Legal Costs Drag Down Deutsche Bank’s Q3 Results
On Wednesday, October 29, Deutsche Bank (NYSE:DB) became the latest banking giant to report a quarterly loss due to significant legal costs. [1] The German bank witnessed a decent operating performance for the period, but the bottom line was hit by its decision to increase legal reserves by an additional €894 million ($1.14 billion) in view of the string of high-profile lawsuits and investigations it is currently a part of. This has been a nagging issue for the banking sector as a whole over the last few years. But the problem remains acute for Deutsche Bank, which has reported a quarterly loss in three of the last eight quarters and has more than 6,000 pending lawsuits – more than 1,000 of them with a potential liability exceeding €100,000. [2]
While the legal problems are likely to drag down Deutsche Bank’s results for the foreseeable future, there are several key factors that are going the bank’s way. Firstly, the bank saw a year-on-year increase in revenues for each of its operating divisions, with all of them (except for the global transaction business) also seeing an improvement in pre-tax income thanks to the focused cost-cutting efforts. Secondly, the bank’s common equity tier 1 (CET1) capital ratio remains strong at 11.5%. And finally, there is tangible progress in Deutsche Bank’s efforts to shrink its non-core operating unit (NCOU) unit with total assets in this division shrinking 7% compared to the previous quarter to fall below $45 billion.
We have revised our price estimate for Deutsche Bank’s stock downwards from $43 to $41 largely to factor in the marked appreciation of the Euro with respect to the U.S. Dollar over the last three months. The new price estimate is still about 25% ahead of the current market price – something we believe is primarily due to the sell-off in the shares of European banks over recent weeks due to the weak economic outlook for the region, as well as the fact that investors remain cautious about Deutsche Bank’s legal overhang.
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Investment Banking Operations Were The Highlight
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 55% of its total value (the Sales and Trading, and Advisory and Underwriting Services divisions put together) according to our estimates. With many investment banks reducing their focus on trading operations to cope with tighter regulatory requirements, and with several of them almost completely doing away with their capital-intensive debt trading desks, Deutsche Bank’s continued push in securities trading seems to be yielding results, as it has gained ground over its competitors in each of the three quarters this year.
Investment banking operations (reported as Corporate Banking and Securities) generated a little more than €3.2 billion ($4 billion) in revenues for the third quarter – 9% higher than the figure seen in Q3 2013, but 11% lower than the €3.5 billion ($4.5 billion) figure for the previous quarter. Although the share of the debt trading desk (which normally brings in between 50-60% of the total investment banking revenues for a quarter) shrunk to 46% this time around with revenues of €1.4 billion ($1.8 billion), this was still a good 15% ahead of the debt trading revenues seen for the year-ago period.
Asset and Wealth Management Division Also Has Solid Quarter
Deutsche Bank’s asset and wealth management business reported its best performance in more than four years, with the division churning out a pre-tax income of €288 million ($367 million). This was the best operating performance for the division since it reported pre-tax profits of €325 million in Q4 2009. Revenues benefited from the fact that assets under management grew to a record €1 trillion ($1.28 trillion) thanks to net inflows, increased market levels and favorable exchange rate movements. At the same time, expenses remained under control – allowing the bank to achieve a cost-to-income ratio of 77% this quarter compared to 83% in the previous quarter and a slightly worse 78% in the year-ago period.
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- Deutsche Bank reports third quarter 2014 income before income taxes of EUR 266 million, Deutsche Bank Earnings Releases, Oct 29 2014 [↩]
- Deutsche Bank says faces around 1,000 big lawsuits, Reuters, May 22 2014 [↩]