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Mounting pressure on capital leaves Deutsche Bank confronting state aid speculation

Alreadystruggling to meet capital and earnings targets, faces further pressurefrom looming litigation payments that threaten to leave state aid as one of adwindling set of options it has to meet market and regulatory expectations.

Analystestimates of the lender's capital shortfall vary from upwards of €5 billion toas much as €20 billion, which would dwarf its dwindling market capitalization. Deutscheshares have shed more than half their value year-to-date to push market capunder €15 billion, with renewed pressure in recent weeks sparked by the U.S. Departmentof Justice's $14 billion opening demand to settle legal action over mortgage securities.

Resultsfor the past several years compiled by S&P Global Market Intelligence showweakening equity, high leverage and a poor earnings record, and the gap betweenrecent performance and the bank's targets looks considerable. Thelender aims to have a 12.5% common equity Tier 1 ratio by 2018, which wouldexceed the ECB's requirement of 12.25% by the start of 2019, but which is alsonearly 2 percentage points ahead of where it stood at June 30.

Consensusestimates for full year 2017 suggest that the CET1 ratio will come close to the2018 target thanks in part to a reduction in risk-weighted assets, but theyforesee weak returns around 4% — and downgrades cannot be ruled out.

"DeutscheBank has seen one of the very biggest earnings downgrades in 2016 after [CEOJohn] Cryan said that he only more or less expects to break even thisyear," noted Credit Suisse bank analyst Jon Peace.

Evenassuming that the DOJ settlement does not raise charges above €5 billion forall RMBS-related claims, Peace predicted in an interview that Deutsche Bankfaces a €7 billion shortfall. He also said the market is likely to demand aCET1 ratio of around 13% in 2018.

DeutscheBank has vowed that it will pay nowhere near the $14 billion demanded, and Citianalysts wrote Sept. 26 that consensus estimates suggest a €4 billion to €6billion total for all RMBS litigation. There are, however, other significantunsettled legal claims relating to money laundering in Russia and forex trading.

Deutschehas scrapped its dividend for 2016, and Peace projected in an interview thatnone would be paid in respect of 2017 either, emphasizing that litigation costswould severely reduce earnings and the bank's ability to generate capital. Hesaid the global markets business was the principal cause for the bank's weakreturns.

DeutscheBank's capital plans look adequate before potential litigation costs, but thesemight require fresh equity of "five, six or seven billion euros,"said Alain Tchibozo, a bank analyst at Mediobanca. "This is catastrophicgiven the bank's capitalization," he added, observing that asking forcapital equivalent to above 25% of a bank's value would be challenging.

Broadlyusing consensus figures and assuming the sale of , Citi wrote thatDeutsche Bank would have to make good an €8 billion equity shortfall to achievea 4.5% leverage ratio in 2018.

Othersare even more bearish. SocGen analysts wrote Sept. 16 that even assuming thatexisting provisions cover the entire DOJ settlement, the bank needs €12.5billion of equity. Should the fine rise significantly above the €5.4 billionset aside, the capital need could balloon to €20 billion.

DeutscheBank is deleveraging to improve its capital position, but progress is slow andis threatening its earnings and profits. The £935 million cash of Abbey Life, announcedSept. 28, produces only a relatively small 10-basis-point boost to the CET1ratio, and it will result in an €800 million pretax loss on impairment ofgoodwill and intangible assets. Given current market conditions, there is alsoa major question mark over the Deutsche Postbank sale, which Citi described as"increasingly challenging to execute."

Theturbulence surrounding Deutsche Bank has prompted a series of media reportsabout a state-led rescue, which the bank and the German government havedenied several times.The latest came Sept. 28, when Die Zeitclaimed that work wasunderway on a rescue plan that potentially includes fresh capital for the bank.

 

Click here to view Inquiry Financial consensus estimates for Deutsche Bank.

Click here to view SNL's profile of individual banks and view key information in both tabular and graphical format for your selected company.