Shrugs greet Deutsche’s loss
The markets didn’t quite ignore the rushed news of Deutsche Bank’s fourth-quarter 2013 €1.2 billion loss stemming from litigation charges, restructuring costs and weak performance in its fixed-income business. Sure, the shares fell 6.5%, but this came after a more than 20% rally from the middle of 2013. Investors might have contented themselves that, after stripping out all the accounting nonsense and the litigation one-offs, the underlying performance wasn’t too bad.
So far, the bank has paid out restructuring costs equal to or ahead of realized savings in the first two years its so-called operational excellence programme has been running. In 2014, cost savings should finally outstrip the expense of achieving them, possibly quite substantially.
On the earnings side, yes, Deutsche Bank still derives a high proportion of revenue and profits from a corporate banking and securities division that is more dependent on fixed-income sales and trading and on Europe than global peers such as JPMorgan, Barclays and Goldman Sachs. And there’s no reason to think the markets will be any kinder this year than they were last. But although 2013 was tough, the group full-year underlying operating profit, at €8.4 billion, was close to Deutsche’s record result back in 2006.
What’s more, the bank has achieved this on an asset base 30% smaller than its peak in 2006 and on risk-weighted assets 27% below their peak at the end of 2010. As it continues to deleverage, the bank’s funding is more stable, its capacity to absorb losses much improved and its business mix is becoming better balanced. On an underlying business basis, stripping out the one-offs, even the supposedly troubled CB&S division recorded a 14% return on equity for 2013: perhaps not market leading, but hardly shoddy.
Could investors be taking too sanguine a view and not just on Deutsche Bank, but on the banking sector more broadly? At 9.7% common equity tier 1 the bank is far from the most strongly capitalized among its peers and its leverage ratio of 3.1% puts Deutsche towards the rear of the pack. The bank sold equity last year, but has yet to get its AT1 bank capital issuance programme off the ground. Investors are being asked to bet that the bank can continue to cut RWAs, after the easiest hits have already been taken, without taking heavy losses and without further undermining a signature fixed-income client franchise already losing market share to US rivals.
The problem with slashing high-capital-consuming assets is that the bank also loses revenue, while associated funding costs may continue. Believing, as the bank insists, that it really can maintain client market share as it shrinks requires a leap of faith. Co-CEO Anshu Jain concedes that in the past Deutsche maintained market share in revenue-generating trading businesses such as commodities that were high consumers of capital and produced low returns on assets. In now targeting market share only in select markets, the bank is bowing to reality. Even the market leaders can no longer be all things to all customers.
Jain claims that inside the bank fixed income is leading the way in improving cost/income efficiency and returns on assets. He says that the bank’s legacy derivatives book is a high consumer of RWAs through counterparty credit and that Deutsche can manage this exposure down without harming its client franchise. That sounds like quite a trick. Jain also admits that new investment is needed, especially in the US.
Concern over funding this pales next to the other big unknown for Deutsche and many of the world’s larger banks. That is for how long and in what amounts they will continue to pay out fines and litigation costs. Jain says that 2014 will be a turning point after which the bank will put most of these troubles behind it. But litigation costs hit all the big banks so regularly now that it is surely testing the limits of investors’ patience and of accounting licence to continue to refer to them as one-offs.
They resemble more a continuing operating cost of business, like having to pay interest on liabilities. As Deutsche rushed out news of its latest fourth-quarter loss, talk was turning to a new investigation from regulator BaFin into what light the world’s leading foreign exchange bank might shed on fixing in that market. The bank says these inquiries are at a very early stage and that it is engaging in its own internal investigation. Saying that Deutsche is committing tremendous internal resources to this effort might have been intended to reassure investors. It sounded anything but.