Fixed-Income Rebound Tests Deutsche Bank’s Pledge to Retreat

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Deutsche Bank AG and Barclays Plc’s rebound in fixed-income revenue during the second quarter will test their leaders’ pledges to scale back in that business.

Europe’s largest investment bank posted a 16 percent increase in revenue from trading debt and currencies, surpassing analyst estimates. Barclays said income from its rates and currency businesses jumped 10 percent as the political turmoil in Greece boosted volatility. BNP Paribas SA, France’s largest bank, said Friday that fixed-income sales rose 4 percent driven by currencies and commodities.

The lenders, powerhouses of Europe’s fixed-income market, have sought to cut back operations in that area as rules introduced in the wake of the financial crisis make it less lucrative and force them to bolster capital. The two firms, which replaced their chief executive officers in recent weeks, are under shareholder pressure to revive profitability.

“One quarter of positive trading growth has created more problems than it’s solved for these banks,” said Chirantan Barua, a banking analyst at Sanford C. Bernstein in London. “Management are now starting to doubt themselves and think we need to retain these desks and give our traders more capital as markets might just come back.”

Even so, Deutsche Bank Chief Financial Officer Marcus Schenck said Thursday its investment banking and trading unit will probably see revenue decline in the second half. Likewise, Barclays Finance Director Tushar Morzaria said he expects the second half at the securities unit will be weaker and less profitable than the first.

Market Trough

U.S. competitors are already predicting a turnaround. Daniel Pinto, JPMorgan Chase & Co.’s corporate and investment bank chief said in an interview with Financial News published this week that the fixed-income market is near the bottom and it would be a “really bad idea” to start cutting back to revive profit.

At Deutsche Bank, “I assumed we’d see lower debt trading revenue, which would make the whole strategy debate go down easier,” according to Stefan Bongardt, an analyst at Independent Research GmbH in Frankfurt. “It would be easier to take capital out. Capital will always be the problem.”

That’s exactly what Barclays has done: It’s cutting about 7,000 jobs at the investment bank, run by Tom King, and set up a unit to prepare assets such as complex derivatives for sale.

Deutsche Bank’s co-Chief Executive Officer John Cryan is under pressure to follow. He replaced Anshu Jain this month after investors pushed for more radical cuts. The company shrunk its leverage assets by 5.7 percent to 1.46 trillion euros ($1.6 trillion) in the three months through June, the largest share of which came from cuts at the investment bank, its filings show.

Capital Boost

“Upcoming regulation like the fundamental review of the trading book is really going to hit their structured products and credit business, so they have been cutting there in advance,” said Alevizos Alevizakos, an analyst at Keefe, Bruyette & Woods who rates Deutsche Bank an underperform. “They really need to get their fixed income business to a state where it doesn’t consume much capital, like UBS.”

Switzerland’s UBS Group AG has shrunk its fixed-income business since 2012 to focus on managing money for the wealthy. Since then, its shares have outperformed both London-based Barclays and Deutsche Bank of Frankfurt. UBS is up 69 percent in the period, Barclays is up 34 percent, while Deutsche Bank is unchanged.

The Swiss bank’s 14.4 percent capital ratio at the end of June is also the highest of global investment banks, according to data compiled by Bloomberg. Of the 12 banks that have reported second-quarter earnings, Deutsche Bank was tied for fourth place with an 11.4 percent ratio while Barclays came in fifth with 11.1 percent, the data show.

Still, those ratios will come under pressure. Deutsche Bank said it will deduct as much as 1.5 billion euros from its capital ratio in the second half to comply with standards that call for more prudent valuation of trading book assets.

Morzaria told analysts that he expects Barclays to face “headwinds” related to the bank’s risk-weighted assets, which are used to determine its capital ratio, in the second half, and cautioned the measure will probably stay at about the same level through the year.

Barclays and Deutsche Bank sought this week to play down concern they need to raise capital. Barclays said it has no plans to ask investors for more while Cryan said tapping shareholders wouldn’t solve the bank’s core problem: low returns and poor capital generation.

“This isn’t a question of leaving the party when it starts to go strong, this is a crowded room with not enough drinks for the guests,” said Alevizakos. “Deutsche Bank used to have the ability to be one of the last banks toughing it out in fixed income, but their capital levels are just too fragile.”