What payout policy would you recommend for the selected company – dividend or share

repurchase, and how much?

Introduction to Commerzbank

Commerzbank AG is the fourth largest bank in Germany in terms of assets with almost 50% share
in Germany’s trade finance market. The bank significantly reduced its investment banking business
post the financial crisis and established a restructuring strategy focusing on its core business
activities with SMEs and Corporates.

Dividend Payout Trends for Commerzbank and the Banking Industry

Since the global financial crisis, Commerzbank did not distribute any dividends until 2015, when it
paid out a €0.20 dividend per share, implying a ~21% payout ratio on its recurring EPS. Following
2015, the bank stopped paying dividends in order to finance its restructuring programme and
improve its CET1 ratio.

The banking industry globally has also shown substantial increase in dividend payouts thanks to
strengthened regulatory capital levels. Increasing dividends is also a way for the banking industry to
increase investor confidence. Banks have also been doing share buybacks with large cap banks
reducing their outstanding shares by about 5% in 2017.

In summary, we have seen aggressive payouts in the overall banking industry, which represents a
natural benchmark for Commerzbank.

Should Commerzbank Return Cash to Shareholders?

We believe that Commerzbank should return excess cash to shareholders based on the following
analysis:

 Stronger Profitability: Commerzbank’s current capital base is much stronger and they have
successfully passed the 2018 EBA stress test with bank’s CET1 at 13.0%, well above the
regulatory requirements. The bank announced a net profit for the first nine months of 2018 of
€751m compared to €53m in 2017. This shows that the bank is very well positioned to return
excess cash to the shareholders and finally send a positive signal to the market.

 Current Interest Rate Environment: Given the current ultra-low interest rate environment,
there is scarcity of lucrative opportunities to deploy capital, it follows that excess cash should be
returned to shareholders.

 Signalling Impact: To signal confidence to investors and favour a recovery of its stock price,
Commerzbank should initiate a shareholder distribution programme. This is also true in light of
recent press speculation about a potential merger with Deutsche Bank. A more compelling
remuneration policy, if unexpected by the market, would help to increase Commerzbank’s share
price and shift the potential merger terms (i.e. exchange ratio) in favour of its shareholders.

Dividend vs Stock Repurchase:

Now that we have determined that Commerzbank should return excess cash to its shareholders, we
will briefly compare the two different options:
If Commerzbank were to set a dividend payout target, investors might focus on this metric as
opposed to the overall profitability of the bank and its fundamentals. Dividend yield would become
one of the main valuation metrics used by the market and a dividend decrease would send a bad
signal to the investors. A publicly stated dividend policy, on the other hand, could be viewed as a
signal of management’s confidence in the bank’s future and might make the stock more attractive to
yield-chasing investors. For instance, the German Government, which is one Commerzbank’s
largest and most influential shareholders, would strongly benefit from the bank returning to a
dividend.

Conversely, one of the benefits of share repurchases is that they provide management with a
greater degree of flexibility over timing and overall amount of cash returned to shareholders. By
stating a maximum repurchase amount over a certain time-frame, management can also take
advantage of market downturns and purchase stock when it trades below its intrinsic value.

Recommendation

To preserve a greater degree of flexibility but still signal confidence to the market, Commerzbank
should set a relatively low minimum dividend payout policy along with a multi-year programme
buyback. A payout policy based on EPS, in fact, would be less constraining than setting a dividend
floor.

During the Q3 2018 results conference call, management disclosed that they were aiming to
resume a dividend, targeting a ~€0.20 dividend per share on 2018E earnings. Assuming a 2018E
EPS of €0.72, in line with current broker consensus, the implied dividend payout ratio would be ~30%
and dividend yield of ~2.4%.

Management should therefore disclose a ~30% payout policy for the 2018-2022 period, and all the
cash flow available for distribution in excess of the stated dividends should be used to repurchase
stock. Commerzbank is projected to have an EPS of EUR 0.72 by the end of 2018 and EUR 0.83 in
2019 (Source: Business Insider and Factset). The recommended ~30% payout ratio will result in
0.72*0.3 = EUR 0.22 dividend per share for 2018 and 0.83*0.3 = EUR 0.25 for 2019. These figures
are in line with EUR 0.20 paid in 2015 and reflect the improvement in its balance sheet and overall
financial health since that year.

As management has already disclosed its dividend target for 2018, steering away from the ~30%
payout level could also send the wrong signal to the market. This level is already priced in and the
market has a clear a view in terms of its expected shareholder distributions, as shown in the DPS
consensus estimates in Table 1. Additionally, a ~30% payout is consistent with Commerzbank’s
historical average level in the 2004-2007 period, when the bank was paying dividends with an
average payout ratio of approximately 30%.

On the basis of the analysis presented in Table 1 and in addition to a constant ~30% dividend
payout policy, we believe that Commerzbank has capacity for a ~€900m buyback programme in the
2018E-2022E period. This amount was calculated as the cumulative 2018E-2022E excess
cashflows after distributing dividends as per the ~30% payout policy.
Figure 1 – Model Output
Per Share (EUR) Dec '18E Dec '19E Dec '20E Dec '21E Dec '22E

EPS 0.72 0.83 1.14 1.33 1.43

Dividends per Share 0.20 0.30 0.44 0.60 0.80

Consensus Implied Payout Ratio 28% 36% 38% 45% 56%

Assumed Fixed Payout Ratio 30% 30% 30% 30% 30%

Assumed Dividend Per Share 0.22 0.25 0.34 0.40 0.43

Implied Excess Cash p.s. Available for Buyback 0.00 0.05 0.10 0.20 0.37

Shares Outstanding (m) 1,252 1,252 1,252 1,252 1,252

Implied Total Cash Available for Buyback 4 64 119 252 465

Cumulative Buyback Amount '19E-22E -- 64 184 436 901