Fair weather failings
Even with turbocharged fixed income markets, Europe’s two biggest investment banks were leagues away from turning an economic profit in the third quarter. Deutsche Bank and Barclays both gained from Wall Street’s fervour for trading currencies and bonds. But legal bills dragged return on tangible equity down to 2 percent at Deutsche and 3.6 percent at Barclays. That’s still a long way below the industry’s estimated 10 percent cost of capital.
Deutsche Chief Executive John Cryan can nonetheless be somewhat upbeat. The bank’s third-quarter profit of 278 million euros ($303 million) was a pleasant surprise. News that the U.S. Justice Department had threatened a $14 billion fine for mis-selling mortgage securities could have spooked trading counterparties and damaged Deutsche’s business. The bank’s solvency was also under scrutiny. Yet liquidity reserves have stabilised at around 200 billion euros after falling by a tenth last month, said Chief Financial Officer Marcus Schenck.
Deutsche’s business model remains under strain, however. Despite a 14 percent rise in debt-trading revenue, the bank’s markets division managed a return on tangible equity of just 3.7 percent in the third quarter. It would have had to slash expenses by almost a fifth to reach a 10 percent return, according to Breakingviews calculations. Besides, Deutsche has already cut investment banker pay sharply.
The picture is equally bleak in its transaction and retail banking businesses: KBW analysts reckon a protracted low interest rate environment could halve Deutsche’s net interest income. This alone could pull it into the red by 2020.
By comparison, Barclays boss Jes Staley faces more clement weather. Unlike its German rival, the UK lender gained market share in trading in the third quarter. The bank thinks the 600 million pounds it set aside for mis-sold UK loan insurance will last until a regulator-imposed deadline for claims in mid-2019. Spread the charge over the next three years and Barclays’ return on tangible equity for the most recent quarter could have been more than 8 percent.
That’s ok, but still nothing to write home about given the strong trading environment. Both Deutsche and Barclays need more fair winds to blow their way.