Deutsche Bank (NYSE:DB) has worked quite hard over the recent past to shore up its balance sheet in order to comply with stringent Basel III capital requirement norms. Drawing severe criticism for being one of the worst capitalized global systemically important banks (G-SIBs) at the end of 2011 with a pro-forma Basel III core Tier 1 capital ratio of 6.6%, the German banking giant has slashed billions in non-core assets since then and also issued fresh equity worth €3 billion this April to push the figure to a strong 9.5% (see Understanding Deutsche Bank’s Challenges With Basel III Compliance). The bank is now among the best capitalized G-SIBs in terms of the core Tier 1 capital ratio.
But Deutsche Bank still has some distance to cover to meet other regulatory requirements – most notably the leverage ratio. In response to pressure from German financial regulator BaFin to continue culling its risky assets, the bank has targeted a €250 billion ($330 billion) reduction to its balance sheet in the near future. And only after it satisfactorily meets all regulatory requirements will the bank shift its focus on returning cash to investors by means of dividend hikes and stock repurchases.
We are in the process of updating our $54 price estimate for Deutsche Bank’s stock to factor in the negative impact of slower-than-expected growth in its dividend payout over the coming years.
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Deutsche Bank was placed in ‘Bucket 4’ by the Financial Stability Board (FSB) as part of its classification of the G-SIBs, which means that the bank will be subject to an additional capital requirement of 2.5% over and above the minimum base requirement of 7% – a total of 9.5%. This is the figure Deutsche Bank targeted, and achieved, for its core Tier 1 capital ratio, as once the Basel III norms kick in the bank will be allowed to hand out dividends only if its balance sheet shows a capital ratio of 9.6% or above. But the bank needs to build an additional buffer for this figure, as the current capital ratio is subject to the underlying calculation of its risk-weighed assets value and is yet to be finalized by the Basel committee.
Because of this and the demand for additional capital by BaFin, it is only natural for Deutsche Bank to withhold dividends in the near future – choosing to retain all its earnings in the interest of building its capital reserves. Having lowered the dividends from a high of €4.50 per share in 2008 to the current level of €0.75 which has been maintained since 2010, it looks like this level of dividends will stay for at least a year more.
The impact of this on Deutsche Bank’s share value can be understood by making changes to the chart below which captures the bank’s dividend payout ratio as adjusted for any share repurchases (although it must be mentioned that the last time the German banking giant repurchased a sizable number of shares was in 2006). Do note that we have set the dividend payout ratio for 2012 as 0% despite the payment of €689 million ($886 million) in dividends because net income for the year was €237 million ($305 million) – working out to a payout ratio of about 300%, which is not meaningful.