July 29 (Bloomberg) -- UBS AG and Deutsche Bank AG’s better-than-estimated second-quarter earnings were overshadowed by the disclosure of new regulatory probes as the banks struggle to boost revenue.
UBS fell 0.8 percent by 2:17 p.m. in Zurich trading, posting the fifth-biggest decline of the 43 companies in the Bloomberg Europe Banks and Financial Services Index, while Deutsche Bank rose 0.5 percent in Frankfurt after slumping as much as 1.6 percent.
While Deutsche Bank and UBS posted “clean” pretax profits ahead of estimates, “the focus remains on capital at risk from litigation,” said Kian Abouhossein and Amit Ranjan, analysts at JPMorgan Chase & Co., in a note today. “The only way to reassure investors is showing strong capital progression.”
UBS, which settled a German tax investigation for about 302 million euros ($406 million) this month, said today the U.S. Securities and Exchange Commission has been investigating its dark pool private-trading venue since early 2012. Deutsche Bank, whose legal costs totaled 3 billion euros last year, said it’s responding to requests for information from regulators about high-frequency trading.
“Everybody’s waiting for some kind of a stop in the regulatory onslaught,” said Arun Melmane, an analyst at Canaccord Genuity Corp. in London who recommends investors hold Deutsche Bank shares and buy UBS. “There’s a bit more in terms of fines to come. The tail will probably be nine months off.”
UBS and Deutsche Bank, the largest lenders in Switzerland and Germany, respectively, are not alone in grappling with spiraling regulatory investigations into areas ranging from the sale of mortgage-backed securities before the subprime crisis to alleged manipulation of benchmark interest rates, currencies and precious metals.
European banks may still face $50 billion in litigation costs after already paying fines and setting aside funds worth $82.3 billion, Morgan Stanley analysts estimated last week. They predicted the highest costs still to come, more than $11 billion each, for Barclays Plc and Royal Bank of Scotland Group Plc, and estimated additional litigation charges of $5.3 billion for Deutsche Bank and $2 billion for UBS. They forecast $19.7 billion in litigation costs for major U.S. banks after they incurred $131.6 billion.
“Litigation concerns overhang wholesale banks,” the analysts, led by London-based Huw van Steenis, said in the note. “We think European banks are only about 60 percent of the way through settling litigation in our base case. We think this holds back dividends and drives more deleveraging.”
UBS’s dark pool was the second-biggest by U.S. shares traded in the week starting July 7, behind Credit Suisse Group AG, according to data published by the Financial Industry Regulatory Authority yesterday. Deutsche Bank’s alternative trading system ranked fifth-biggest in the week, with Barclays paring some losses following a lawsuit by New York for allegedly lying to customers of its private exchange.
The British bank is fighting allegations it masked the role of high-frequency traders as it sought to boost revenue at what used to be Wall Street’s second-largest dark pool.
Legal costs have been hampering Deutsche Bank’s efforts to build capital and increase returns for investors. The Frankfurt-based lender last month raised 8.5 billion euros by selling shares to boost its capital ratios enough to allow expansion in fixed-income trading, which surprised analysts with better revenues than at U.S. competitors in the second quarter.
Some 40 percent of the capital the bank raised may be used for paying for litigation, Amit Goel, a London-based analyst at Credit Suisse, estimated. Moody’s Investors Service today downgraded Deutsche Bank’s long-term debt rating, citing “modest” profitability that’s “being dragged down by litigation and restructuring costs and legacy losses.” The firm’s short-term rating was also lowered.
Reserves for litigation expenses rose 450 million euros from the first quarter to 2.2 billion euros. The German bank said litigation costs for the rest of the year were “unpredictable.”
Deutsche Bank’s profit before tax rose 16 percent to 917 million euros in the second quarter from a year earlier, compared with an estimate of 702 million euros.
The “results demonstrate the resilience of the investment-bank franchise as well as continued cost control, although litigation and regulatory issues continue to take the ‘shine’ away,” Citigroup Inc. analysts including Kinner Lakhani said in an e-mailed report from London today. They recommend investors buy the shares.
UBS posted a 15 percent increase in net income in the second quarter to 792 million Swiss francs ($876 million) as it cut costs and reduced the loss from assets earmarked for sale. It made 441 million francs in fresh legal provisions in the quarter, bringing the total to 1.98 billion francs.
Under Chief Executive Officer Sergio Ermotti, who took over in September 2011, UBS has paid about $3.6 billion in fines. Ermotti said he sees inflation in regulatory costs.
The Swiss bank last week faced a demand for a 1.1 billion-euro security deposit to cover a possible fine for laundering the proceeds of tax evasion in France. The bank is appealing the demand, which Ermotti said “makes no sense,” given that it’s a multiple of the settlement in Germany, where UBS has a “much bigger business.” The bank had previously been in “advanced” talks with French authorities over a “double-digit million settlement,” Ermotti said in a Bloomberg Television interview today.
Dirk Becker, a Frankfurt-based analyst at Kepler Cheuvreux, said UBS got off relatively easy in the German investigation.
“In France it will be less easy,” Becker said. “Then we also have dark pools and the foreign exchange investigation -- quite a lot is still to come.”
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