Against all odds, Deutsche Bank (DB) reported a profit in the third quarter, surprising markets and sending its shares higher in early trading on the Frankfurt Stock Exchange. The shares then lost some of their luster, see-sawing in mid-morning as investors tried to come to grips with the result.
Net profit was €278 million ($303 million), reversing a loss of €6 billion in the same period a year ago, according to the bank's earnings release. But this was no miracle recovery: The profit was mainly driven by a sharp reduction in noninterest expenses, which halved to €6.5 billion. (You can read more about what the bank's CEO John Cryan told analysts on TheStreet.com.)
Over the past year, fears that the bank will need to raise fresh capital have been haunting investors, driving a 50% plunge in the share price on German markets. The results released by the bank on Thursday suggest that, at least in the immediate future, the bank is in no dire need to go out to the markets again and ask for money.
It would take days to go through all the detail of the bank's results and interim report, but here is a quick look at the latest news on the main issues that have been worrying investors:
-- The Department of Justice's request that DB pay $14 billion in damages for the sale of mortgage-backed securities that went toxic in the 2007-2009 financial crisis. The novelty here is that Deutsche Bank "has entered into a tolling agreement with the DOJ in connection with various RMBS offerings to toll the relevant statutes of limitations." I am not a lawyer, but from what I have read about these agreements their purpose is to allow one party additional time to look at the damages requested or at their claims without filing an action. That's because the party is waiving the right to defense based on the statute of limitations. To me this sounds like a thawing of relations between the DOJ and Deutsche Bank. It also sounds like the bank is preparing for long negotiations over this amount, perhaps longer than many in the markets expect. DB did not disclose the amount of provisions it made for this, reiterating its previous stance that "such disclosure can be expected to prejudice seriously the outcome of these regulatory investigations." It raised litigation reserves modestly, to €5.9 billion ($6.4 billion) from €5.5 billion in the previous quarter.
-- Common Equity Tier 1 (CET1) capital ratio. This has been worrying investors, because it is a key measure of financial strength and had been weakening recently. It exceeded analysts' expectations, coming in at 11.1% at the end of September vs. 10.9% forecast by analysts surveyed by Bloomberg and 10.8% at the end of June. The minimum required under Basel III rules is 6%, but the median in the eurozone is 14.6%. Deutsche Bank's third-quarter level brings its CET 1 ratio back to where it was in December 2015. This does not mean the bank has managed to magically raise capital without tapping the markets: CET1 capital fell by 1.5% to €42.9 billion in the third quarter from the previous one, affected by a lower discount rate on pensions, higher deductions for intangible items and the negative impact of the Abbey Life sale agreement. Year on year, CET1 capital fell by 3%.
-- Risk-weighted assets (RWA). This is the other side of the CET1 ratio and it recorded a marked improvement. The bank's results were keenly watched to see whether it manages to reduce the RWAs and thus improve the ratio. It did. RWAs were cut by €23 billion to €385 billion compared with the same quarter of last year. This was primarily driven by a cut in risk-weighted assets in the bank's non-core operations unit, where they fell by 55% to €17.8 billion. Compared with the second quarter of this year, the reduction in RWAs is 35% in the unit. Digging deeper into the report, the bank says the reduction achieved includes "the wind-down of largest derivatives exposures" within the non-core operations unit, but did not offer any other details (at least not that I could see -- as I said, the documents are huge). Calls to Deutsche Bank's London press office went unanswered.
-- Derivatives exposure. This is something investors keep worrying about. I wrote an extensive story a while ago explaining the position, so I will not insist too much on it, except to repeat for those who don't want to read it again that in essence the derivatives positions roughly cancel each other out, as they are mainly hedging positions. On the assets side of its balance sheet, the bank shows positive market values from derivative financial instruments of €542.2 billion, while on the liabilities side it shows negative market values from derivatives of $524.1 billion. That's a net positive market value from its exposure to derivatives of €18.1 billion. There does not seem to be anything to worry about here, although derivatives have been dubbed "financial weapons of mass destruction" by none other than Warren Buffett, which says a lot about how risky these instruments are.
-- Liquidity position. Deutsche Bank's cash and central bank balances were stronger than a year ago, at €108.6 billion vs. €91.2 billion, but fell slightly from the second quarter's €122.9 billion. The bank's liquidity reserves were €200 billion at the end of September, €15 billion lower than at the end of last year but still amply sufficient to cover any immediate needs. The bank said it ran a stress test to determine its Liquidity Coverage Ratio -- a ratio under Basel III calculated as the amount of high-quality liquid assets divided by total net cash flows over a period of 30 days -- and it was 122% at the end of September. The minimum is 100% and a previous test showed it was 119% at the end of last year.
Deutsche Bank's third-quarter results show that, at least for now, the bank is unlikely to rush to the markets, cap in hand, asking for more capital. But they also show that cost cutting was the main driver of profit. This is never a good thing over the long term.