Commerzbank boss Martin Blessing has restored the German lender to health but it is unlikely to meet ambitious 2016 turnaround targets as it faces tough competition at home and a stagnating European economy.

Mr Blessing is half-way through a four-year, post-crisis recovery plan for Germany’s second-biggest bank. He has cut costs, reduced its balance sheet by about €40 billion and is in the middle of laying off 5,200 staff.

But the lender’s target of reaching a 10 per cent return on equity (ROE) - a key measure of a bank’s profitability - by 2016 appears out of reach.

Since the lofty goal was set, the euro crisis has dragged on, depressing demand for financial services and forcing the European Central Bank to keep interest rates at record lows, hurting banks' ability to make money from lending.

“When Commerzbank set out its 2016 targets in 2012, no one could have predicted the development of the interest-rate environment,” said a person close to the thinking of Commerzbank’s management board. “The 10 per cent target has become much harder to achieve.”

The result is that Commerzbank, a household name that finances over a third of Germany's exports and competes with Deutsche Bank, will need to cut costs deeper, push restructuring harder, and sell assets faster - and even then, it may need lower its target.

Failing to meet turnaround goals could also deter potential buyers for the bank, which has been the focus of takeover speculation for decades as some industry players regard it as too small to succeed.

Commerzbank posted an ROE after taxes of 5.7 per cent in the first nine months of 2014 in its core bank, which excludes the €88 billion euro portfolio of unwanted assets - or “bad bank”.

That’s better than Deutsche Bank at 4.9 per cent but below its ROE target and its cost of capital, which it also estimates at 10 per cent. And that places Commerzbank at just over half-way down its reform path, with the steepest part left to climb.

“Commerzbank has made very good progress with its restructuring,” one of the bank’s top 10 investors said. “The turnaround seems to be a success.”

A Commerzbank spokesman declined to comment.

Critical Mass

Commerzbank’s equity stood at €27.6 billion as of September 30th, of which €20.2 billion resided in its core bank. To achieve a 10 per cent return based on that, its core bank would need to earn at least €2 billion in 2016, much more than the €1.4 billion net profit forecast by Thomson Reuters Starmine.

That target will only get tougher as Commerzbank builds equity to meet rising regulatory demands and shifts assets from the bad bank to other divisions.

Rather than resort to swingeing cuts, Commerzbank is likely to look for smaller opportunities to adjust activities and trim costs, said the person close to management thinking.

The investment bank is one of the divisions in line for more cutbacks, he said, putting Commerzbank on par with other banks trimming their markets activities due to stagnant demand.

By contrast, retail banking has grown by leaps and bounds, adding around half a million net new clients in the past two years without increasing costs.

But the bad bank continues to drag, with an operating ROE of minus 10.4 per cent, even though Commerzbank is ahead of schedule in cutting unwanted assets.

It contains investments from an expansion drive that backfired, requiring the government to spend around €18 billion on a bailout in the financial crisis.

How far Mr Blessing - a University of Chicago graduate and former McKinsey consultant - goes with reforms will help determine the appeal of the lender, which is still 17 per cent owned by the German government, to potential buyers.

A quick stake sale to the likes of BNP Paribas, Societe Generale or UBS is unlikely. Regulators do not want bigger banks threatening the stability of the financial system and all those lenders have said they are not interested.

More important to the government than maximising proceeds from the sale of its stake would be finding a secure home in case Commerzbank needs a partner to achieve the critical mass needed to survive, a person close to the government said.

Reuters