of the acquisition of Aquila where we bought a little bit less than 75%. Those transactions are still in the closing period. So they have not been closed yet. So you won't see that in the moment. We still are in the preparation for closing and it's an important element. But clearly, it's only one piece of the puzzle. So for organizing the growth, which we have laid out also in our strategic plan, which is 4% year-on-year, we specifically need to also organize the organic growth. And we think that we have very good prerequisites for that. And Private Clients, if you look at our customer base, there are many, many clients who, let's say, have a single product with us and where we have lots of opportunities to also expand that towards management. So they are not cold calls but there are calls, which you can do. And also on the Corporate Client side, we have a very good basis with our product offering to expand the fee income. And that's all very much on the Corporate Clients organic growth and same holds true for mBank. So -- and that's equally split. If you look on to 2027, there will be basically very equal shares of increase in net commission and coming from mBank from Corporate Clients and from Private Clients. And yes, we will consider further add-on acquisitions that might be very small ones and bigger ones, but nothing which will be so changing that you would say the majority comes from inorganic. So it's really only add-ons and they should help us. Aquila is really meant to help us besides the partnering offerings we have with our partners to really enhance our value proposition. That's the whole reason why we did that acquisition.

Any further questions? Okay. We'll come back to the audience again. I think, Bettina, you touched upon 2 very key points, costs and fees. So I think we have not spoken enough about costs.

Nobody was interested in that. We have seen that 0% will drive our share price because of cost control.

That's probably a good thing. But look, I think the cost restructuring over the last 2, 3 years has been very successful. So one key question we get as Germany is an economy where controlling costs on the personnel side becomes a bit difficult. So first, if you can give us an understanding of how that was achieved and what gives you confidence that you can keep on controlling costs in the same way going forward?

Yes. I mean, we have implemented a very large transformation and cost reduction program because in total we have signed agreements with nearly 10,000 FTEs, and that was -- the majority was done actually in Germany. And then we, on the other side, have increased our FTE base, specifically in the nearshore and offshore locations to also get costs down. And it's also clear that we had to invest into IT specialists, et cetera, to also get our external spend for external consultants down and to also not only this shift from costly German base to nearshore locations but also turning on costly external resources into more less expensive internal resources. And that story is continuing as we speak, at least the one shift from external to internal because we also have the feeling that our efficiency will go up when we become less -- more reliant on external, specifically in the IT area. And -- I mean, you can do a lot in Germany. You just have to have the offerings in place. And then in our case, also age structure clearly helped because the most socially responsible thing you can do is offering age instruments. We have done that to a very large extent but it's also very clear that it's ongoing. I mean, we have to have a continuous improvement process in place, and we do that. We have a group-wide project, which is called Keep It Simple, as a simplification effort, which goes hand-in-hand with the cost continuous improvement because otherwise, we will not keep the cost/income ratio, et cetera, because there are already burdens at the horizon with respect to that there will be also negotiations with the unions about the pay scale workers in the banking industry that is about to start in summer. And I don't know how many following up the situation in Germany and I think it's very similar to other countries. There are a lot of strikes ongoing and lots of ask for taking the inflation burden away. And we have embedded clearly also certain assumptions in our plans and it will be important to balance it out. So we see inflationary effects. We also see that we have an increased demand to invest into IT, into cybersecurity and other things. And therefore, there is a continuous improvement. And I mean, there will be also -- but there will be no big transformation fully, but there will be also headcount reduction in certain areas, which will no longer be needed because of the digitalization efforts and automation efforts we are currently implementing. So this is a story, which will not end.

Okay. That is extremely useful. So I think -- and then just to be on costs for a bit more, can you -- I think one key point you mentioned was you have made some conservative assumptions already in terms of taking into account wage inflation, et cetera. And then you have the cost income target of 60% or less, which is a steering metric.

Yes.

But let's say in a scenario where revenues don't perform as planned. Thankfully, they are doing well right now, but in a scenario where it doesn't, what sort of flex do you have to manage that cost/income ratio?

I mean, first of all, we are very short term -- you have short-term measures, which are not nice to enact but they are clearly at the hand if the results aren't coming in as planned, then clearly, this will have an effect on the compensation. And it's also clear that we always have -- we have a so-called headroom steering where we basically also put always some cost aside to then make sure that we have that to do either investments into IT or last year we used the headroom, which we had for paying out the inflation bonus, which was basically tax-free program of the German government. And then, I mean, if you see that you need this headroom and then you don't spend it and you keep it to also make sure that the cost-income ratio is coming at the right area. And then there are clearly also some non-personnel-related costs which you can shortly -- or short-term influence. But besides that, it is so important to do this continuous improvement. So that even if you then have a short-term effect that you know that you can get there by a certain cost discipline.

Okay. That is very helpful. Just quickly going to look at the audience since we have 2,3 minutes left, if there's any questions? Okay. I think none. And so I think I'll probably -- I have a question again on NII side, if I can come back on that. But I think a key question, many of us are wondering is about also the lending margins. Clearly, last year with the rate hike hasn't been good for margins. How do you see the evolution of that going forward? And do you see room for expansion now?

I mean when -- at the point where interest rate levels come down, you probably should see that but it's very much dependent on how fast this is happening. If it's a slow process, it will be also a very slow adaptation. And then it also clearly dependent on the competitive environment, because we see that probably a competitive environment is even more important for driving that than the interest rate level per se. But -- and we have been very cautious. So we haven't included in our plans for example, an improvement of the margins despite the fact that we have included a decline in the NII -- in the interest rate environment. We have not assumed that margins will improve because we thought it's better to stay cautious on that.

Okay. I think that is very fair. If there is any further questions. If not, then I think Bettina, we have answered all the questions. It's been a great session. Thank you so much for being here.

Thank you very much.