Deutsche Bank’s capital-raising highlights leverage ratio bite

Sid Verma
Published on:

Deutsche Bank’s belated battle to boost its equity position underscores growing capital pains for global banks just as regulators in the US, and possibly UK, appear to be fighting tooth and nail for a sharper leverage ratio to reduce systemic banking risks.

On Monday, Deutsche Bank sold €2.9 billion of stock without a discount, increasing its fully loaded Basel III common equity tier 1 capital position from 8.8% at the end of March to 9.5% in the process.

After spending years arguing the bank could meet regulatory requirements through retained earnings and risk-weighted assets (RWA) reduction, Deutsche also announced it might issue a further €2 billion in subordinated capital in the coming months to further buttress its capital position.

Despite the modest equity dilution, the bank’s shares rallied as much as 8.5% on Tuesday morning, as shareholders breathed a sigh of relief that the bank no longer is considered one of the least capitalized of the large European banks.

The capital-raising exercise drew mixed reviews from analysts.

Analysts at JPMorgan were particularly bullish. Upgrading DB to overweight from the neutral the analysts said, “Deutsche Bank is finally starting to address its capital issues; we have suggested for DB to raise equity since the structured credit crisis.. In fact DB is setting a new capital bar for Eurobank peers.”

Analysts at Nomura were slightly less positive. “The under-performance of Deutsche Bank in the last few months has been capital-driven,” said Jon Peace, European bank analyst at the Japanese bank. “The bank has gone from the bottom of the pack, in terms of risk-weighted tier 1, to above-average.”

“Its position is not as strong as the likes of UBS or Morgan Stanley but it is now above-average,” said Peace, who upgraded the bank from underweight to neutral after the share issue, a move also followed by the Credit Suisse European bank equity team on Tuesday.

At 9.5% tier 1, DB is ahead of many of its peers on a reported basis with Barclays at 8.4%, JPMorgan at 8.9%, Citi 9.3% and Bank of America at 9.4%. But market fears over Deutsche’s capital position have not abated, with the stock still trading significantly below book value.

One big regulatory concern: the bank’s challenge in complying with the Basel III leverage ratio of 3%, a non risk-adjusted prudential measure to backstop tier 1 capital requirements.

Before the capital-raising, the bank’s leverage ratio stood as low as 2.3% and the latest round of capital-raising is small in absolute terms and also relative to its gross assets, meaning the bank, like some of its large investment banking peers, still fails to comply with the 3% leverage ratio, which won’t be binding until 2019.

For many regulators, Deutsche Bank could be seen as a poster child for the benefits of a stringent leverage ratio.

For example, even after incurring a $3.5 billion loss, the bank beefed up its capital position after adjusting its RWA calculation in January. In its words, the bank achieved €55 billion of “de-risking” in fourth quarter of 2012, through the “roll out of advanced models”, “data improvement exercises”, “portfolio maximization” and “optimizing risk mitigation”.

In other words, investors and regulators were unclear as to the principal sources of DB’s capital improvement, whether from better hedging of market risks or a modification of the data inputs behind risk calculations.

This move sat awkwardly with calls from regulators in recent years for greater capital transparency, more objective external assessments of banks’ leverage positions and a desire for capital-raising through conventional routes: raising equity capital, reduction of RWA, retention of earnings or conversion of hybrid instruments into common equity.

The recent cash call, therefore, suggests the bank is paying heed to these calls.

What’s more, for global bank-reform aficionados, any push for Deutsche Bank to conform to tighter leverage norms should be seen less about regulatory compliance for compliance sake or the equity costs involved in complying with an oncoming capital surcharge imposed in the US on foreign banks.

DB’s capital problems are structural, with respect to liquidity and solvency risks, even without taking into account its new US challenges, their detractors argue. Deutsche Bank might be increasing capital relative to assets but gross asset reduction needs to kick to meet basic leverage ratio requirements, unless all profits are retained in the coming years, says Peace at Nomura.

“On the investment banking side, the bank might consider the issuance of a lot more additional Tier 1 capital or cutting exposure to derivatives and low RWA gross assets, such as repo, in order to meet its leverage ratio requirements.”

As financial commentator and author Jonathan Weil points out, Deutsche Bank’s recent results highlight the bank had tangible equity of €41.5 billion as of March 31, equivalent to just 2% of total assets. But he adds: “Even that may have overstated Deutsche Bank’s ability to absorb losses. The equity figure included €7.6 billion of deferred-tax assets, which would be worthless in a crisis.”