Investors Overlook Deutsche Bank’s Massive Q3 Loss To Focus On Reorganization Plan

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Deutsche Bank

Deutsche Bank (NYSE:DB) saw its shares drop nearly 8% over trading on Thursday, October 29, as investors expressed their displeasure towards several aspects of the long-term reorganization plan detailed by the bank that day. [1] The German banking giant revealed its new financial targets under the ‘Strategy 2020’ plan on the heels of an unprecedented quarterly loss figure. [2] Notably, the impact of the latter on the share price would have been negligible, given that Deutsche Bank prepared investors for a huge Q3 loss due to €7.6 billion ($8.3 billion) in one-time charges nearly a month ago. [3] In fact, adjusting Deutsche Bank’s results for these impairments shows that the bank actually performed quite well operationally – especially its trading unit, which reported a year-on-year improvement in revenues during a largely weak quarter.

Building on the blueprint for Strategy 2020 provided in April (see A Detailed Look At Deutsche Bank’s New Reorganization Plan ‘Strategy 2020’), Deutsche Bank announced that its ongoing shake-up will result in a reduction of total headcount by nearly 35,000 over the next two years. 20,000 of these jobs will be eliminated as the bank spins off Postbank and exits low-profit operations in at least 10 countries categorized under the non-core division. [4] The bank will also shrink its risk-weighted assets by roughly 20% by 2018 in its bid to improve its common equity tier 1 (CET1) ratio to 12.5% from 11.5% now.

The single biggest problem with Deutsche Bank’s plan from an investor’s perspective is its decision to eliminate dividends for 2015 and 2016. Additionally, the bank has yet to clear a bulk of its legacy legal backlog – something that will continue to weigh on its operating performance over the coming years. While we believe that Strategy 2020 will ensure long-term sustainability of profits across Deutsche Bank’s operations, we have reduced our price estimate for its stock from $38 to $33 primarily due to its new dividend policy. The new target is roughly 20% ahead of the current market price.

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FICC Trading Desk Outshines Competition, Equities Trading Took A Hit

The importance of Deutsche Bank’s investment banking division to its business model is demonstrated by the chart above, which shows that the business accounts for 54% of its total value (sales and trading, and advisory and underwriting services put together) according to our estimates. Revenues for the bank’s Corporate Banking and Securities business unit were €3.2 billion ($3.5 billion) for the quarter – 26% below the figure for the previous quarter but marginally higher than that for the year-ago period.

Notably, Deutsche Bank’s trading desks churned out €2.3 billion ($2.5 billion) in revenues this time around – a 7% improvement compared to the performance a year ago. This is in sharp contrast to the year-on-year decline in trading revenues reported by each of the five largest U.S. banks. Deutsche Bank’s FICC (fixed-income, currencies and commodities) trading operations did extremely well to generate €1.7 billion ($1.9 billion) in revenues this quarter – down from €2.1 billion in the previous quarter, but a good 20% higher than the €1.4 billion figure for Q3 2014.

The high volatility in global equity markets stung the bank’s equities trading desk, though, which reported quarterly revenues of under €600 million for the first time in nearly three years. These revenues fell 19% year-on-year, and a steep 40% quarter-on-quarter. Market conditions also visible weighed on the bank’s equity origination fees, which fell to the lowest level since Q4 2011. Debt origination fees also shrank from the all-time high figure of €456 million in the previous quarter to €378 million. Fortunately, the impact of this on the top line was mitigated to an extent by an exceptionally strong M&A advisory performance.

Global Transaction Services Continues To Drive Profits

Deutsche Bank’s transaction services business, which includes the banking giant’s trade finance, securities services and cash management offerings, is expected to largely remain unchanged over coming years even as Deutsche Bank shakes up its business model. The reason for this is evidently the division’s ability to churn out steady profits without locking up a large amount of capital. The division is also Deutsche Bank’s most important source of value after its trading desks – contributing almost 20% of its total share value, according to our estimates.

A strong U.S. dollar and lower operating costs helped the division report a pre-tax income of €402 million in Q3 2015 – only marginally lower than the record figure of €408 million for the first quarter of this year. An increase in trade finance revenues resulted in total revenues for the division reaching an all-time high of €1.16 billion ($1.3 billion) for the quarter.

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Notes:
  1. A Message from John Cryan on Strategy 2020 to employees, Oct 29 2015 []
  2. Deutsche Bank reports third quarter 2015 net loss of EUR 6.0 billion after specific items, Deutsche Bank Press Releases, Oct 29 2015 []
  3. Deutsche Bank announces anticipated Charges impacting third Quarter 2015 Results, Deutsche Bank Press Releases, Oct 29 2015 []
  4. Deutsche Bank to Shrink Workforce by 35,000 in Broad Revamp, The Wall Street Journal, Oct 29 2015 []