Commerzbank Slumps as Operational Risk Lowers Capital Level

Inside Commerzbank's Operational Risk
  • Banks see litigation risk increasing capital requirements
  • Net income drops 32% in second quarter from a year earlier

Commerzbank AG dropped the most in a month after Germany’s second-largest bank disclosed an unexpected drop in a key measure of financial strength in the second quarter, hurt by higher operational risks such as legal expenses.

The common equity Tier 1 ratio declined to 11.5 percent at the end of June, based on preliminary figures, from 12 percent three months earlier, the company said in a statement from Frankfurt late Monday. Net income in the second quarter fell about 32 percent from a year earlier, the firm said ahead of its scheduled earnings release next month, without giving details.

Banks across the world are building capital reserves to absorb costs from so-called operational risks such as legal expenses tied to past misconduct or losses from rogue traders. The regulatory requirements are among stricter rules designed to prevent a repeat of the taxpayer-funded bailouts of banks during the 2008 financial crisis that toppled Lehman Brothers Holdings Inc. and forced Commerzbank into a bailout.

“It doesn’t exactly instill confidence,” said Andreas Plaesier, an analyst at M.M. Warburg with a hold recommendation on Commerzbank shares. “Model adjustments with a 20 to 30 basis-point change in the capital ratio are understandable, but 50 basis points is a lot. You have to wonder why they didn’t see this coming.”

Shares Drop

Analysts had forecast Commerzbank to maintain its 12 percent capital ratio, according to estimates compiled by the company and published on Monday.

Commerzbank fell as much as 6.7 percent, the biggest intraday drop since June 27, and traded 5.2 percent lower at 5.52 euros as of 11:02 a.m. Frankfurt time. That extended the company’s slump this year to about 42 percent, compared with a 28 percent decline of the 48-member Stoxx Europe 600 Banks Index over the same period. Deutsche Bank AG, Germany’s biggest bank, slipped 3.9 percent to 12.65 euros.

The adjustments “provide negative read across” for larger German competitor Deutsche Bank, which reports earnings on Wednesday, Morgan Stanley analysts wrote in an e-mailed note to clients. They had forecast Deutsche Bank to cut risk-weighted assets by 4 percent and boost its capital ratio by 50 basis points to 11.2 percent.

Cryan’s Warning

Deutsche Bank Chief Executive Officer John Cryan said in May that looming changes in the way operational risk is calculated means his firm will probably need to build up even more capital or shrink businesses. The lender said in October that it plans to cut about 28 billion euros, or 14 percent, of the risk-weighted assets of its combined investment banking and trading business by the end of 2018.

The decline in Commerzbank’s capital ratio also reflects higher pension liabilities as well as an increase in capital deductions from revaluation reserves, particularly from higher credit spreads for Italian sovereign debt, the company said.

“As already stated in the past, the capital ratio can be volatile in the current market environment,” Commerzbank said in the statement.

Commerzbank’s net income in the second quarter fell to about 209 million euros ($230 million) from 307 million euros a year earlier, while operating profit declined to 342 million euros from 419 million euros, it said. The capital ratio reflects a dividend accrual of 10 cents per share for the first half of the year, according to the statement.

The lender is scheduled to publish final second-quarter results on Aug. 2.

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