Fitch: Deutsche Bank's 3Q Results Highlight Need To Execute on Cost Reduction
Fitch views positively that the new co-CEO has accelerated reaching clear financial targets by 2018 ahead of further 2020 targets. In particular, efficiency improvements, intended to bring down Deutsche Bank's adjusted costs to below EUR22bn in 2018 and cost efficiency to 70%, would bring the bank more in line with its global trading and universal bank (GTUB) peers. However, the Negative Outlook on DB's Long-term IDR reflects our view that implementation of the revised strategy entails considerable execution risks, not least because DB has a mixed track record of executing its stated financial targets.
Yesterday's strategy communication made clear that new management is not planning a major change in strategic direction, but it did add more transparency around plans to implement the 2020 strategy, including a specific focus on costs and business simplification where possible. There will be some further trimming of businesses in countries and products that fall outside the bank's focus, including those fixed income businesses that will not be able to return their cost of capital given increased regulatory capital that will be needed when the fundamental review of the trading book is implemented in a few years' time.
Adjusting Deutsche Bank's reported loss before taxes of EUR6.1bn for costs-to-achieve, funding valuation, debt and credit valuation adjustments and 'stripping out' goodwill and intangible impairment write-downs and litigation costs in this quarter and in the third quarters of previous years, the EUR 1.7bn for 3Q15 was DB's best 3Q in three years, amid challenging market conditions for peers. However, the main driver of this improvement is a reduced loss at Deutsche Bank's non-core operations unit (NCOU). Excluding the NCOU results, Deutsche bank's core bank adjusted pre-tax profits decreased by 10% compared with 3Q14. On a positive note, adjusted pre-tax profits for the 9M15 are still up by 12% compared with the same period of 2014.
Deutsche Bank reported 3Q pre-tax loss of EUR6.1bn and a net loss of EUR6bn, mainly because of impairments of goodwill and certain intangibles in corporate banking & securities (CB&S) and private & business clients (PBC) of approximately EUR5.8bn. In addition, it includes an impairment of the carrying value of DB's stake in the Chinese Hua Xia Bank Co. Ltd. of around EUR0.6bn as well as litigation provisions of approximately EUR1.2 bn.
Deutsche Bank's adjusted 3Q15 pre-tax income of EUR1.7bn was down 32% from 2Q15 but up by 15% from the same quarter last year (3Q is seasonally weaker than 2Q in investment banking). CB&S, Deutsche Bank's largest segment, reported solid revenues (EUR3,172m), 2% higher y-o-y, including benefits from favourable foreign currency (FX) movements, and although revenues are 26% below 2Q15 the results compare well with most GTUB peers.
Revenue in the bank's fixed income sales and trading franchise (EUR1,725m) were 18% lower q-o-q but 20% higher y-o-y, demonstrating Deutsche Bank's strong global franchise, but also some benefits of reporting in a weakened currency. Within fixed income, revenue from the bank's rates business, its credit and emerging market debt franchises were markedly higher. While debt origination revenues held up well (up 5% y-o-y), higher volatility in equity markets negatively affected equities origination revenues (down 56% y-o-y). Cash equities and equity derivatives were weaker in 3Q15, contributing to a 19% y-o-y revenue fall in equities trading. Operating expenses in CB&S were 112% higher y-o-y , largely due to the litigation expenses of around EUR1bn. Adjusted pre-tax income in CB&S, excluding litigation charges, impairments and severance payments, fell by 59% y-o-y to EUR515m and accounted for an unusually low 27% of Deutsche Bank's core pre-tax profit (i.e. excluding NCOU and corporate centre).
Adjusted pre-tax profit in Deutsche Bank's PBC segment (including Postbank) was 63% higher y-o-y (34% higher q-o-q) at EUR701m or 36% of core pre-tax profit in 3Q15, excluding among others EUR4.3bn of severance payments, impairments of goodwill and intangibles. With revenue stagnant y-o-y at EUR2,385m, excluding the impairment of Deutsche Bank's share in Hua Xia Bank as well as the one-off dividend from a subsidiary, improvement was driven partly by lower impairment charges but mainly by lower costs, including the non-recurrence of rebate charges for loan processing fees.
Revenue in Deutsche Bank's global transaction banking segment improved and adjusted pre-tax profit (EUR416m; 22% of core pre-tax profit) was helped by good business momentum across all regions.
DeAWM (adjusted pre-tax profit of EUR302m or 15.6% of core pre-tax profit) showed weaker performance in 3Q15, down q-o-q by 36.7% as well as y-o-y by 15.4%. However, excluding mark-to-market movements on policyholder positions at Abbey Life in 3Q15 and 3Q14, the y-o-y pre-tax profits would be up by 26%. For 9M15, the segment's pre-tax profit is up by 48% vs the last year (24.5% on an adjusted basis) and can still report net new asset inflows, although in 3Q15 at the lowest level for the last eight quarters.
Within NCOU, Deutsche Bank made solid progress in further reducing balance sheet exposures (down 25% y-o-y) and RWA, EUR 2.5 bn lower than 2Q15 and 31% down from 3Q14. This was achieved without incurring excessive exit costs, and the adjusted pre-tax loss for the quarter (which notably excludes EUR143m in litigation charges) was down to minus EUR74m. At a reported level NCOU's loss of EUR278m is also significantly lower than in 2Q15, EUR909m and compared with 3Q14's EUR1058m.
Importantly, Deutsche Bank reported a fully-loaded CRR/CRD4 Common Equity Tier 1 ratio (CET1) as at end-September of approximately 11.5%, which includes the first-time impact of the European Banking Authority's Regulatory Technical Standards (prudential valuation) that were adopted in the quarter, somewhat later than at peers in other countries. This is 10 basis points higher than at end-1H15, an improvement which was helped by the reversal of past dividend accruals. Fitch views positively that Deutsche Bank increased its target for CET1 to at least 12.5%. The leverage ratio remained stable at its end-1H15 fully-loaded CRDIV level of 3.6%, but management has committed to reaching 4.5% by 2018 on its road to its 5% minimum target for 2020.
Litigation costs were high again in 3Q and are a rating focus. It is difficult to predict when incremental charges will stop mounting, given that certain major settlements are still outstanding and the general level of regulatory fines continues to increase. However, capitalisation is supported by management's plans to forgo dividends for 2015 and 2016.
Fitch expects Deutsche Bank to remain current on coupon payments on its additional Tier 1 securities (AT1), despite its expected annual loss for 2015 and management's announcement that dividends will not be paid on common equity in 2015 and 2016. Fitch views non-payment on discretionary AT1 instruments as non-performance and ratings on the instruments would be downgraded accordingly if a coupon is missed.