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Commerzbank strategy on track but profitability targets 'a stretch': analysts

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Commerzbank strategy on track but profitability targets 'a stretch': analysts

Commerzbank AG is headed in the right direction with its restructuring plan but it may need time beyond the 2020 deadline to achieve its profitability targets, analysts say.

Germany's second-largest commercial bank gave an update on progress with its Commerzbank 4.0 strategy along with its preliminary annual results on Feb. 8.

CFO Stephan Engels said the strategy was "delivering" results after its full year of implementation. "We have invested in our franchise, we're taking [advantage of] opportunities [in] the changing German banking market." The bank demonstrated its confidence in its ability to generate a profit when it announced it would resume dividend payments a year earlier than planned, making a payment for 2018.

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Analysts said Commerzbank was right to move to reduce costs, accelerate digitization and focus on two core businesses — private and small business customers as well as corporate clients — while looking to scale back its sales and trading business and offload non-core activities.

"Strategically I don't think there is any question mark," said Neil Smith, an equity analyst with Bankhaus Lampe. "They are heading in the right direction, I don't think there's much disagreement over that."

Compared to restructuring plans of other peers, especially in Germany, Commerzbank's restructuring plan always looked more achievable, Morningstar equity analyst Derya Guzel said.

However, the profitability levels the bank is aiming for by the end of the four-year program appear to be "a stretch," equity analysts from Macquarie Research said in a Jan. 23 note. "We agree with the strategy but we disagree with the numbers."

Commerzbank wants to generate at least €9.8 billion in revenue, have a return on tangible equity of at least 6% and a cost-to-income ratio of at least 66%, it said in September 2016. To hit those targets, the bank will focus on new client acquisition and cost reduction.

Automation, cost reduction

With a primary focus on domestic retail activities, the bank aims to sign on two million net new private banking customers in Germany and grow its market share in the small and medium-clients segment to between 5% and 8% by 2020. By the same time, costs should fall to €6.5 billion, compared to €7.1 billion at 2016-end. The lower cost base should be achieved through a planned net reduction of 7,300 full-time jobs as well as further automation and optimization of processes.

The plan is heavily dependent on revenue growth as it accounts for two-thirds of the targeted profit increase by 2020, Macquarie's analysts noted. Based on the 2020 goal, Commerzbank will need to grow revenue by some 5% on average per year. That growth rate would be twice the average of the European sector as well as the highest compared to most European banks, the analysts said.

In 2017, Commerzbank gained 502,000 net new private and small business customers in Germany, generating revenues before loan-loss provisions of €9.2 billion, which was below the €9.4 billion achieved a year earlier. Excluding exceptional items of €557 million, last-year's revenues amounted to €8.61 billion, up from €8.57 billion in 2016.

Accelerating the acquisition of new customers has resulted in higher loan and securities volumes, which "almost completely offset the drag from negative rates and pricing competition, confirming our belief that this is the right strategy," Engels said.

However, accelerating the pace of client acquisition in German retail banking, where 60% of the targeted revenue growth is expected, could result in a decline in profit per client as the quality of service might suffer, analysts warned.

CEO Martin Zielke said Feb. 8 that Commerzbank spends between €150 and €200 on each new client. Although he would not say how much revenue the bank made per client, break-even per customer point is reached in 18 months.

Guzel, who projects around €9 billion in annual revenue for Commerzbank in her base case 2020 scenario, said adding a large number of new customers in just two years could prove challenging given the competitive and fragmented German market.

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NPLs on the rise

Any slowdown in the reduction of Commerzbank's legacy asset portfolio and non-core asset sales could create more earnings volatility, Guzel warned.

Commerzbank has managed to reduce a significant part of its legacy asset portfolio but nonperforming loans, primarily in its shipping portfolio, are still on the rise.

Loan loss provisions are also a matter of concern, especially given the implementation of the new International Financial Reporting Standard, IFRS9, from Jan. 1, 2018. Engels said provisions are expected at €600 million in 2018, down from €781 million at the end of 2017.

While the bank's remaining legacy exposures are low, the level of Commerzbank's NPLs and loan loss provisions remain above those of many of its peers with similar weighted economic risk exposure, S&P Global credit analysts Harm Semder and Bernd Ackermann said in a note.

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