Soft European Market Outlook, Legal Uncertainty Could Present Downside To Deutsche Bank’sValue
Deutsche Bank (NYSE:DB) has had its share of problems since the economic downturn of 2008. The largest German bank features in nearly every high-profile lawsuit against global banking institutions by regulators alleging wrong-doing in the run up to the downturn, and the cost to clear itself of the long list of litigation have run into tens of billions of dollars. Last year was no different for the bank in this regard, with the bank incurring €2.5 billion ($3.4 billion) in litigation expenses over the period. ((4Q / Full Year 2013, Deutsche Bank Financial Releases, Jan 19 2014)) The two biggest components of this expense figure were the €1.4 billion ($1.9 billion) settlement with the Federal Housing Finance Agency (FHFA) over faulty mortgage-backed securities sold by the bank to Fannie Mae and Freddie Mac, and a €725 million (~$1 billion) fine imposed by the European Commission (EC) over rate rigging charges (see EC Hands Down $2.3 Billion In Fines To 8 Banks For Rigging Benchmark Rates). [1]
Legal trouble in itself is not something specific to just Deutsche Bank, as the entire banking sector has been dealing with this issue for a while now. But what makes things worse for the bank when compared to its American competitors is its large exposure to European markets which are yet to recover from the recession. This has strained its top line figures over recent years, even as legal charges wipe out any profits the bank ekes out from its business model. The combined effect of these factors was evident in the unexpectedly large loss of €965 million ($1.3 billion) Deutsche Bank reported for Q4 2013 early last week.
While we recognize the fact that these concerns are likely to remain for several more quarters, we believe that the long term benefits from the bank’s continued focus on strengthening its balance sheet and cutting costs as a part of Strategy 2015+ outweighs the short term performance issues the bank is currently facing. Accordingly we maintain our $53 price estimate for Deutsche Bank’s stock, which is slightly ahead of the current market price.
See our full analysis for Deutsche Bank
Investment Banking Operations Hit A Rough Patch
The importance of Deutsche Bank’s investment banking business to its business model is demonstrated by the chart above, which shows that the business accounts for almost 62% of its total value (sales & trading and advisory & underwriting services put together) according to our estimates. The operations generated less than €2.5 billion ($3.4 billion) in revenues for the last quarter – 16% lower than the €2.9 billion ($4 billion) it made in the previous quarter and 27% below the figure for Q4 2013. The decline is largely due to weak debt trading activity over the second half of the year, which dragged down fixed-income trading revenues. [2] Fixed-income trading revenues fell below €1 billion ($1.4 billion) for the first time in at least three years in Q4 2013.
The only notable performance came from the equity underwriting desk, which made up for the lower advisory and debt origination fee revenues over the period.
Expense Management Begins To Yield Results
Deutsche Bank’s organization-wide restructuring plan, dubbed Strategy 2015+, focuses considerably on cutting costs. The plan which was unveiled in late 2012, sought to cut as much as €4.5 billion ($6.1 billion) in recurring costs by the end of 2015 and bring down the banking group’s cost-to-income ratio to under 65% (see Deutsche Bank Set For Complete Shake-up As Part Of ‘Strategy 2015+’). More than five quarters later, things haven’t shown a remarkable improvement in terms of cost-to-ratio figures (75% for FY2011 to 73% for FY2013), as total revenues were depressed over the second half of 2013.
But in dollar terms, the change is quite evident. Deutsche Bank’s operating expenses (non-interest expenses as adjusted for one-time and restructuring-related charges) have fallen from almost €6.5 billion ($8.9 billion) for Q1 2012 to the €5.6-5.7 billion ($7.6- 7.8 billion) level for Q3 and Q4 2013. The improvement is seen most clearly in the bank’s Private & Business Clients division as shown in the chart below.
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Notes:- Deutsche Bank resolves its single largest mortgage-related litigation case, Deutsche Bank Press Releases, Dec 20 2013 [↩]
- Q4 2013 Results Presentation, Deutsche Bank Website, Jan 19 2014 [↩]