Deutsche Bank (DB, Financial) grabbed a spotlight in September last year when the U.S. Department of Justice sought a $14 billion settlement tied to mortgage-backed securities that soured during the financial crisis—almost a decade ago.
Deutsche Bank shares dropped 9.3% the day after with heavy volume.
In late December, the German bank finally settled but was able to trim the penalty down to $7.2 billion.
According to the Department of Justice, Deutsche Bank agreed to a detailed Statement of Facts as part of the settlement. The statement describes how Deutsche Bank knowingly made false and misleading representations to investors about the characteristics of the millions of dollars in residual mortgage-backed securities it made between 2006 and 2007.
Deutsche Bank shares rose 0.49% during this period.
Russian-related fine
In January, the bank agreed to pay another $629 million to end investigations related to Russian equity trades in violation of anti-money laundering laws.
According to The Wall Street Journal, the settlement does not end a separate probe into the Russian trades by the U.S. Justice Department. It is unclear when a settlement for that investigation might be reached.
Deutsche Bank shares fell almost 1% during this period.
Share issuance
Just a week ago, the company announced it would be issuing shares to raise capital, reunite its trading unit and corporate finance and not sell its Postbank unit. According to Fortune, Deutsche plans to launch an 8 billion euros ($8.5 billion) rights issue of 687.5 million new shares on March 21, priced at around a 39% discount to Friday's closing price of 19.14 euros.
Shares fell nearly 3.8% during this period,
Earnings performance
The $26.3 billion German bank delivered its fourth quarter and fiscal 2016 results in early February. In 2016, Deutsche Bank recorded a 10.5% sales decline to 30 billion euros and profit losses of 1.4 billion euros compared to 6.8 billion euros of losses the year prior.
According to Deutsche Bank, the sales declines reflect a challenging market environment, persistent low-interest rates, company-specific pressures and strategy execution.
Profits were mainly affected by impairments of goodwill and other intangible assets related to the sale of Abbey Life—1.0 billion euros, litigation—1.6 billion euros, restructuring and severance—0.1 billion euros and de-risking costs of Non-Core Operations Unit—0.1 billion euros.
“Our results for the year 2016 were heavily impacted by decisive management action taken to improve and modernize the bank, as well as by market turbulence for Deutsche Bank," CEO John Cryan said. "We proved our resilience in a particularly tough year. We finished 2016 with pleasingly strong capital and liquidity ratios and we are optimistic after a promising start to this year.”
Valuations
Deutsche Bank shares currently trade at a good discount compared to its peers. According to GuruFocus data, the German bank had a forward price-earnings (P/E) ratio of 11.3 times (industry median of 16), price-book (P/B) ratio of 0.4 times (industry median of 1.2) and price-sales (P/S) ratio of 0.89 times (industry median of 3.3).
Deutsche Bank does not have any trailing dividend payouts.
Total return
The recent dismal headline headwinds Deutsche Bank received mostly did not affect its total returns as the bank’s share price has provided a total return of 5.25% so far this year—almost on par with the broader S&P500’s 5.98%, according to Morningstar data.
Over a five-year time frame, however, Deutsche Bank delivered an almost indirectly proportional total return with 12.4% total losses versus the S&P500’s 14% total gains.
Deutsche Bank
Founded in 1870, the legal and commercial name of the German bank is Deutsche Bank Aktiengesellschaft.
Deutsche Bank Aktiengesellschaft originated from the reunification of Norddeutsche Bank Aktiengesellschaft in Hamburg, Rheinisch-Westfälische Bank Aktiengesellschaft in Düsseldorf and Süddeutsche Bank Aktiengesellschaft in Munich.
In terms of credit exposure, Deutsche Bank had 32.7%—representing about 337 billion euros total credit exposure—in North America as of December 2015. North America was followed by 27% each in Germany and Western Europe (France, Luxembourg, the Netherlands and the United Kingdom), 9.96% in Asia-Pacific, 1.83% in Eastern Europe (Poland and Russia), 1.45% in Central and South America (Brazil and Mexico) and 0.43% in Africa.
