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 Germany's flagship lender is holding its ground against U.S. leaders
such as JP Morgan and Goldman Sachs in revenues, but its returns are
trailing because it was not as quick to restructure and recapitalise
in the wake of the financial crisis.
European rivals such as UBS <UBSN.VX> and Barclays <BARC.L> have
seen their revenues fall as they have shrunk their bond trading
desks, but their returns are in better shape.
Deutsche bets that its strategy, which is to vacuum up activities
abandoned by retreating European competitors, will pay off when bond
trading rebounds.
With interest rates set to remain at record lows for some time in
Europe and a risk that litigation costs and regulatory scrutiny
could eat up capital, it could be a long wait.
Investors are frustrated. They have seen returns diluted by a $12
billion rights issue this year as Deutsche restocked its balance
sheet ahead of European stress tests.
Deutsche's return on equity of less than 3 percent in the first nine
months of this year was far below the 12 percent it aims to reach in
2016 and a far cry from the 20 percent returns enjoyed before the
crisis.
All banks are aiming for double digit returns given that the
industry's cost of equity is around 10-12 percent.
Deutsche Bank has said it is sticking with the 2016 goal. Privately,
some investors say that looks unachievable, but since its shares are
already among the cheapest in Europe, they say it makes more sense
to wait and see than to turn their backs now.
"You just have to hang in there," said one top 10 investor.
CAPITAL QUESTION
Even with this year's rights issue, there are question marks over
whether Deutsche will have enough capital to grow the investment
banking business given potential litigation costs and new rules
which make it far more expensive to trade.
The bank's leverage ratio, or stock of capital to total assets, is
3.3 percent, close to the 3 percent minimum required globally,
although it aims to increase that to 3.5 percent by the end of 2015.
A review by global regulators of trading books could yet require
more capital, while ongoing investigations, including into alleged
interest rate and forex pricing irregularities, could result in
billions of euros in new penalties, despite Deutsche Bank already
spending over six billion euros on fines and settlements since 2012.
A spokesman for Deutsche, which passed this year's European stress
tests even before its rights issue was taken into account, said the
bank had enough capital to fund its investment banking plans, citing
its core capital ratio of 11.5 percent, which compares to 10.2
percent for Britain's Barclays. But European players who have
abandoned their attempts to be full-service investment banks, such
as Barclays and Switzerland's UBS, are reaping earlier rewards.
Switzerland's largest bank, which has largely exited bond trading,
reported a return on equity of around 7 percent in the first nine
months of the year.
UBS and other banks that have tempered their global investment
banking ambitions now rely less on trading and more on other
businesses such as private banking and retail business for their
earnings.
At Deutsche Bank, investment banking accounted for around half of
its adjusted pretax profits in the first nine months of the year,
which the bank said gave it a balanced portfolio.
Andrea Williams, a fund manager with Royal London Asset Management,
said she preferred UBS and Credit Suisse.
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"The reason I am differentiating them over Deutsche is because of
the wealth management and private banking side, which Deutsche does
not really have," said Williams. "Deutsche still has a lot of
litigation issues and it still needs capital."
REDEPLOYING RESOURCES
Washington's swift recapitalisation of its banks in the heat of the
crisis gave U.S. banks a head start in getting their balance sheets
ready for a world of tighter regulation.
JP Morgan is one of the few banks that now earns more now than it
did before the crisis and it comfortably leads the revenue rankings,
coming top of the Thomson Reuters league table for global investment
banking fees every year since 2008.
JP Morgan's return on equity was 10 percent in the first nine months
of 2014.
Deutsche has retained its No 6 Thomson Reuters ranking this year and
is tagged at No 3 for fixed income, currencies and commodities,
which generates around half its investment banking revenue,
according to data compiled by consultancy Coalition.
But Coalition predicts that the investment banking market, in terms
of revenue, will fall to $257 billion in 2014, down 4 percent from
2013 and down 27 percent from their peak in 2009.
To try and generate better returns from a smaller pie, Deutsche has
been adding staff and expanding into riskier areas.
“Our redeployment has paid off and if you look at Europe in
particular, the trend towards greater investor interest in risk
assets such as equities, financing, and high yield credits will
continue in the low interest rate environment - all areas where we
are a top provider,” Deutsche Bank’s investment bank chief Colin Fan
told Reuters.
But expanding into new areas is expensive: costs in the investment
bank rose 10 percent in the third quarter versus a year ago and the
introduction of a bonus cap for bankers in the European Union,
starting next year, is expected to raise European banks' fixed
costs.
Deutsche is cutting back activities that cost too much in capital,
including pulling out of part of the credit derivatives market this
year. It has also appointed Stefan Krause, its outgoing chief
financial officer, to a new board role focused on strategy to help
plot its future course.
With few signs of a major upswing in trading and lingering
uncertainty over litigation and regulation, more cuts are in store,
not just at Deutsche Bank but in the European investment banking
industry as a whole.
“There still needs to be more efficiency, more reshaping, more
careful capital allocation. More banks need to be more selective
about where they can compete and play to their strengths,” said Ted
Moynihan, global head of corporate banking at consultancy Oliver
Wyman. “There is room for a European at the top table.”
(Additional reporting by Steve Slater and Carolyn Cohn in London;
writing by Carmel Crimmins; editing by Philippa Fletcher)
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