FICC Helps Deutsche Bank's 1Q17, Profit Growth Still Challenging
(The following statement was released by the rating agency) LONDON, April 28 (Fitch) Deutsche Bank's results in the first three months of the year improved from a poor first quarter of 2016 but its pre-tax return on equity (RoE) of only 7.3%, excluding debit valuation adjustments (DVAs), and reported return on tangible equity (RoTE) of 4.5% highlight challenges ahead to reach longer-term profitability targets, Fitch Ratings says. The bank has seen returning client net invested assets across most regions after several quarters of outflows, led by US and EMEA, and positive underlying developments in most of its businesses, but these have yet to translate into notable revenue improvement. Sales and trading fared well, underpinned by strong markets, especially in primary debt issuance and fixed-income, currency and commodity (FICC) trading, which are Deutsche Bank's traditional strengths, but these revenues are notoriously volatile, with performance usually stronger at the start of the year. The Corporate and Investment Bank, Private, Wealth and Commercial Clients (PWCC) and Asset Management divisions' returns met the group's overall long-term return on RoTE target of 10% in 1Q17 (the latter's RoTE significantly boosted under this measure given substantial goodwill and intangibles in its equity base). However, further profitability improvement is needed from the Global Markets division, which houses capital intensive sales and trading businesses, and generates about a third of group revenue, Postbank and PWCC's low-risk/low-return German retail banking business. Unlike some of its peers, Deutsche Bank allocates almost all of its capital to the operating divisions, which can distort profitability comparisons; only 4% of tangible equity is allocated to the Consolidation and Adjustments segment. Global Markets' net revenue improved 8% and pre-tax profit more than doubled from a weak first quarter of 2016, excluding debit valuation adjustments. The division benefited from a good operating environment for debt sales and trading, particularly in the first two months, when rates, credit and business sourced in APAC recovered, while foreign-currency trading suffered from low volatility. Equities gained from an improved US issuance market, but the division is still suffering from 4Q16's lost prime finance clients and increased funding costs. The Global Markets division's EUR219 million pre-tax debit valuation adjustment loss in 1Q17 included EUR136 million caused by a recalibration of the valuation of derivative liabilities, to incorporate the improved credit standing of derivative counterparties following the introduction of the German Resolution Mechanism Act in January 2017. Fitch routinely excludes gains and losses relating to banks' own credit standing from earnings assessments. In the Corporate and Investment Bank, flat revenues balanced an improvement in Corporate Finance against weaker Global Transaction Banking performance. Origination revenues benefited from buoyant debt markets, where leveraged finance and high-yield volumes surged in anticipation of a US rate hikes, and recovering equity origination from a weak prior quarter. Management said the substantial decline in transaction banking revenues was caused by Deutsche Bank's strategy to reduce its client, products and country presence, but the division remains of key importance to the bank's strategy and an area of growth. According to Coalition league tables published in April 2017, Deutsche Bank ranked fifth in transaction banking worldwide and within the top three in EMEA. In PWCC, underlying revenues were stable, although the division is sensitive to low interest rates. The division had EUR3 billion inflows of net invested assets resulting from marketing campaigns and returning clients. At Postbank, volume growth helped offset margin pressure, but results were burdened by a negative hedging effect. The Asset Management division's revenues increased, excluding the impact of policyholder positions in Abbey Life and one-off gains in 1Q16, reflecting higher management fees and net asset inflows across several products and geographies, after six quarters of outflows. Cost reductions remain in focus given Deutsche Bank's still high 84% cost/income ratio. Adjusted costs declined 4% yoy at constant currency rates, driven by lower costs relating to the former non-core unit, consulting and professional service fees. Compensation costs declined only marginally despite headcount being down 3% yoy. The cost benefit of branch closures will continue to come through in the coming quarters, but management has indicated that it intends to return to more normal variable compensation levels after having used this as a lever to cut expenses in 2016. Realising synergies and further cost reductions are paramount for the combined Postbank and PWCC division to reach its targeted RoTE, according to management. The group completed a EUR8 billion rights issue in April, which increased its pro-forma fully loaded common equity Tier 1 (CET1) ratio to a solid 14.1% at end-1Q17. Risk-weighted assets (RWAs) were stable from the year end, balancing some increases from higher business volumes against targeted reductions. Management has guided towards RWA growth from increasing business activity in 2017, which should be adequately absorbed by the increased capital. However, litigation and restructuring are expected to continue to dampen 2017 results and, in light of these risks, the bank has guided towards a CET1 floor of 13% in 2017. Deutsche Bank targets a fully loaded CRD IV leverage ratio of 4.5% in the medium term, but management has indicated that business growth opportunities may lead to a decline from the pro-forma 4% at end-1Q17. Deutsche Bank's liquidity position is comfortable as reflected by its large EUR242 billion reserve, consisting 74% of cash and cash equivalents, and a liquidity coverage ratio of 148%. The bank raised EUR8.5 billion of its planned EUR25 billion wholesale funding for the year in 1Q17, but funding costs, as reflected by an average spread of 113bp above Euribor for an average tenor of 5.4 years, remain elevated. About half of the bank's funding (excluding derivatives and settlement balances) consists of retail and transaction banking funding, which are mainly deposits. Contact: Bridget Gandy Managing Director +44 20 3530 1095 Fitch Ratings Limited 30 North Colonnade London E14 5GN Ioana Sima Associate Director +44 20 3530 1736 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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