Profits Plunge at Deutsche Bank

Hurt by weak performance in its Investment bank division, Deutsche Bank AG ( DB - Snapshot Report ) reported net income attributable to its shareholders for second quarter 2012 of €650 million ($798 million) or €0.68 per share, significantly down from €1.2 billion or €1.24 per share in the prior-year quarter.

Results reflect the impact of the European sovereign debt crisis on investor confidence and client activity across the bank. A weak Euro also affected its expense base.

In addition to posting discouraging results in the second quarter, Deutsche Bank also announced 1,900 layoffs for the rest of the year. This will include 1,500 job cuts in its Corporate Banking & Securities and related infrastructure areas.

As per the company, this measure will help in saving around €350 million of its overall cost saving target of €3 billion. The job cuts will mainly take place at units outside Germany. Alongside, the company is also reassessing its compensation practices.

Quarter in Detail

Deutsche Bank reported net revenue of €8.0 billion in the reported quarter, down 6% from the comparable quarter in the prior year. Deutsche Bank’s Corporate Banking and Securities (CB&S) revenues of €3.5 billion were down 11% year over year, primarily driven by lower sales and trading revenues.

Revenues at Deutsche Bank’s Private & Business Clients (PBC) segment were €2.4 billion in the reported quarter, representing a decline of 5% from the prior-year quarter. Lower revenues in Postbank as a result of the prevailing low interest rate environment and the absence of positive effects recorded in the year-ago quarter largely led to a drop in revenues at Private & Business Clients segment.

Volatility in the market and lower levels accounted for the drop in Advisory/brokerage revenues at Deutsche Bank since retail clients shied away from making investments.

Asset and Wealth Management (AWM) revenues fell 9% year over year to €891 million. Results reflect the positive impact of the realignment of Sal. Oppenheim in 2011. In addition, revenues also suffered from low asset flows in Asset Management due to negative market impact.

Yet, on the positive side, Global Transaction Banking (GTB) revenues advanced 10% year over year to €972 million in the reported quarter. Even in the midst of the low interest rate environment, the business witnessed solid business momentum.

The provision for credit losses at Deutsche Bank decreased 10% to €419 million in the reported quarter with the majority being attributable to lower provisions at Postbank. However, this was partly offset by increased provisions for credit losses at the GTB and CB&S segments.

However, Deutsche Bank’s non-interest expenses were €6.6 billion, up 5% year over year. Results reflect the impact of foreign exchange rate movements as well as higher litigation-related expenses and operational losses, IT costs and professional service fees.

Deutsche Bank’s core Tier 1 capital ratio came at 10.2% at the end of the second quarter, up from 10.0% at the end of the prior quarter. Risk-weighted assets moved up to €373 billion at the end of the reported quarter from €368 billion at the end of the prior quarter, primarily due to the foreign exchange effect, partially offset by a reduction in credit risk. Total assets increased by 7% to €2.2 trillion at the end of the second quarter as against €2.1 trillion at the end of the prior quarter.

Even with such circumstances, Deutsche Bank continues to expect its Core Tier 1 ratio including “phase-in” to be approximately 9%, equivalent to 7.2% on a fully-loaded basis at the beginning of 2013.

By the end of the first quarter of 2013, Deutsche Bank targets to achieve a Basel 3 Core Tier 1 ratio of approximately 10% on a phase-in basis, equivalent to at least 8% on a fully-loaded basis.

It will scale back its risk-weighted assets to mitigate the impact of lower earnings. Also, it will implement every capital levers it can before opting for any equity raise from investors.

Peer Performance

At one of Deutsche Bank’s rivals, UBS AG ( UBS - Analyst Report ) , increasing Eurozone concerns, stressed market conditions as well as losses associated with the glitches of the Facebook Inc. ( FB - Analyst Report ) initial public offering at the Nasdaq OMX Group Inc. ( NDAQ - Analyst Report ) led a to drop in profits. The outlook is also bleak.

UBS AG reported second quarter net profit attributable to shareholders of CHF 425 million ($434 million) or CHF 0.11 per share, down from CHF 827 million or CHF 0.22 per share in the prior quarter. Earnings also fell short of CHF 1.0 billion or CHF 0.26 per share reported in the prior-year quarter.

The quarter’s results at UBS AG were impacted by a decrease in trading revenues as well as a decline in net fee and commission income. Operating expenses were also higher in the quarter.

Our Take

Deutsche Bank has adopted several strategic initiatives, including the repositioning of its core business and bolstering of its capital levels. While such initiatives augur well, costs associated with such efforts cannot be denied.

Hurt by the Euro zone debt crisis, Deutsche Bank experienced trading revenue declines in the past. Apart from a drop in revenues in the second quarter, the weak euro has added to its woes.

As a matter of fact, Deutsche Bank is also facing scrutiny for its alleged participation in interest rate manipulation, including Libor. Given the stressed operating environment, we believe that any significant improvement in its earnings in the upcoming quarters would remain elusive.