Deutsche Bank’s (BBB+/Negative) 2Q18 results were affected by the bank’s restructuring, but reported pre-tax profit of EUR711 million showed reasonable revenue resilience during a quarter when the bank exited business segments no longer considered core, Fitch Ratings says. Earnings in the quarter exceeded market expectations, which had been low in light of the bank’s challenges, but performance remains weaker than at higher-rated peers.
Fitch sees challenges ahead as Deutsche Bank aims to improve profitability and turn around its business model over the next 18 months. This substantial execution risk motivated our revision of the bank’s Outlook to Negative in June 2018. Failure to achieve its 4% return on tangible equity (RoTE) target in 2019, cost targets in 2018 and 2019 or further loss of franchise in its core businesses, which we view as key risks for the bank’s restructuring efforts, would likely result in a downgrade of Deutsche Bank’s ratings.
The bank’s ability to stabilise revenue generation, despite scaling down some businesses, is an important consideration as it would demonstrate the resilience of its core franchises. Group net revenues fell 4% yoy in 2Q18, excluding the impact of own credit and of debit valuation adjustments (DVA), as revenue weakness due to business exits and continued restructuring were in part offset by a sale-related gain and non-recurrence of specific losses. A modest redeployment of freed capital resources, and an improved trading environment could prove helpful for revenue in 2H18, but the bank will also have to prove its ability to compete with peers, most of which have fewer constraints as they have completed their own restructuring projects.
Improving cost efficiency also remains an important factor for the bank’s ratings. Non-interest expenses increased by 1% yoy in 2Q18 reflecting a modest decrease in “adjusted” costs, which was offset by higher restructuring expenses, net of releases relating to litigation and conduct. Cumulative “adjusted” costs of EUR11.9 billion incurred in 1H18 represent more than half of the targeted EUR23 billion for the full year, and management is committed to further reductions in 2H18. These should be helped by efforts to prioritise IT spend, reduced staff numbers, and a more even accrual of staff benefits throughout the year than in the past.
Among the bank’s divisions, the Corporate and Investment Bank’s (CIB) profit before tax was a modest EUR475 million, and its net return on tangible equity a low 3.4%, highlighting the need for improvement to catch up with higher rated peers and to reach the bank’s profitability target. Revenues in the division declined by 5% yoy in 2Q18, excluding DVA, reflecting lower revenues from the businesses that the bank is exiting, which were partly offset by growth in origination and advisory revenue and by a gain on a business disposal in global transaction banking. The scaling down of some trading businesses led to a decline of 20% in sales and trading revenue, excluding DVA, which was mainly driven by fixed income and currencies, where the bank reduced its presence in the US rates business. Equities sales and trading revenue also declined, by 6% yoy compared with an already weak 2Q17, but the bank indicated that revenues from its prime finance business, where it has reduced volumes, had strengthened as business exits related to the least profitable customers and margins had improved.
The private and commercial bank (PCB) reported a modest EUR262 million pre-tax profits of which EUR77 million was from one-off items and exited businesses. The division’s underlying performance was stable, but 2Q18 results were burdened by costs related to the legal entity merger of the two former German retail and commercial banks completed in May. The merger marks progress towards the planned integration of these businesses, which over time should allow for improved cost efficiency (from a weak 86% for PCB in 2Q18, towards the aspired 70% by 2021 and improved returns (from 6.3% in 2Q18 towards 12% by 2021).
The Asset Management division reported weakened pre-tax profits of EUR93 million as revenues declined because of non-recurrence of bi-annual performance fees, and lower management fees driven by net outflows of assets under management. Net outflows of EUR5 billion in 2Q18 and EUR13 billion since the beginning of the year were driven by active fixed income and cash products, whereas passive products saw asset inflows.
The bank’s ratings remain underpinned by its capitalisation, which improved during the quarter, driven by deleveraging efforts. Deutsche Bank’s fully-loaded CET1 ratio increased 38bp during the quarter to 13.7% and remained above the targeted of at least 13%. The fully-loaded regulatory leverage ratio improved 28bp to 4% as leverage exposure declined by EUR114 billion from reduced business volumes, mainly in US rates and in equities. Management expects further leverage exposure reductions in equities to be redeployed for core business growth and expects the leverage ratio to remain flat for the remainder of the year.
Liquidity is prudently managed, with a liquidity coverage ratio of 147% at end-2Q18 and liquidity reserves of EUR279 billion remaining at historically high levels.
During 2Q18, Deutsche Bank was notified of its minimum requirement for own funds and eligible liabilities (MREL) by the resolution authorities, which was set at 9.14% of total liabilities and own funds (TLOF) for 2018, which at end-2Q18 amounted to EUR1,102 billion. At that date, Deutsche Bank’s available MREL amounted to EUR119 billion, equal to 10.8% of TLOF, which means that the bank exceeds the requirement by EUR18 billion.