Even in a country where banks have a propensity to shoot themselves in the foot, Commerzbank’s acquisition of Dresdner at the height of the financial crisis in autumn 2008 looked like a dangerously existential flirtation with friendly fire. By the time the deal closed, it needed an €18.2 billion equity recapitalization from SoFFin (Sonderfonds Finanzmarktstabilisierung), the German banking bailout fund.
The price initially agreed to take Dresdner Bank off the hands of insurance company Allianz was €9.8 billion. That is more than Commerzbank’s current market capitalization. The sense that Commerzbank is apt to overpay for the wrong assets has not been helped by the more recent €2.2 billion write-down on Greek government bonds. "Management does not have the greatest reputation with investors, and that’s probably an understatement," says Ronnie Rehn, senior vice-president and banks analyst at Keefe, Bruyette & Woods (KBW) in London.
But in retrospect, the Greek write-down might be seen as a turning point. It was financed from Commerzbank’s core business, something that would have been inconceivable 18 months ago. Full nationalization, never a desirable outcome but one that was mooted as late as last winter, is now off the agenda. A large rights issue, which seemed all but inevitable, has been avoided.
The deleveraging of Germany’s second-biggest bank since 2008 is surely destined to be a much-read Harvard Business School case study. Commerzbank has cut the assets on its balance sheet by 38% to €661 billion at the end of the last financial year; it has closed 23 different business lines; it has rebuilt its capital position to above Basle III’s 9% core tier 1, ahead of the European Banking Authority’s timetable; and the tangible equity to assets ratio of around 4% is now in line with the European average. "The house is in as good a state as it ever has been," says Michael Bonacker, divisional board member and head of group development and strategy at Commerzbank.
The problem area remains its asset-based finance division, which includes the commercial real estate loan portfolio of Eurohypo and a shipping book mostly acquired from Dresdner. The portfolio restructuring unit, which was set up in 2009 with €40 billion (more than 70% from the proprietary trading positions of Dresdner) has reduced exposure to €8.7 billion and made an operating profit of €164 million in the first quarter.
Asset-based finance lost €4 billion in 2011 and €425 million in the first quarter of 2012. Commerzbank has reached an agreement with European regulators to wind down Eurohypo rather than sell it. Although exposure to Greece is now negligible, Commerzbank still has €12.1 billion of eurozone periphery risk. This is what drove the decision to take money from the European Central Bank’s long-term refinancing operation.
Bonacker explains: "It was a difficult decision because we are able to fund ourselves. We took the decision because it meant divisions like Eurohypo are now less dependent on the group. We also took the opportunity to hedge against a euro break-up. We now have Spanish euros to back Spanish assets and Italian euros backing Italian. If the euro were to break up, we would not be exposed to currency risk. If you think about the risks there are now, I would be more worried about a break-up of the euro than a default of Italy."
The jury is still out on whether the new stripped-down Commerzbank can thrive. Eurohypo remains a big risk, even in run-down, and first-quarter results were mixed. Investment banking income declined sharply, but profits from the Mittelstandsbank unit were up 12.5%. The acquisition of Dresdner might yet provide a boost to the private-client business. The cost-cutting has once again been impressive.
An 18% decline in operating expenses helped offset a poor market backdrop. Low interest rates and volatile stock markets make it difficult to sell products to private clients. However, the results were flat in the first quarter compared with last year (€112 million versus €116 million). Although the cost-income ratio remains high at around 80%, a better market environment should set the stage for a sharp profits rebound.
In spite of the dramatic shrinking of Commerzbank’s balance sheet and range of business, Bonacker insists: "We have not done anything that we will regret in the future." All areas of the core bank – private customers, the Mittelstandsbank, Poland, and corporate and markets – were profitable in the first quarter. The loan-to-deposit ratio in this business is comfortably below 100%. "We want to be a much more boring bank," says Bonacker.
KBW’s Rehn thinks a German and Mittelstand strategy can work and praises Commerzbank for what it has achieved so far. "It deserves a bit more credit," he says. "Strip out the real-estate risk and sovereign debt overhang and this would be a good business already. Germany will be a much better place to do business for the banking sector for the foreseeable future. In the medium term, the idea that Germany’s second-biggest bank has a market capitalization of €9 billion is a nonsense."
The next step is to pay back the government. Commerzbank says it will do this "in pieces or in total" by 2014. There is much riding on this. The tie-up between Commerzbank and Dresdner was always something of a shotgun wedding, with German regulators, supervisors and politicians smiling beatifically as they approached the altar.
They wanted to build a second strong German private-sector bank to ensure the long-term supply of credit to a Mittelstand still reliant on bank funding as Landesbanken dealt with their mounting challenges. SoFFin ended up paying a hefty dowry. But the problem offspring of that ill-fated union is showing signs that it could yet grow up into a model citizen.