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The German Bank That's Painfully Honest About Profit

Elisa Martinuzzi

(Bloomberg Opinion) -- Commerzbank AG, Germany’s second-biggest publicly traded bank, has just unveiled a strategic overhaul that is supposed to secure its future as a standalone company. But even if everything goes well, its new “Commerzbank 5.0” plan foresees meager profitability at best.

Weakened by fierce domestic competition, bloated costs and a squeeze on margins from negative central bank interest rates, Commerzbank explored a combination with its larger rival Deutsche Bank AG earlier this year. Its response to that deal’s failure is a painful reminder that its returns aren’t going to improve in a fragmented German market dominated by smaller savings and cooperative lenders.

As part of Chief Executive Officer Martin Zielke’s revamp, Commerzbank plans to cut about 20% of its branches and 5% of its workforce, costing the company about 850 million euros ($934 million). That leaves it with 750 million euros to invest in technology to help the state-owned lender try to win more business from small- and medium-sized companies.

To fund the reorganization, Commerzbank hopes to sell a majority stake in its Polish unit, thereby increasing its dependence on the German market.  Moody's warned the sale would be bad for Commerzbank’s revenue and profit growth.

What’s more, the plan stops well short of offering much hope of sustainable profitability once it’s completed. Missing from its aspirations was a sense for how much the lender might grow. Revenue should be higher by 2023, the bank said, without providing details. That’s a sign that growth will remain elusive.

And while Commerzbank was a little bolder in how much it can cut from its expenses (costs should decline by about 20% by 2023), investors may hardly notice the difference. In the medium term, profitability may reach an uninspiring 4% when measured by return on tangible equity. That is substantially below estimates of its cost of equity, the nominal toll extracted by investors in exchange for holding the shares.

The best that can said is that Commerzbank is being realistic — depressingly so. More details on the overhaul and the assumptions behind those underwhelming financial targets are due on Friday after the board gives its approval.

It turns out many other German banks are still being too optimistic about their profitability, with more than half of the 1,400 or so smaller lenders expecting interest rates to rise according to a recent survey by the country’s finance regulators. Good luck waiting for that.

There were a number of problems with combining Commerzbank and Deutsche Bank: The deal would have left them with an inefficient securities unit, while requiring tens of thousands of politically difficult job cuts to make the numbers work.

Yet with interest rates falling lower and lower and the German economy suffering its worst slump in seven years, the need for domestic bank consolidation is as pressing as ever. Loan losses will probably get worse and, though smaller lenders have “sound capital” under various stress tests according to the BaFin regulator and the Bundesbank, competition will get tougher in the current rate environment.

About 1,500 lenders are vying for business in Germany, the lowest concentration in European banking. Public sector savings banks and their associated Landesbanks make up about 25% of the country’s banking total assets, while cooperatives account for another 11%. That leaves the top five institutions with just 30%. As a result, the German banks’ return on equity has trailed the rest of Europe. Forcing cooperatives to become corporations might be one way of kickstarting consolidation, according to Peter Hahn of the London Institute of Banking & Finance.

Commerzbank’s easiest way out might be to sell out to one of the European suitors that have knocked on its door. That won’t solve Germany’s overbanked industry, though.

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Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

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