Deutsche Bank’s Key Capital and Cost Challenges in Four Charts

Deutsche Bank AG shares almost doubled from a record low in September and Chief Executive Officer John Cryan last week spoke of “green shoots” of recovery, giving the bank’s long-suffering investors something to cheer.

But that doesn’t mean all of the German lender’s troubles are behind it.

Misconduct costs, the highest among European banks, have wiped out years worth of profit and made it tougher to meet future regulatory capital thresholds. Cryan wants to avoid tapping shareholders and is selling assets and shrinking capital-intensive bond-trading businesses instead. The problem is, the banking assets aren’t fetching as much as Deutsche Bank would like and bond traders generate the largest share of its revenue.

“There’s a lot of euphoria in bank stocks at the moment, but Deutsche Bank still faces challenges,” said Philipp Haessler, an analyst at Equinet Bank AG who has a neutral stance on the stock. “They should be able avoid a share sale if their litigation bills aren’t too high, but they need to be making money to do so. We’ll see in coming quarters if they can.”

The Frankfurt-based lender will probably report a fourth-quarter net loss of 1.35 billion euros ($1.44 billion) on Thursday, based on the estimates of 11 analysts surveyed by Bloomberg News. That’s after setting aside 1.3 billion euros in legal provisions and taking an 800 million-euro charge tied to the sale of its Abbey Life unit. Deutsche Bank probably benefited from a pickup in revenue from fixed-income trading, but not as much as U.S. rivals, the estimates show.

Russia Settlement

The bank took steps this week toward clearing another legal hurdle when it agreed to pay a total of about $629 million to authorities in the U.S. and U.K. to settle investigations into money laundering involving its Moscow, London and New York offices. “The settlement amounts are already materially reflected in existing litigation reserves,” Deutsche Bank said in a statement on Tuesday in Frankfurt. The bank said it’s “making progress” in resolving other probes into the matter.

The four charts below illustrate some of the bank’s challenges.

Following their rebound, Deutsche Bank shares are currently about 22 percent above the level at which analysts expect them to trade in a year’s time. That’s led some to speculate investors are getting ahead of themselves. “We see the stock as overvalued,” Citigroup Inc. analysts, including Andrew Coombs in London, wrote in a Jan. 26 report. “Given Deutsche Bank’s poor returns, and therefore a limited ability to generate capital organically, we believe that a rights issue is inevitable.”

The bank’s capital has been “burdened by material litigation expenses” in recent years, which will probably continue in 2017, according to Commerzbank AG analyst Michael Dunst. Still, the sale of a 20 percent stake in a Chinese lender added about half a percentage point to its common equity Tier 1 ratio in the fourth quarter, and Deutsche Bank is looking to sell additional assets. It put an initial public offering of German consumer lender Deutsche Postbank AG on hold last year to wait for a more “attractive” price. Deutsche Bank is also weighing a sale of a stake in its asset management unit through an IPO, according to people familiar with the matter.

Deutsche Bank probably underperformed U.S. competitors for a fifth straight quarter in fixed-income trading, according to the average of analysts’ estimates. Cryan has said he’s willing to sacrifice some revenue as he improves the firm’s internal controls and scales back debt-trading operations that require increasing amounts of capital. “Going all in, increasing market share would be desirable for Deutsche Bank,” says Piers Brown, a Macquarie Group Ltd. analyst. “But they don’t have the capital.”

With scant revenue growth in recent years, Cryan has set out plans to reduce net costs by as much as 1.5 billion euros by 2018 to improve profitability, partly through 9,000 job cuts. Deutsche Bank may show some progress in the quarter, as analysts surveyed by Bloomberg see little change in its legal costs from a year earlier and a decline in severance and overhaul charges. While the bank’s expenses may fall further this year, the lender will probably narrowly miss its goal of reducing adjusted costs to less than 22 billion euros in 2018, according to the average of 17 analyst estimates compiled by Deutsche Bank.

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