Deutsche Bank's Surprise Profit -- WSJ

Lower-than-expected legal, restructuring costs are recorded; troubles aren't over

By Jenny Strasburg 

Deutsche Bank AG on Thursday posted an unexpected profit and set aside more cash to cover litigation costs amid talks aimed at settling mortgage-securities probes with U.S. authorities.

Third-quarter net income was EUR278 million ($303.3 million), beating analysts' average expectations for a net loss of around EUR610 million. That compared with a net loss of EUR6 billion during the same period last year, driven by billions of dollars in write-downs as part of a companywide restructuring.

The bank's restructuring and litigation costs for the third quarter were lower than analysts had expected, in part because employee compensation dropped. Revenue from trading, especially in credit and interest-rate products, was stronger than a year earlier, offsetting weakness in equities trading within the lender's important global markets business.

Deutsche Bank shares gained 0.6% Thursday after the announcement.

Meaningful concerns remain about Deutsche Bank's ability to pay big legal fines, cut costs and stabilize profits without selling shares or taking other painful capital-raising steps, analysts said. Also, they noted that the bank's funding costs have gone up, threatening to crimp trading and investment-banking revenue.

Deutsche Bank also didn't benefit as much as big U.S. banks did in the third quarter from a boost in bond trading, which disproportionately benefited players more concentrated in the U.S. market.

The German lender earmarked an additional EUR501 million in the third quarter for litigation costs. The bank is "working hard" to reach a mortgage-probe settlement with the U.S. Justice Department, the bank said. Talks are continuing and are "constructive," it said.

Looming anticipated settlements with the Justice Department, which could amount to billions of dollars, have weighed on Deutsche Bank's shares and fueled concerns about whether it has adequate capital to cover potential losses and meet regulatory requirements.

The Wall Street Journal reported Sept. 15 that the Justice Department initially proposed the bank pay $14 billion to close out mortgage-securities investigations. Deutsche Bank said in response that it didn't intend to pay "anywhere near" that amount, which was much higher than investors or the bank expected.

The disclosure of the government's opening bid rattled Deutsche Bank clients, and markets. Some clients curtailed their business with Deutsche Bank over the course of several weeks, including by pulling deposits, executives said Thursday.

Since early October, the situation "has stabilized," Marcus Schenck, Deutsche Bank's finance chief, told analysts on a call Thursday morning.

As of Sept. 30, the lender had a total of EUR5.9 billion in litigation reserves to cover a wide range of anticipated legal expenses, including the expected U.S. mortgage settlement. That was an increase from EUR5.5 billion in litigation reserves as of June 30.

In results released before the market opened, Deutsche Bank said third-quarter net revenue was EUR7.5 billion, a 2% increase from the same period a year earlier and better than analysts' average estimates.

Deutsche Bank's global markets business had a 10% net revenue increase in the quarter, driven largely by strong credit, currency and rates trading. Low interest rates hurt the lender's global transaction banking revenue, which was down 5%. Its overall investment-banking revenue declined slightly, but Deutsche Bank said it gained back strength in its core deals business, including advising companies on stock offerings.

Deutsche Bank's common equity Tier 1 capital ratio, a measure of financial strength, increased to 11.1% from 10.8% in the second quarter. The lender is working to boost that ratio to at least 12.5% by 2018.

Deutsche Bank's shares have fallen 41% this year, more than twice the decline of the Stoxx Europe 600 Banks index.

Despite harsher economic conditions and challenges specific to Deutsche Bank, including its legal woes, executives said Thursday they are sticking to multiyear financial targets they set in late 2015. The lender has ramped up cost-cutting plans, and is still planning to dispose of its burdensome German retail-banking unit called Postbank, executives said.

A review of the bank's asset-management business is under way, Chief Executive John Cryan said Thursday. Executives have looked at selling all or part of the business, people familiar with the matter previously said, but executives haven't made details of those discussions public. Mr. Cryan on Thursday called asset management "an integral part of the group," but also said that the business's new head, Nicolas Moreau, is reviewing capital allocation and other elements of strategy and will report back on his recommendations. Mr. Cryan didn't say how long the review would take.

Last year's big third-quarter loss was driven by write-downs of the value of investment-banking and other assets. The period marked the start of a multiyear cost-cutting and turnaround plan under then-new CEO Mr. Cryan.

Deutsche Bank's earnings since have been under pressure from low interest rates that squeeze retail-banking margins, while broad economic concerns have curtailed deal-making revenue. Some hedge-fund and other clients have tapered their trading and financing relationships with Deutsche Bank during recent months, when concerns about the lender's capital intensified, The Wall Street Journal and others reported last month.

Mr. Cryan said a "personal rule" dictates that he spend at least an hour a day with clients. Lately, he said, executives have spent more of their time dispelling what he called "the more lurid of the myths" about Deutsche Bank.

Questions about whether the bank has enough ready cash to meet obligations and needs of clients were especially distracting in September and October, Mr. Schenck said Thursday. Deutsche Bank ended the third quarter with EUR200 billion of liquidity reserves, compared with EUR223 billion at the end of June.

Analysts said the liquidity position is still strong, and not a central concern.

Write to Jenny Strasburg at [e-mail]

(END) Dow Jones Newswires

October 28, 2016 02:47 ET (06:47 GMT)

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