Business segments discussion
As per a recent news release, Deutsche Bank has six segments: Global Markets, Corporate and Investment Banking, Private, Wealth and Commercial Clients, Deutsche Asset Management, Postbank and Non-Core Operations Unit.
Prior to this segment arrangement, Deutsche Bank had fewer segments, five to be exact, in 2015. These were Corporate Banking and Securities, Global Transaction Banking, Deutsche Asset and Wealth Management, Private and Business Clients and Non-Core Operating Unit.
In October 2015, the German bank announced a reorganization of its business structure.
“We believe that these structural changes better equip us to deliver on Strategy 2020 and we aim to have our cost reductions and capital measures materially completed by the end of 2018.”
Global markets, corporate banking and securities
The German bank split its Corporate Banking and Securities into two: Corporate Banking and Securities sales and trading activities, and Corporate Banking and Securities corporate finance business.
Corporate banking and securities sales and trading activities have been combined in a newly created business division called Global Markets, with a primary focus on institutional clients.
In 2016, net revenue for Deutsche’s global markets declined by 14% from 2015 to 9.29 billion euros. Income before income tax rose to 16 million euros compared to losses of 1.82 billion in 2015.
Further, global markets recorded a cost-over-income ratio of 97.8% in fiscal 2016 compared to 116% in 2015. Post-tax return on equity—as will be discussed in the financial metrics section—also improved to 0.0% from -4.8% in 2015.
According to the company, net revenue for the segment was impacted by a challenging environment for equities, Deutsche Bank-specific concerns and the impact of Strategy 2020 implementation—reorganization.
Global markets generated 30.5% of total Deutsche Bank net revenue, minus any adjustments, in fiscal 2016.
Corporate and investment banking and global transaction banking
The Corporate Banking and Securities corporate finance business combined with Global Transaction Banking to form a new business division called Corporate and Investment Banking.
Corporate and investment banking is focused primarily on servicing corporate clients.
In 2016, net revenue for the segment dropped by 7% to 7.48 billion euros compared to 2015; income before tax markedly improved by 17% from 2015 to 1.7 billion euros in 2016.
The segment’s cost-over-income ratio was reduced to 68.4% from 77.9% in 2015, while having recorded a post-tax return on equity of 9.2% versus 7.4% in 2015.
Corporate and investment banking generated 24.5% of total Deutsche Bank net revenue in fiscal 2016, minus any adjustments.
Deutsche asset management
Deutsche Asset and Wealth Management has also been split into Asset and Wealth Management.
Asset management has become a standalone business division and focuses exclusively on institutional clients and the fund's business.
In 2016, the segment's sales grew flat to 3.02 billion euros and delivered an income before tax loss of 204 million euros, compared to profits of 684 million in 2015.
According to Deutsche, losses were caused by a 753 million euros impairment after selling Abbey Life.
Asset management generated 9.9% of total Deutsche Bank net revenue, minus any adjustments, in fiscal 2016.
Private, wealth and commercial clients and private and business clients
Deutsche Bank Wealth Management is now run as a business unit alongside the Private and Business Client division to form the new Private, Wealth abd Commercial Clients business division focusing on private, commercial and high-net-worth clients.
In 2016, net revenue grew 3% to 7.72 billion euros while income before taxes improved to 1.07 billion from losses of 774 million euros in 2015.
As observed, the segment recorded more than 1.5 billion less in relation to goodwill and intangible impairments and restructuring charges that lead to profits in 2016.
In 2016, the segment experienced a net asset outflow of 39 billion euros versus 3 billion inflow in 2015.
The segment delivered a cost-over-income ratio of 82.9% versus 106.3% in 2015. The segment also had a post-tax return on equity of 7.8%, up from -4.9% in 2015.
The segment generated 25.3% of total Deutsche Bank net revenue in fiscal 2016.
Postbank
Postbank was first acquired in 2008 by Deutsche for more than 6 billion euros.
