Buried within the dry language of Commerzbank's Q1 and Q2 2018 earnings transcripts lies a tantalizing mystery: the impact of the newly implemented IFRS 9 accounting standard. While analysts focused on revenue growth, cost targets, and the competitive landscape, a subtle shift in accounting practices might be hiding a significant profit driver for Commerzbank. The bank's CFO, Stephan Engels, himself hinted at this enigma, repeatedly referring to the "beauties of IFRS 9" and the need to "gather some life experience" with its application.

IFRS 9, which replaced the older IAS 39, fundamentally changed how banks recognize loan loss provisions. Under the old standard, provisions were based on incurred losses. IFRS 9, however, requires banks to forecast expected losses over the entire life of the loan. This seemingly technical change has profound implications for a bank's profitability. Engels alluded to this complexity, stating that IFRS 9 "has a huge number of different accounting rules than the previous world," many of which are automated but not easily decipherable.

The intrigue intensifies when we examine the shifts in Commerzbank's net interest income (NII) between Q1 and Q2 2018. Engels admitted that "bookings of NII bits into the fair value result" had occurred, creating a distorted picture of the bank's commercial performance. Specifically, he pointed out that Corporate Clients' NII decline of €54 million quarter-on-quarter included only €10 million from actual loan and deposit margin pressure. The remaining €40 million was attributed to these IFRS 9-driven shifts, essentially a paper loss, not reflecting actual business trends. Engels acknowledged that Q1 was likely "more right" than Q2, meaning the accounting treatment in Q2 was even more opaque.

This lack of clarity, however, might be masking a positive development. Could it be that Commerzbank is actually experiencing lower loan loss provisions under IFRS 9 than initially anticipated? Engels, while cautiously maintaining the full-year risk result guidance of less than €600 million, hinted that it would likely be lower, perhaps even below €500 million by year-end. This implies a significant drop from the €600 million initially expected. If true, this would translate into a major profit boost for Commerzbank, potentially flying under the radar of analysts engrossed in the usual metrics.

Adding to the mystery, Engels also revealed that Commerzbank increased its share of modeled deposits. Modeled deposits, being less sensitive to interest rate changes, have a lower impact on a bank's NII sensitivity to interest rate hikes. However, the bank's guidance for a 100-basis point rate rise remained unchanged, implying that the unmodeled deposit portion might be generating higher NII than expected.

Analyzing Commerzbank's Net Interest Income Shift

The following table illustrates the shift in Commerzbank's Corporate Clients NII between Q1 and Q2 2018, highlighting the impact of IFRS 9.

Reference: Commerzbank Q2 2018 Earnings Call Transcript - Seeking Alpha

So what could be happening here? It's possible that Commerzbank, in its "life experience" with IFRS 9, is discovering that its loan book quality is even better than initially assessed. This would result in lower expected loss provisions, boosting profitability. Moreover, the bank might be optimizing its deposit mix, strategically allocating capital to maximize NII generation.

While the exact details remain shrouded in the IFRS 9 enigma, the potential for a hidden profit windfall is real. This is a story worth watching. As Commerzbank continues to navigate the complexities of IFRS 9, the coming quarters could reveal a financial picture significantly brighter than current analyst expectations.

Hypothesis:

IFRS 9 implementation is leading to lower-than-expected loan loss provisions due to better-than-anticipated loan book quality.

Commerzbank's deposit optimization strategy is driving higher NII generation from the unmodeled deposit portion.

Key Figures:

Risk Result Guidance: Initially €600 million, revised to less than €500 million by year-end.

Corporate Clients NII: Q1-Q2 decline of €54 million, only €10 million attributable to actual margin pressure, remaining €40 million due to IFRS 9-driven shifts.

"Fun Fact: Commerzbank holds a Guinness World Record for the largest coin mosaic. In 2008, the bank used 1,111,111 1-cent coins to create a mosaic of the Brandenburg Gate in Berlin, celebrating the 20th anniversary of the fall of the Berlin Wall. Source"