Commerzbank Market Cap (as of 17/05/13): €4.42bn
Deal Type: €2.5bn Rights Issue
On Tuesday Commerzbank announced the details of the rights issue it previously declared in March. This rights issue will aim to raise €2.5bn in line with Basel III capital requirements. An earlier vote of the Board of Directors on April the 19th approved to pay back in full the support given by the Financial Market Stabilization Fund (SoFFin) which injected €18.2bn in January 2009 in exchange for shares lacking voting power. This equity issuance will decrease the share of the Government in the bank from 25% to 17% following both the repayment and the dilution deriving from the issuance of the new shares. At the same time, debt owed to Allianz following the €8.8bn acquisition of Dresdner in 2008 and amounting to €750 mln will be paid back. These paybacks will help the bank save approximately €200 mln in interests per year.
The rights issue helps the bank improve its Tier-1 capital ratio and move towards a stronger financial consolidation. Under the Basel III rules, the recapitalization of the banks will need to follow a gradual convergence of total capital plus conservation buffer to 10.5% by 2019. However, by 2015 banks will have to reach a capital ratio of 8%. In fact, even if the rights issue helped Commerzbank achieve a Tier-1 capital ratio of 8.4% from 7.5%, enough to respect the requirements for the following two years, the stock price has been lagging in the last five months due to a poor first quarter with falling revenues and €500m in restructuring costs. Moreover, investors are worried about the large amount of non-core assets: the German bank managed to further decrease its non-core portfolio by approximately €7.3bn since the end of 2012 after a loss of €454mm in the first quarter of 2012 but investors are weary of the capital needs of these businesses.
A rights issue is an equity secondary offering typical of European companies, in particular banks, as in Europe existing shareholders have preemption rights on new shares’ issuance: the right is granted to better protect them from dilution and to ensure that their economic position will be maintained. Existing shareholders are granted a right to acquire shares at a discount to the Theoretical Ex-Rights Price (TERP), which is the price at which shares can be expected to trade at after the capital increase. The price that Commerzbank proposed to its shareholders of €4.5 per share was at 32% discount to the €6.6 TERP [Note here that TERP=(1.14bn shares outstanding*€7.66 + 555m new shares*€4.5)/1.695bn total shares]. This relatively cheap stock price led to a positive reaction in the day following the announcement with the stock jumping 12% from €7 to €8 on Wednesday and with analysts’ estimates being revised upwards.
Basel III rules require largest global banks to overtake 9.5% capital core tier I ratio if they want to distribute stable dividends to shareholders, further pressuring banks toward high capital ratios. European banks have been moving forward to achieve their regulatory goals: Crédit Agricole and Société Générale, whose Core Tier-1 ratios respectively stand at 9.3% and 10.7%, aim to further increase their capital ratios through a risk-asset restructuring and a revision of their businesses while UK banks, such as RBS with a Core Tier-1 ratio at 8.2% and HSBC with the same factor stable at 12.3%, rely on contingent convertible bonds. Indeed, depressed financial markets discourage any equity raise for banks: despite the success of Deutsche Bank, which managed to raise capital on the market and improve its ratio up to 8.8% in less than two years since 2011, other banks are reluctant to tap equity markets as a way to improve their capital.
The greater requirements for capital that are now characterizing European banks as opposed to American ones should make us think about the implications. European banks were quite overleveraged compared to their American counterparts before the crisis but now are almost overcompensating. The new rules are pushing them into a vicious circle in which they are forced to recapitalize during adverse market conditions, either by disposing of non-core assets at a discount or by tapping increasingly expensive and weary equity markets, but at the same time cannot contribute to properly restart the real economy as increasing their loan portfolio will require them to increase even more their capital. In terms of competitiveness, Europe may then be in for quite some suffering as American banks can benefit from lower capital requirements, making them a more attractive investment (ceteris paribus) as well as enabling them to offer more competitive rates to borrowers. From the point of view of borrowers, let’s not forget that greater requirements for capital may (and likely will) result into more expensive loans!
This last remark may result in a serious undermining of one of the Basel Committee objective, that is leveling the playing field for banks, and risks choking the banking sector even further.
The rights issue was underwritten by Commerzbank, Deutsche Bank, HSBC and Citi.
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