Deutsche planned to dispose of this mass-market retail operation in 2015. Several shareholders along with analysts agree with this decision as it could help the bank’s profitability, as cited by the Wall Street Journal.
Deutsche, under the same management, later decided not to pursue the disposition.
In 2016, Postbank recorded an 8% gain in net revenue to 3.4 billion euros compared to 2015.
According to Deutsche, “increase in revenues by 34% primarily related to ceased revenue burden from an adjustment to Bauspar interest provisions in 4Q2015 and to a lesser extent by sale of certain investment securities.”
Postbank also recorded an income before tax profit of 367 million euros versus losses of 2.6 billion euros in 2015.
The cost-over-income ratio for Postbank was 84% in 2016 versus 177% in 2015. The bank’s post-tax return on equity figure was at 4%, an increase from -21.5% in 2015.
In review, Postbank recorded a 2.6 billion euros impairment in fiscal 2015 operations. Lastly, Postbank generated 11% of total Deutsche Bank net revenue in fiscal 2016.
Non-core operations unit
The Non-Core Operations Unit consists of two major businesses: Wholesale Assets and Operating Assets.
According to Deutsche, wholesale assets mainly includes credit correlation trading positions, securitization assets, exposures to monoline insurers, assets reclassified under IAS 39 and assets and liabilities from PBC, including Postbank.
Operating assets contains separate operating entities from the former Corporate Investments division (all of which have been transferred into NCOU) and some assets formerly within Corporate Banking and Securities and Asset and Wealth Management.
The secgment further contains several legal contingent risks transferred from Deutsche Bank’s core business divisions.
The non-core operations unit recorded negative net revenue of 382 million euros in 2016 versus a positive 794 million euros in 2015. The segment also had losses of 3.2 billion euros in income before tax in the period versus losses of 2.26 billion euros in 2015.
Financial metrics
Return on equity ratios
Investopedia says return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a company's profitability by revealing how much profit it generates with the money shareholders have invested.
Deutsche Bank goes further and reports its post-tax return on average shareholders' equity and tangible equity. The bank considers this as a non-GAAP measure with the post-tax returns on average shareholders’ equity and average tangible shareholders' equity. It is calculated as net income (loss) attributable to Deutsche Bank shareholders as a percentage of average shareholders’ equity and average tangible shareholders' equity, respectively.
In 2016, Deutsche Bank recorded post-tax returns on average shareholders’ equity of -2.3% compared to -9.8% in 2015. The German bank also had post-tax returns on average tangible shareholders' equity of -2.7% versus -12.3% in 2015.
Return on assets
Investopedia defines return on assets (ROA) as an indicator of how profitable a company is relative to its total assets.
Deutsche Bank recorded a profit loss of 1.36 billion euros in 2016, leading to an ROA figure of -0.085% versus -0.416% in the year prior.
Revenue per risk-weighted assets (1)
The Wall Street Journal recently pointed out this metric to see whether banks are finding it difficult to attract business while being stingier with their capital, or taking less risk.
As it turns out, Deutsche improved its business per asset, raising it by 31 basis points to 1.98% in fourth-quarter 2016 compared to the same period the year before. Deutsche’s risk-weighted assets, meanwhile, declined 9.9% to 358 billion euros in the same period.
Provision for credit losses
The provision for credit losses is treated as an expense on the company's financial statements as expected losses from delinquent and bad debt or other credit is likely to become default and unsatisfied.
In 2016, Deutsche’s credit losses provision grew by 45% to 1.4 billion euros compared to the year prior.
Year-on-year growth in Deutsche’s provisions was mostly observed in the following bank’s divisions (in order): global markets, non-core operations unit and corporate and investment banking with 184%, 151% and 96.5% respectively.
Capital adequacy in Tier 1 and revenue per risk-weighted assets
Tier 1 capital
According to Investopedia, tier 1 capital consists of shareholders' equity and retained earnings. Tier 1 capital is intended to measure a bank's financial health and is used when a bank must absorb losses without ceasing business operations.
