German Slump Threatens Bank Profits as Loan Risk Spreads

(Bloomberg) -- Germany’s deepening economic slump is squeezing the life out of the nation’s struggling banks, a little more than a decade after a crippling financial crisis from which many never fully recovered.

Lenders ranging from Deutsche Bank AG and Commerzbank AG to HSBC Holdings Plc’s German subsidiary all reported deteriorating second-quarter earnings. They had to set aside more money for loans to companies reeling from the impact of global trade disputes, Brexit uncertainty and distress in the autos sector. All are now doubling down on cost cuts to offset the rising threat to profitability.

“Headwinds from interest rates and the economy are intensifying,” HSBC’s Germany head Carola von Schmettow said on Wednesday. There is an “increased danger of credit defaults” in the second half of the year, according to the bank.

The growing threat could hardly come at a worse time for a banking industry already debilitated by years of sub-par profitability and failed turnaround plans. Deutsche Bank recently unveiled the most sweeping restructuring plan in its recent history and has since acknowledged that the underlying macro-economic assumptions didn’t factor in the rapidly deteriorating outlook.

Commerzbank is working on a strategy update while the world around it slides toward recession. About a third of the lender’s total loan book -- or about a fifth of its total balance sheet -- is pledged to German companies.

The pain hasn’t just been felt at publicly-traded banks. State-owned Landesbank Baden-Wuerttemberg, as well as DZ Bank AG, Germany’s largest cooperative lender, also saw loan loss provisions rise in the first half after a benign period a year earlier.

Rising risk provisions will be a test case for foreign banks operating in Germany too. HSBC, ING Groep NV, BNP Paribas SA and JPMorgan Chase & Co. have all been boosting lending to German companies in a bid to wrest market share from Germany’s largest corporate lenders on their home turf.

ING’s German unit has been particularly active: it’s tripled lending to companies over the past half decade, growing corporate credit to 15% of its balance sheet last year.

Intense competition from foreign banks has been one factor driving lax lending standards at some banks, regulators have said, though individual lenders including Commerzbank are keen to say that doesn’t apply to them. Still, some banks including BNP have indicated that they’re willing to lose money on some corporate loans if they can ultimately earn a return by selling the client other products.

Almost all the banks are working on deeper cost cuts to cope with the challenge to their profitability. Deutsche Bank’s expense drive is the industry’s most ambitious by far as it rips out large swathes of its securities trading operations and scours its retail division for additional cuts as well, including centralizing its workforce in Frankfurt and closing additional branches, according to people familiar with the matter.

The latest set of earnings may only have been the tip of the iceberg. Analysts expect the loan-loss provisions at both Deutsche Bank and Commerzbank to soar over the coming years, posing a growing threat to the banks’ bottom lines, especially if their efforts to stop several years of shrinking revenue continue to fail.

The situation is compounded because both lenders are already burning through financial reserves to fund their overhauls. A surge in delinquent loans could bring the banks even closer to their minimum capital requirements -- at a time when raising fresh funds from investors is especially hard given their stock prices are near all-time lows.

The outlook for some of Germany’s key industries and in particular the automotive sector is worrisome. Several carmakers and parts suppliers including Daimler AG and Continental AG have issued profit warnings. The insolvency last month of Eisenmann SE, a maker of surface coating machines for car producers, has increased the focus on the sector.

This year, Commerzbank increased its expectations of losses from exposure to the automotive industry to the highest in more than four years. The larger part of the second-quarter loan impairments at HSBC came from a small number of big defaults, including within Germany’s automotive industry, according to a person familiar with the matter.

“Some of Germany’s banks were struggling already during the boom times and that’s going to get worse in a weaker economy,” said Isabel Schnabel, finance professor at the University of Bonn and a member of Chancellor Angela Merkel’s council of economic advisers. “We’ll see in the downturn whether banks loosened their lending standards too far.”

--With assistance from Stephan Kahl.

To contact the reporters on this story: Nicholas Comfort in Frankfurt at ncomfort1@bloomberg.net;Steven Arons in Frankfurt at sarons@bloomberg.net

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Iain Rogers, Daniel Schaefer

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