German banks
Still facing headwinds
Alexander Hendricks, CFA
Research Analyst
(49) 69 910 31928
alexander.hendricks@db.com
1Q2008 underlying profits down 22%; expect ongoing challenges
Large German banks reported an average 22% reduction in underlying profits for
1Q08; Deutsche Postbank was the notable exception. In our view, market
challenges remain in the coming quarters, including pressure on fee-based
revenues, funding cost issues, and credit quality deterioration. We do not expect a
quick recovery from underlying profitability levels and remain slightly biased to a
cautious stance overall. Mid-term, sector consolidation in the German market and
more sensible risk pricing could improve the profitability potential.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Industry Analysis
Companies featured
Commerzbank (CBKG.DE),EUR22.94 Hold
Deutsche Postbank (DPBGn.DE),EUR57.67 Hold
Hypo Real Estate Group (HRXG.DE),EUR22.48 Hold
Return on equity (%)
16.7
12.9
11.1 11.0
14.4
7.1
9.0
13.2
6.4
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
Commerzbank Deutsche Postbank Hypo Real Estate Group
1Q2007 core 1Q2008 core 1Q2008 normalised
Global Markets Research Company
Large German banks’ 1Q2008 underlying profits down 22% year-over-year
On average, large German banks reported a 22% reduction in core operating
profits in 1Q08, with Postbank the positive outlier: HVB Group and Hypo Real
Estate Group were down c41%, Commerzbank and Dresdner Bank were down
c.23%, while Postbank was up 26%. The average core revenues were down 11%,
costs 6%, loan losses reduced by 1%. The average return on equity was down
from 14% in 1Q2007 to 9% in 1Q2008 and the average cost-income ratio
increased by 4ppt to 63%. Loan loss provisions remained on low level (14% of net
interest income, 2bps of total assets or 5bps of total customer loans).
So far so good, but headwinds get stronger: fee income, funding, credit risk
Generally, financial performance of German banks in 1Q2008 was quite solid, in
our view. But we fear that the pressure on profits will continue for three reasons:
1) fee income should come under pressure from fewer securities revenues as
trading activity slows and asset values could shrink; 2) we expect funding costs to
rise in 2H2008 as the current benefit of Pfandbrief funding from back-book
business runs off and banks need to rely more on senior issues again; 3) credit risk
costs are materially below expected losses and should revert to the mean if the
global economy slows down (however, a high portion of German business could
limit this negative trend). Thus, we remain slightly biased to a cautious stance.
Valuation and risk
We generally value German banks based on a sum-of-the-parts approach.
Forecasting individual business segments' profits and equity consumption, and
applying business-specific assumptions on long-term growth potential as well as
cost of equity we compute fair price-to-book multiples; these are derived directly
from a constant growth dividend discount model. We adjust theoretical company
values by company-specific factors, like revaluation reserves and hidden assets, if
suitable. The current market environment adds significant challenges for banks
that in the short term can result in a material deviation of profits from potential. For
additional guidance on valuation we highlight the stated tangible equity and NAV
of FY2007. Temporarily, we partly use tangible equity and NAV as a key variable to
derive our target price. Important sector-specific risk factors are development of
insolvencies and credit risk charges, corporate investment appetite and lending
demand, level of interest rates and type of yield curve, trading activity levels both
on-exchange and OTC.

Table of Contents
Still facing headwinds....................................................................... 3
1Q2008 trend in underlying profits ...........................................................................................3
Company data...........................................................................................................................7
Company pages ............................................................................... 12
Commerzbank.................................................................................. 14
Deutsche Postbank.......................................................................... 19
Hypo Real Estate Group.................................................................. 25