Under Basel III, the minimum tier 1 capital ratio is 6%, which is calculated by dividing the bank's tier 1 capital by its total risk-based assets.
According to Deutsche, its common equity tier 1 capital ratio is defined by common equity tier 1 capital as a percentage of the risk-weighted assets for credit, market, and operational risk.
In December 2016, Deutsche’s common equity tier 1 capital ratio rose by eight-tenths of one percent to 11.9% compared to the prior-year period.
Book value figures
Deutsche Bank reports both of its book value and tangible book value per basic share outstanding—non-GAAP measures.
Book value per basic share outstanding represents the Bank’s total shareholders’ equity divided by the number of basic shares outstanding at period-end.
In 2016, Deutsche recorded a 5.4% reduction in book value to 42.74 euros a share—an 18.9% decline from the first-quarter 2015 figure, in further comparison.
Tangible book value represents the bank’s total shareholders’ equity, less goodwill and other intangible assets. Tangible book value per basic share outstanding is computed by dividing tangible book value by period-end basic shares outstanding.
In 2016, Deutsche had a 4.1% decline in its tangible book value to 36.33 euros a share—an 11.9% decline from the first-quarter 2015 figure, in further comparison.
Cash and debt (2)
As of September, Deutsche Bank had 118.9 billion euros in cash due from banks and 184.6 billion euros with a debt-equity* ratio of 2.78 times—compared to 2.79 times the year before.
(*Debt-equity calculated as other short-term borrowings plus long-term debt over total shareholders’ equity)
Cash flow (3)
In review of fiscal 2015 (not 2016), Deutsche Bank’s cash flow from operations significantly jumped 3,177% to 67.3 billion euros despite its 6.8 billion profit losses during the period.
Significant cash flow increases were observed in the following: Interest-earning time deposits with central banks and with banks without central banks, other assets, deposits, financial liabilities designated at fair value through profit or loss and investment contract liabilities, trading assets and liabilities and positive and negative market values from derivative financial instruments.
Deutsche allocated 432 million euros in property and equipment purchases, leaving it awash with 66.8 billion euros in free cash flow—compared to 1.38 billion euros in 2014.
Deutsche Bank also placed near 30 billion euros in financial assets purchases that were available for sale as it received 22 billion euros in sales and maturities of these investment purchases in the same period.
In 2015, Deutsche Bank issued 899 million in long-term debt net repayments, repurchased and extinguished 5.19 billion preferred securities and treasury shares net issuance and provided 1.04 billion in dividends, including to non-controlling interests.
Conclusion
As observed, Deutsche Bank could certainly create free cash flow when it needs. The bank’s decision not to get rid of Postbank would definitely be smart as the segment demonstrated good profitability in 2016 operations—minus billion-dollar impairments from the year prior.
Deutsche Bank, hopefully, is done or at least in favorable status with its Non-Core Operations Unit—for the segment has recorded terrible performance (5).
Despite appearing to have a highly leveraged balance sheet in terms of the debt-equity metric, Deutsche Bank appears to have adequate capital and its plan to dilute its existing shareholders to further improve this may be of warrant given its settlements and penalties associated with its past dealings.
Nonetheless, the bank trades at a good discount compared to its book value. There could be a 130% upside from today’s share price should the bank trade at par—excluding the upcoming share dilution—which it also has not done since before the financial crisis.
Meanwhile, assigning a 30% margin from Deutsche’s tangible book value would mean a value of $27 a share.
In summary, Deutsche Bank is a speculative buy with $23 per share target.
Notes
(1) Me:
Deutsche Bank did not provide these figures. I calculated this by dividing total revenue per quarter over risk-weighted assets in the same period.
(2) Me:
I used Morningstar data since I have difficulties obtaining figures from recent press release.
(3) Me:
Data accurate as of third quarter filings using Morningstar data.
(5) Me:
Disclosure: I have shares in Deutsche Bank.
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