Deutsche Bank’s reported EUR 2.2 billion loss for the fourth quarter included EUR 1.9 billion of impairments on goodwill and other intangibles and EUR 1.0 billion of litigation provisions, as well as EUR 0.7 billion of losses from the company’s new noncore operations unit. While the quarterly loss was larger than expected, investors were pleased to see many signs that Deutsche Bank’s business remains on track. Notably, revenues of EUR 7.9 billion for the quarter and EUR 33.7 billion for the full year were up 14% and 2%, respectively, and the 6% year-over-year drop in provision for loan losses (to EUR 1.1 billion) would have been even more impressive if write-backs on provisions for losses at PostBank had not flowed through the revenue line.
In other ways, however, measures of Deutsche Bank’s performance remained contradictory. For example, the bank improved its pro forma Basel III ratio an impressive 100 basis points since the third quarter to 8.0%, but its leverage ratio remained unchanged at 21 times. Similarly, variable compensation as a percentage of net revenue fell to 9% in 2012 from 11% in 2011 (and 22% in 2006), but total compensation increased to 40.1% of revenue in 2012 from 39.5% in 2011.
As a result, Deutsche Bank’s overall cost/ income ratio remains stubbornly around 80%, even excluding special charges. We continue to see a 25% chance that Deutsche Bank will need to raise capital, especially given capital demands from U.S. regulators, but we may raise the price at which we expect it to do so in light of the bank’s higher Basel III capital ratio. We expect our fair value estimate to increase marginally as we incorporate this change, which will be partially offset by the higher-than-expected one-time charges in the fourth quarter.
A full balance sheet has not yet been released, but we see little reason to expect material improvement from the third-quarter 3.0% tangible common equity ratio, as we calculate it, which is among the worst in Europe. By the bank’s own admission, nearly half of the Basel III improvement in the fourth quarter was due to modeling changes rather than any change in the underlying risks. At the same time, U.S. regulators are calling on Deutsche Bank to more fully capitalize its U.S. operations. While the outcome of these discussions is not yet known, we think European regulators would not be happy to see Deutsche Bank move a substantial amount of its capital to the United States without replenishing some of its European capital base. We think a capital raise remains a material possibility, especially if the current calm in European markets begins to dissipate.
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