FRANKFURT Commerzbank (CBKG.DE) said it will earn less this year from its core division that lends to Germany's small and medium-sized companies as competition hots up to do business with the booming sector.
European banks have seen the Germany's Mittelstand, often family-owned firms producing quality engineered goods, as a potential area for profit as other areas of their business suffer from the fallout of the euro zone debt crisis and new regulations.
But the companies have done so well they have built up cash reserves, reducing the need for loans from banks which are competing for a slice of the market.
Commerzbank, Germany's second-biggest lender expects profit at Mittelstandsbank, its biggest division, to decline this year, board member Markus Beumer told German business daily Boersen-Zeitung on Tuesday.
"The result will not be as good as in 2012," he said.
Analysts have forecast a 1 billion euros operating profit this year compared with the 1.65 billion it posted in 2012.
Much of the forecast drop in profit is because the bank needs to set aside a normal amount of spare cash to cover for potential bad loans in 2013 after the Mittelstand's success in 2012 allowed it to take the unusual step of reclaiming bad-loan reserves it had set aside during the financial crisis.
But pressure from rivals who have launched initiatives to tap the strength of the German Mittelstand is also increasing.
Competition from rivals such as Deutsche Bank(DBKGn.DE), BNP Paribas (BNPP.PA) or Societe Generale (SOGN.PA) as well as state-owned and savings banks, will make the going tough for anybody wanting a piece of the action.
"The headline news is that the Mittelstand is doing well, which is right, but it is very difficult for creditors to make money there," said Mittelstand expert Bernd Venohr. "Whoever enters this sector as a lender is going to struggle."
Small- and medium-sized companies form the backbone of Germany's economy, with around 3.6 million businesses employing two of every three workers.
Often family-owned, over half of the firms expect sales to rise in the second half of 2013, with many ramping up their expectations since the start of the year, according to a July study by Ernst and Young.
"These companies are cash rich," BNP Paribas Chief Executive Jean-Laurent Bonnafe said last week while in Germany to promote his bank's push into the German corporate market. But Bonnafe sees specialty services like debt-capital management and trade services as more promising than plain lending.
Commerzbank shares dropped 1.7 percent, briefly making it the biggest loser among European banks .SX7P. The shares are down more than 18 percent so far this year, compared to a 15 percent rise for the index.
Commerzbank will see its pretax profit plunge by two-thirds to 553 million euros this year, according to estimates from Thomson Reuters I/B/E/S.
"Companies are cash-rich at the moment, demand for loans is rather low and the price war among banks is increasing - but competition it is not the dominating factor here," LBBW analyst Ingo Frommen said.
In the crisis of 2009, Commerzbank put aside large sums to cover potential bad loans. As Germany came out of the recession quickly, Commerzbank benefited by writing back those provisions - but the effect is coming to an end.
"Loan loss provisions of Mittelstandsbank are still below the long-term average, and I expect them to normalize further", said Metzler Securities analyst Guido Hoymann.
Commerzbank, like other lenders, struggles to make money with deposits from corporate customers, given that central banks have pushed market rates to record lows in an effort to kick start the global economy.
"Margins are squeezed to near zero, so of course, that is affecting their earnings," Hoymann said.
Analysts expect the Mittelstandsbank unit to book provisions of 350 to 400 million euros this year, up from the 30 million it booked in 2012.
In the first six months of this year, Commerzbank's Mittelstand unit saw operating earnings drop 38 percent to 542 million euros ($736 million), hit by a rise in loan loss provisions and poor lending margins.
(Additional reporting by Jonathan Gould, Thomas Atkins, Michelle Martin, Laura Noonan; editing by Anna Willard)