(This story originally appeared on IFRe, a Thomson Reuters publication)
By Gareth Gore
LONDON, April 30 (IFR) - Massive cuts to the balance sheet and the creation of a non-core unit have done little to lower the need for fresh capital at Deutsche Bank, with the firm forced to find more than 1bn of additional equity in the first quarter alone after reclassifying its assets to comply with new rules.
The latest capital bill comes despite the bank offloading 396bn of assets - almost a fifth of its entire balance sheet - over the last year, illustrating how leveraged Deutsche's business has been in recent years compared to peers, and the uphill struggle the bank now faces to adjust to new rules.
First-quarter profit of 1.1bn covered the additional capital requirement, but the adjustments risk pushing the bank back into the "hunger march" that co-chief executive Anshu Jain declared over last year, raising speculation that the bank will need to tap equity markets for the fourth time since the beginning of the financial crisis.
"Deutsche has long relied on leverage to fuel profitability and appears to aim for having capital near the low end of acceptable," said Erin Davis, a senior analyst at Morningstar, who added that there are "a number of signs that the lower end of the acceptable target is higher than Deutsche anticipated".
The blow comes after the bank finally adjusted its capital calculations to the European Union's Capital Requirements Directive IV rules, which became mandatory on January 1. Unlike many of its rivals, Deutsche chose to delay implementing the rules until the last possible moment.
Those changes have had a massive impact on the risk-weighted asset calculations that determine how much capital the bank needs to hold as a safety net. RWAs have risen to 373bn under CRD IV from 300bn under Basel 2.5 rules at the end of last year - a 24% increase.
Analysts believe that the bank will face further headwinds over coming quarters as it is forced to book litigation charges - including an expected fine from regulators over the bank's alleged role in Libor manipulation - which could push it even further behind in its "hunger march".
In addition, bank chiefs may have to make an adjustment of as much as 2bn for prudent valuation adjustments, and also faces the possibility that the European Central Bank and European Banking Authority stress tests will identify a further capital shortfall later this year.
"There are a lot of moving parts to this given potential litigation charges, costs to achieve and the implementation of new rules," said Fiona Swaffield , an analyst at RBC, who said the bank's aim of a 10% core Tier 1 ratio by this time next year "looks difficult to achieve".
Deutsche maintains it can get there - but doesn't rule out a capital raise.
"We're confident we can meet these challenges and we remain committed to our capital targets," Jain said on a conference call with analysts. "We have a range of measures which will help us do that. We would not rule out any option that's in the best interest of Deutsche Bank. Our preference is to reach our target by organic means, but we reiterate our commitment to take all necessary measures."
The investment bank, which Jain ran before taking on the top job, looks to be the main source of the additional capital needs. RWAs there jumped to 166bn under CRD IV from just 115bn under Basel 2.5, accounting for almost all the extra 1bn of equity the bank was forced to find at group level.
Deutsche was notorious through the 2000s for optimising capital rules, especially in its trading unit. The clean-up of the unit to conform to new rules has been slow. In late 2012, the firm set up a non-core unit, transferring 122bn of mainly trading assets to the unit to be wound down. Analysts have accused the firm of delaying its clean-up in order to boost earnings in the short term.
The unit has been forced to cut leverage, with total assets at the corporate banking and securities arm now down to 1.1trn from 1.7trn at their peak.
Since adjustment to the new rules began, profitability at the firm's investment bank has dramatically fallen off. Profit at CB&S fell in the first quarter to 1.49bn - 22% down from a year ago - following a 10% decline in debt sales and trading revenues to 2.43bn. Equity trading and origination revenues were up slightly, while debt origination revenues slumped 21%. Advisory jumped by about half.
Analysts say that eyes will now be on whether or not the shrunken-back and cleaned-up investment bank can perform, and whether its flagship fixed-income business can buck an industry-wide slump.
"The debate for investors is the extent to which transfers to non-core have flattered the picture, and/or whether there is a further benefit to come for Deutsche (and other European firms) as European clients begin to transact more in FICC products," said Barclays analysts.
Morningstar's Davis is not convinced that will be enough. "For some time, Deutsche Bank has strongly resisted suggestions that it should raise additional equity capital, but we see increasing signs that management is weighing the idea," she said. (Reporting by Gareth Gore, editing by Matthew Davies)