Germany's Commerzbank AG will need to keep a close eye on costs and capital management if it is to complete its strategic restructuring by 2023 as originally planned while also battling the effects of the COVID-19 pandemic, according to analysts.

Its Commerzbank 5.0 strategy, unveiled in September 2019, envisioned a net reduction of some 2,300 full-time equivalent positions and the closure of about a fifth of its branches in Germany, along with the sale of its 69.3% stake in Polish unit mBank SA.

But it has canceled the mBank sale amid concerns it would be unable to fetch an attractive price due to worsened market conditions. This leaves it short of funding for the overhaul which, together with other negative effects of the pandemic on asset quality and profits, could delay the restructuring at a time when it also faces pressure from regulators to cut more costs, according to analysts.

COVID-19 impact

Commerzbank cut both its capital and profit targets for 2020 when it released its first-quarter earnings results May 13. It said it could face credit losses of €1.0 billion to €1.4 billion in 2020 and that aiming for a full year profit would be "very ambitious."

In swung to a first-quarter consolidated loss of €295 million from a year-ago profit of €122 million. Owing to lowered regulatory requirements, it also cut its 2020 common equity Tier 1 ratio target to 12.5% from 12.75% in order to give itself some more flexibility in the ongoing restructuring.

Commerzbank's exposure to sectors hardest hit by COVID-19 makes up roughly 3.5% of its €463.63 billion total assets as of 2019-end. Speaking at a financial conference June 11, CEO Martin Zielke said the exposure is "limited and really diversified" with 88% of loans in retail and 83% of loans in travel being rated at investment grade.

"Our balance sheet is very solid and healthy," he said.

The bank has made progress de-risking its portfolio, an important part of which was selling off most of its shipping book. Its ratio of nonperforming loans to loans at amortized cost has remained at a little over 1.5% since the first quarter of 2019.

Criticism

But its efforts to cut costs have been criticized. Under Commerzbank 5.0, annual costs would have been reduced by €600 million, or about 10%, on a net basis, but the ECB called for deeper cuts in a December 2019 review. Commerzbank then launched a second cost-reduction program in February, details of which will be released with second-quarter figures Aug. 5.

In April, the German government, which still holds a 15% stake following a financial crisis-era bailout, replaced two Commerzbank supervisory board members, which was seen as a sign of disapproval for a lack of improvement in its performance, the Financial Times reported.

Commerzbank cut first-quarter operating expenses to €1.50 billion from the year-ago €1.57 billion and now expects 2020 costs at the prior-year level, which is €150 million less than originally planned. Nevertheless, U.S.-based shareholder Cerberus Capital Management LP, which has a stake of some 5% in Commerzbank, criticized the group's management earlier in June for not being decisive enough about cost cutting, Bloomberg News reported.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Costs and capital

Analysts see the discarded mBank sale as a pressure point.

The proceeds were meant to cover part of the anticipated €850 million restructuring costs. They were also to provide capital relief allowing Commerzbank to maintain a CET1 ratio of 12% to 13% while investing €750 million in IT infrastructure.

Although economically sensible, the decision to keep mBank will make it harder for Commerzbank to complete its restructuring in time and hit all financial targets, Fitch Ratings said in a May 15 report. In a note following the cancellation of the sale, Morgan Stanley equity analyst Izabel Dobreva said there is a risk the restructuring could be knocked off course by COVID-19.

A key question is where the bank could slim down further.

Given its focus on digitization, it could shutter more than the 200 branches already planned for closure, Fitch said. The most likely route, according to Dobreva, is cutting risk-weighted assets, or RWAs, in its international corporates division by refocusing the business on Germany, which would lead to capital gains and higher profits.

Rating agency Moody's welcomed the decision to keep the lucrative Polish subsidiary, but said short-term restructuring costs would constrain its ability to generate capital in the coming few years. Fitch has noted the bank's CET1 capital of €24.4 billion, as of 2019-end, can take only a 5%, or €10 billion, increase in RWAs before dropping below the 12.5% CET1 ratio target.

Commerzbank has seen RWAs increase by €10.4 billion to €181.77 billion in 2019 from €171.37 billion in 2017.

CEO Zielke said June 11 that the CET1 ratio of 13.17% as of March-end is strong enough not to limit any strategic initiatives.

Commerzbank plans to free up CET1 capital through issuing additional Tier 1 and Tier 2 instruments to keep its ratio above the 10.78% maximum distributable amount threshold, Zielke said.

It recently launched a €3 billion AT1 program. The maximum distributable amount threshold determines how much capital and loss-absorbing debt reserves a bank must hold without facing restrictions on dividend and coupon payments.