UPDATE 3-Commerzbank returns to profit, spurs European bank relief rally

* Q4 net profit 187 mln eur vs 280 mln loss yr-earlier

* Q4 operating result 376 mln eur vs 260 mln loss yr-earlier

* CET1 ratio 12 pct at end-2015 vs 9.3 pct end-2014

* Commerzbank says expects 2016 profit increase

* Shares up 17 percent (Adds CEO quotes from press conference)

By Arno Schuetze

FRANKFURT, Feb 12 (Reuters) - Commerzbank returned to profit in the fourth quarter as bad loan provisions fell and it announced it would close its “bad bank” of troubled loans, sending its stock sharply higher and triggering a rally in European banking shares.

The 17 percent spike of Commerzbank’s shares helped lift bank shares across Europe.

“Today, we have helped the market”, outgoing Chief Executive Martin Blessing said at the bank’s annual press conference on Friday.

Traders, which have seen days of extremely volatile trading of bank shares, agreed. Bank shares have been hit by concerns over their profitability in a low-growth and low-interest rate environment.

“There’s a sense of relief. There’s so much nervousness in the market at the moment that even slightly good news out of a bank like Commerzbank is taken very well,” said Mark Priest, sales trader at ETX Capital.

Even shares of Deutsche Bank were up 10 percent, outperforming the 4 percent stronger sector despite a downgrade by rating agency Standard and Poor’s.

Deutsche Bank had reported a 2015 record loss.

By contrast, Blessing said: “For the first time in five years we have attained a (full-year) net profit of more than 1 billion euros ($1.1 billion) and have seen further significant strengthening of our capital base.”

In the fourth quarter, Germany’s second-biggest lender reported a net profit of 187 million euros, meeting expectations with a swing from a loss of 280 million euros a year earlier.

The bank also announced it was closing its “bad bank” after reducing assets in the division to 63 billion euros at the end of 2015 from 160 billion in 2012 and halving the division’s full-year operating loss to 401 million euros.

Remaining assets will be transferred to other divisions, except for 18 billion euros, less than four percent of total group assets, which will be bundled in a newly-created “Asset and Capital Recovery Unit”.

The bank plans to announce a successor to Blessing in time for its annual shareholder meeting on April 20, Chairman Klaus-Peter Mueller said in a message to staff.

Blessing said he was leaving the bank with mixed feelings adding that his time at the helm of Commerzbank had been like a roller-coaster ride.

Commerzbank CFO Stephan Engels said that while the bank expects a slight increase in net profit in 2016, a return on equity target of 10 percent remains out of reach due to low interest rates.

Analysts say Commerzbank has strengthened its financial position markedly in the last few years by slashing its multi-billion-euro commercial real estate and shipping portfolios and boosting capital.

Low interest rates continue to hamper Commerzbank’s ability to boost profits in its home market, where fierce competition among banks keeps margins worryingly thin.

While Commerzbank saw the operating profit of its retail bank double to 160 million euros in the quarter, profits at its cash cow Mittelstandsbank - which caters to Germany’s prized medium-sized companies - fell 15 percent to 212 million euros on lower margins.

Earnings at its investment bank shrank 60 percent to 47 million, in line with the performance of peers like Deutsche Bank.

Commerzbank’s Polish subsidiary mbank remains vulnerable to possible changes in that country’s banking laws, with analysts worried government moves to convert Swiss franc-denominated mortgages into zlotys could herald a more hostile environment generally for banks. ($1 = 0.8865 euros)