(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
By George Hay
LONDON, July 25 (Reuters Breakingviews) - Anshu Jain and Juergen Fitschen are having a baptism of fire. Investors had been hoping the new Deutsche Bank co-chief executives (DBKGn.DE) would unveil roughly 1 billion euros of second-quarter net income when they present the group’s first results under their leadership next week. Instead, the numbers have come early and it’s not good news.
Deutsche’s net income for the period will be only 700 million euros, 42 percent below the same quarter last year. The main culprit looks to be its operating cost base, which has risen to 6.6 billion euros compared to 6.3 billion euros in the second quarter of 2011.
The expense inflation is to an extent an issue peculiar to Deutsche. A big part of the bank’s costs are booked in dollars or sterling, currencies that lately gained against the euro, in which results are reported. Deutsche’s failure to better hedge this risk is slightly embarrassing, given its market-leading position in foreign exchange.
Currency woes may have been exacerbated by revenue weakness. Investment banks in general probably saw revenue in core areas like rates, foreign exchange and credit fall by 5 percent to 10 percent quarter on quarter. Deutsche has yet to reveal how it fared, but it probably did no better.
The wider problem for Jain and Fitschen is that they can’t easily shrug off these revenue and cost challenges. Continuing macroeconomic gloom means weaker client activity in bond and equity issuance, while the ongoing euro zone mess will continue to hurt Deutsche’s reporting currency, which seems to have established a firm downward trend.
It is surprising then that Deutsche still looks behind the pack in its moves to reduce its investment banking headcount. Even allowing for an additional 1,000 jobs likely to be cut, Deutsche is being less aggressive than competitors like Credit Suisse CSGN.VX or Morgan Stanley (MS.N).
Worse, Deutsche is a capital laggard too. While the bank says its core Tier 1 ratio remains above 10 percent, on a Basel III basis it is around 7 percent, below many peers.
Jain’s strategy, like that of Bob Diamond, the recently departed Barclays boss, looks to depend on the investment banking slowdown being cyclical, not structural. That view may be difficult to sustain in the second half of 2012.
- Deutsche Bank on July 24 reported net income for the second quarter of 700 million euros, down 42 percent year on year and almost a third off consensus estimates.
- The German universal bank said it expected total net revenues of 8 billion euros for the second quarter, compared to 8.5 billion euros for the same period in 2011. Second quarter non-interest expenses were likely to rise to 6.6 billion euros, compared to 6.3 billion euros in the second quarter of 2011.
- Deutsche said that the inflated cost base was caused mainly by the weakening euro, which fell 5 percent against the U.S. dollar in the second quarter. A large proportion of the lender’s operations are in the U.S and UK, but it reports in euros.
- Deutsche did not reveal whether trading volumes in its investment bank fell in the second quarter, but revenues in rates, foreign exchange and credit are estimated to have fallen across the industry by 5 percent to 10 percent quarter on quarter, according to Morgan Stanley research.
- The bank also revealed that its Core Tier 1 ratio was 10.2 percent at the end of the second quarter, or 7.2 percent on a “fully loaded” Basel III basis. The bank said it would offset lower end-year net income projections by what it called “additional de-risking measures”. These could include selling assets and/or not replacing capital-intensive assets that mature, according to a person familiar with the situation.
- Full interim results will be divulged on July 31. Deutsche disclosed details of its profit miss due to strict guidelines from the German regulator Bafin, which requires domestic companies likely to miss consensus estimates by over 5 percent to inform investors as soon as possible if the miss is likely to impact the share price.
- Deutsche Bank shares closed down 0.2 percent at 23.5 euros on July 24. By 1000 GMT on July 25, they had fallen 3.6 percent to 22.6 euros.
- Deutsche Bank statement, July 24: here
- Reuters: Deutsche Bank blames euro for weak second quarter [ID:nL6E8IOIES]
- For previous columns by the author, Reuters customers can click on [HAY/]
(Editing by Chris Hughes and Sarah Bailey)
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