P&L Check Commerzbank has to protect its home turf

Commerzbank has avoided a foreign takeover and recovered from the 2008 crisis. But with Brexit bringing more competition, Germany’s second-largest bank will have to work even harder to stop rivals from taking its clients.
Commerzbank boss Martin Zielke should keep his eye on the ball.

The takeover speculation has been so constant that Commerzbank executives are pretty darn tired of talking about it. “It’s not my job to look into crystal balls,” CEO Martin Zielke said recently, adding that, in any case, consolidation doesn't heal all wounds.

Germany's second-largest bank has been linked to a variety of foreign suitors over the past year, ranging from Unicredit to UBS to Deutsche Bank. One reason is that the German government, which acquired 15 percent in exchange for a bailout in 2009, is looking to sell. Whoever buys in will get a bank that is relatively stable: Non-performing loans have been cut and its core capital ratio — a measure of financial health — has climbed to 14.1 percent. After a decade of woes, "there's light at the end of the tunnel," Wolfgang Aleff, who represents smaller investors, said at the annual shareholders meeting Tuesday.

Even so, Mr. Zielke might want to direct his crystal ball to another problem lurking around the corner: The prospect of Brexit is prompting many Anglo-Saxon banks to shift resources from London to Frankfurt. Many of them will be looking to muscle in on Commerzbank's home turf.

It's a crowded field. Germany has more small retail banks than any other developed country.

That home turf chiefly involves lending to small and medium-sized German businesses, known here as the Mittelstand. This is where Commerzbank shines, supplying about a third of all export financing. Considering Germany has the world’s largest trade surplus, that’s a fairly big market to dominate. And demand is growing. Corporate lending rose 5.2 percent in 2017, an “unusually good” year according to the state-backed KfW bank.

Critics argue that Commerzbank has taken its eye off the prize: A controversial restructuring has seen its “Mittelstandsbank” fused with its investment banking unit. Some employees fear this has muddied the waters, causing it to lose focus on the small-business clients that are the bank’s backbone. It doesn’t help confidence that Michael Reuther, who heads the new division, was previously head of investment, not corporate, banking.

The numbers suggest Commerzbank’s edge is shrinking. Revenue in its corporate and investment banking division fell 10 percent to €4 billion last year. Profits slumped even further, down 37 percent to €809 million. Considering the bank earned just €156 million in total net income last year (the lion's share of earnings went towards an ongoing restructuring), a drop in profits in its biggest money-making division is a serious problem.

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There’s a variety of reasons for the decline, but one of them is no doubt heightened competition. While demand for corporate loans is rising, the German central bank says lenders across Germany have continued improving their lending terms (thereby reducing their profit margins) to stay competitive. Commerzbank has responded with a new marketing campaign and set a goal of targeting small businesses with annual revenues of up to €100 million. But it’s a problem that is only likely to get worse as foreign banks increase their presence in Frankfurt over the coming years.

The bank is hoping to make up the difference by expanding its retail banking arm. It set a goal of winning 2 million new customers by 2020. It has done reasonably well so far, adding 639,000 since the target was announced in the fall of 2016. But this, too, is a crowded field. Germany has more small retail banks than any other developed country, while Commerzbank’s chief rival, Deutsche Bank, is also looking to end its Wall Street adventures and return to its German roots.

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If Commerzbank really wants to fend off foreign competition, it will have to become more efficient. That has been the message from Stephen Feinberg, head of Cerberus, which became one of its biggest shareholders last year. Lax controls have cost the bank fines from regulators, while its cost-income ratio actually increased 1.8 points to 77.3 percent in 2017 (even its online bank Comdirect has a ratio of 75 percent). This is despite the restructuring process, which is set to be completed by the end of the year.

Like many lenders in Germany, Commerzbank likes to blame the low-interest rate policies of the European Central Bank for depressing its margins. Its cost-income ratio should fall to 60 percent as interest rates normalize, the bank predicts. But the fact is other German banks have been far better at controlling costs under the same conditions (see graphic above).

Mr. Zielke dismisses the charge: To grow your customer base, you have to spend as well as save, he says. At the bank's annual shareholders' meeting on Tuesday, he placated investors by promising a dividend in 2018, which would be just the second payout since the German government's intervention during the financial crisis. But if foreign banks, operating from a lower cost base, start aggressively going after Commerzbank's customers, Mr. Zielke will start to wish he had looked into that crystal ball much sooner.

Andreas Kröner is a financial correspondent with Handelsblatt based in Frankfurt. Christopher Cermak adapted this story for Handelsblatt Global. To contact the author: [email protected]