What analysts are watching for in Deutsche Bank earnings

Deutsche Bank CEO John Cryan
Daniel Roland | AFP | Getty Images
Deutsche Bank CEO John Cryan

When a struggling Deutsche Bank reports third-quarter earnings, investors will focus on capital levels and management commentary.

The earnings call, set for early Thursday morning New York time, is the first since mid-September media reports that the U.S. Department of Justice is demanding what could be a $14 billion settlement for Deutsche Bank's former sales practices for mortgage-backed securities.

The large size of the DOJ's proposed fine brought the already struggling bank under increased scrutiny by U.S. investors, and the New York-traded Deutsche Bank shares fell to record lows at the end of September.

Shares have since recovered to trade near levels from just before the DOJ news report. But the bank's ability to implement a restructuring plan successfully remains a concern, especially after the International Monetary Fund said in June that the bank "appears to be the most important net contributor to systemic risks in the global banking system."

When Deutsche Bank reports earnings, "I am looking at three things in general, which are capital levels, overall progress on costs, and general execution on the core business," Stephen Ellis, director of financial services equity research at Morningstar, said in an email. Morningstar has a four-star rating on Deutsche Bank, just above its three-star "fair return" rating.

While Ellis does not expect the bank will give significant clarity on its legal issues, other analysts expect more concrete clues especially as an official announcement has already been more than a month in coming.

Late Monday, a Sky News report, citing a banking industry source, said that the DOJ may want to settle simultaneously with other European banks, which likely would result in a final decision not coming until after the November U.S. election.

"Market concern surrounding (the bank's) litigation is such that we expect the bank to depart from industry practice of 'no comment' and provide a detailed update," Goldman Sachs analysts Jernej Omahen and Marco Di Matteo said in a Tuesday note. "Were (the bank) to provide no guidance, the market would move to assume a worst case outcome, in our view," they said.

Goldman is "neutral" on Deutsche Bank and the analysts expect the final settlement to be around $3.5 billion.

Deutsche Bank has also said it expects the final figure to be far lower than $14 billion. On Sept. 30, Deutsche Bank CEO John Cryan sent a letter to all employees that said the bank has "strong fundamentals" and indicated he expects the final settlement to be lower given the relative fines of other major banks.

A presentation from the bank's second-quarter earnings report said Deutsche had 5.5 billion euros (about $6.00 billion) in litigation reserves as of June 30. Analysts will be looking for whether the bank increased those reserves in the third quarter.

The DOJ settlement is only the most recent negative headline on the bank. The firm also is in the middle of a new restructuring strategy launched about a year ago. So far, the results have not been enough to restore investor confidence. The U.S.-traded shares are down more than 50 percent over the last 12 months.

As the bank faces litigation and restructuring costs — Goldman expects those to total about 1 billion euros for the third quarter — analysts generally expect Deutsche to announce a plan to raise capital, whether in the earnings release or another time in the near future.

"We now think it is likely that (Deutsche Bank) will look to raise capital quickly after its DOJ settlement for a number of reasons," Credit Suisse analysts Jon Peace and Jan Wolter said in a note. "These include stabilizing the customer business, satisfying European Central Bank demands for rapid capital action on banks with potential losses plus low corporate profitability and a capital deficit, and reducing political pressure."

The analysts said disposals of the bank's stake in HuaXia and Abbey Life insurance business will help, but the bank could look to raise 6 billion to 8 billion euros quickly to raise its highest-quality capital ratio, known as Common Equity Tier 1, a measure of financial strength, to 12.5 percent to 13 percent, above the European Central Bank's full minimum requirement of 12.25 percent.

Illustrative capital needs and sources for Deutsche Bank (in billions of euros for the second half '16 to '18)

Source: Credit Suisse estimates

Despite those major burdens, on Thursday the struggling German bank could see headline figures on its third-quarter earnings report helped by the same trend that boosted the major U.S. bank earnings — a surge in bond trading revenue.

Deutsche Bank ranks third in global market share for fixed income, currencies and commodities trading (FICC), according to a research note from the bank's U.S.-based analyst Matt O'Connor. JPMorgan ranks first while Citigroup is second, the note said. Both of those banks reported a more than 30 percent jump in bond trading revenue in the third quarter.

"Deutsche Bank is a big FICC house so along with banks generally like Barclays or BNP it should not be too bad," said Steven Gould, analyst at Natixis, which has a "sell" rating on the German bank.

The consensus of analysts polled by Reuters for the German bank's overall earnings is 0.27 euros a share on revenue of about 7.22 billion euros.

In the second quarter, Deutsche Bank reported a 20 percent year-over-year decline in net revenue to 7.4 billion euros and a nearly 100 percent decline in net income.