Deutsche Bank Q1 Results: PBT In Line, Weak CET1, More Litigation In 2016

| About: Deutsche Bank (DB)

Summary

Deutsche Bank has reported 1Q16 results.

Although earnings were better than expected, the results once again highlighted that DB remains under pressure from significant structural issues.

Taking into account a structural RoE, DB looks cheap. Having said that, the stock will not rerate before the key structural challenges have been addressed.

Deutsche Bank (NYSE:DB) has reported 1Q16 results on Thursday. Although earnings were better than expected, thanks to Postbank and the non-core, the results once again highlighted that DB remains under pressure from significant structural issues.

Our takeaways were as follows:

1) Underlying PBT beat consensus expectations by 37%, thanks to a) improved asset quality at Postbank - the unit posted a 27% y/y decrease in provisions for credit losses, b) better than expected results from the NCOU (non-core operations unit). On an adjusted basis, DB's PBT was 16% below consensus estimates.

Although it is always good to see decent asset quality trends, Postbank is a non-core business for Deutsche Bank - the deconsolidation of Postbank is an important part of the bank's strategy and a key element of DB's plans to reduce RWAs/boost capital adequacy ratios. Hence, DB's results should be adjusted for NCOU/Postbank's results - on an adjusted basis, DB's PBT was 16% below consensus estimates.

2) Global Markets, CIB, AM results were in line with expectations. PWCC was weaker than expected.

3) Non-interest expenses were down 17% y/y. The decline was driven predominantly by a reduction of EUR1.4bn in litigation expenses.

At last, litigation charges have somewhat stabilized. However, during the conference call, DB's CFO guided that litigation costs might be "material" in the rest of this year after they were very low in 1Q16. To recap, Deutsche Bank still needs to settle the US RMBS and Russian sanctions cases: the biggest uncertainties for Deutsche Bank here are the timing and the level of claims. The current market expectations would be for settlements around $1-2bn for the Russian sanctions case and $2-3bn for the US RMBS case. If those estimates are accurate, then they are affordable from existing litigation reserves (circa EUR6bn). Should total litigation claims exceed these numbers, capital fears would hit DB hard.

4) Basel 3 CET1 capital ratio declined by 40bps from 11.1% in 4Q15 to 10.7% in 1Q16. This reflected a decrease in CET1 capital of EUR1.3bn and a slight increase in RWA.

This was the key negative from the results. CET1 capital down €1.3bn q/q of which EUR0.6bn from FX effect and EUR0.3bn from equity compensation related share buybacks and hedge premia. Although DBK indicated that Hua Xia Bank's sale is expected to close in 2Q16 and is expected to increase CET1 ratio by c.50 bps, the current Basel 3 CET1 of 10.7% looks weak.

To recap, capital adequacy remains a key concern for DB due to the following factors:

  • DB faces significant RWA inflation risks due to new rules for the calculation of minimum capital requirements in banks' trading books (FRTB).
  • The bigger concern for DB's investors must be its weak Basel 3 leverage ratio, which have further decreased in 1Q16 to 3.4% from 3.5%.
  • Higher litigation/restructuring charges could also trigger a capital raising.
  • If the Postbank disposal were completed at a multiple significantly below BV, DB could also face a capital deficit.
  • Finally, a delay in Postbank deconsolidation would also have a negative impact on DB's capital position.

In our previous article that generated much interest with SA readers, we made a scenario analysis of the impact of possible capital raising on DB's financial metrics. According to the calculations, a EUR20bn capital increase at a 60% discount to the current share price would result in a 70% EPS dilution and a forward P/B of 0.96x.

Bottom line

The results are much less worse than feared and DB stock should get a lift from them. The current market valuation suggests to us that the market has already priced in a capital increase, and if the management avoids raising a capital, the stock should offer a decent upside. Having said that, I think DB will not revalue before the following 4 main challenges have been addressed: 1) capital adequacy, 2) litigation, 3) cost-cutting measures, and 4) Postbank deconsolidation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.