* Banks target booming Mittelstand in weak European backdrop
* Competition driving down margins on loans to Mittelstand
* Long-term banking relationships may be tough to break
By Andreas Kröner
FRANKFURT, Jan 13 (Reuters) - Cut-throat competition anddecades-old banking relationships mean lenders aiming to profitfrom Germany's booming middle-sized companies may be chasing amirage.
On the surface, foreign and domestic banks' expectations ofselling more financial services to the thousands of German"Mittelstand" companies seem fully justified.
These often family-run, capital market-shy firms have grownrapidly to dominate global markets in speciality engineering ortechnology and contribute a big chunk of Germany's much-enviedtrade surplus of about 190 billion euros ($260 billion).
With the rest of Europe in the doldrums, major lenders likeDeutsche Bank, BNP Paribas and HSBC have stepped up their focus on the Mittelstand,challenging the likes of Commerzbank and public sectorlenders which see them as their traditional customers.
They can't all be successful.
"There are so many banks piling into that business that youhave to wonder if there are enough Mittelstand companies to goaround," said Bundesbank Vice President Sabine Lautenschlaeger,one of Germany's top banking supervisors.
Company executives attest to bankers' ardent pitches.
"Banks are proactively approaching us in ever increasingnumbers," said Stefan Wolf, chief executive of auto partssupplier Elring Klinger, based in southern Germany.
The company is paying less than 1 percent for financing ofup to a year, and pays only up to 2 percent for loans of up tothree years. "Money is sensationally cheap," Wolf said.
But it may take more than the offer of easy credit fornewcomers to dislodge the "house" banks whose relationships withtheir Mittelstand companies often go back decades.
Steffen Walter, chief executive of machine tool safetyequipment maker Hema, uses two lenders, his local Maingausavings bank for immediate financing and Italy's UniCredit to support his operations in Italy and Romania.
"Our banker knows the company inside out," Walter said,stressing the ease and speed of arranging any financing needed.
"My philosophy is to be loyal to the bank, because in acrisis, I can also expect loyalty from the bank," he said.
Auditing firm Ernst & Young found in a study that while bankloans remain central to corporate funding in Germany, companiesnow see the reliability of loans as more important than cost.
"The Mittelstand hate it if the customer service personchanges and they hate it when bank products disappear or foreignbank branches close," said Martin Fischedick, Commerzbank'sdivisional head for the segment.
Commerzbank, Germany's second-biggest lender, bills itselfas a Mittelstand "house" bank, with around 130 billion euros inloans and credit lines to the sector.
"FAIR WEATHER BANKING"
Lately there has been an increase in foreign banks trying tomuscle in, said Fischedick, who has been advising Mittelstandclients for a quarter of a century.
He reckons Mittelstand companies pay about 23 billion eurosper year for banking services but banks collectively aretargeting revenue of 29 billion.
"Not all lenders will reach their goals because Mittelstandbusiness is certainly not going to grow by 6 billion," he said.
Commerzbank is targeting growth of 5 percent per year foritself, but it will need to fend off incursions from BNPParibas, which is adding 500 staff to its business, and HSBCTrinkaus, which is widening its net beyond large clients toinclude companies with annual sales of 35 million euros or more.
HSBC Trinkaus aims to double its corporate client base overthe next four years, from about 1,500 now, and expects a fight.
"It's not lost on me that this is possibly the mostover-banked client business segment in the world," said StephenPrice, head of corporate banking at HSBC Trinkaus.
Germany's biggest lender, Deutsche Bank, said it would starthandling corporate customers from 250 locations rather than theprevious 70, with Co-Chief Executive Anshu Jain's personalvisits to companies like Wuppertal-based vacuum cleaner makerVorwerk underscoring Deutsche's interest.
The lender's focus is on selling multiple services toclients, with about 70 percent of corporate borrowers also usingits other services.
The battle between large commercial players like DeutscheBank, Commerzbank, BNP and HSBC, who control less than 15percent of Germany's corporate banking market, andnot-for-profit rivals in the public and cooperative sector, whocontrol more than 60 percent, does not bode well forprofitability.
Loans may be serving as loss-leaders. The average grossmargin for Mittelstand loans of 1 million euros with a 5-yearmaturity has fallen to around 1.5 percent, while on loans of250,000 euros to 1 million it is around 2.3 percent, bankingconsultant Peter Barkow calculated.
"Margin pressure usually starts with large loans and spreadsdown," Barkow added, pointing out that the gross margin isbefore banks subtract costs and provision for bad loans.
Eager banks and cheap money are a combination that could endbadly because risks are not being priced in, warned Martin Faustof the Frankfurt School of Finance and Management.
"This is fair weather banking. Only the next recession willshow who is being sensible in their approach," Faust said.