Deutsche Bank has had a wild two weeks.
The German bank reportedly may be on the hook for $14 billion in fines for a settlement with US regulators over bad investment products from the financial crisis era. The steep fine has lead to speculation over a government bailout and a possible decrease in exposure by hedge funds, signalling no confidence in the bank.
Add all of this up, and Deutsche Bank now has its lowest share price ever and a US market cap smaller than Twitter.
According to the Kian Abouhossein, a European bank analyst at JPMorgan, the problems at Deutsche Bank go much deeper than its current conundrum and don’t appear to be going away anytime soon.
Essentially, said Abouhossein, the bank has been unable to become leaner on the cost side — as many other banks have — at a time when many investment banks are bringing in lower revenues. Here’s his assessment (emphasis added):
“Judging from its track record DB seems to have an inability to cut net costs and generate operating leverage independent of management in charge. Even under new CEO John Cryan, who we rate highly, DB has been unable to illustrate cost savings on a net basis so far. The inability to adjust the business model to a declining revenue environment is a major problem for an IB-geared bank and has lead to the inability to generate retained earnings and hence capital generation in our view.”
Going deeper, Abouhossein noted that the tangible book value per share, essentially a measure of the real assets that the bank holds, has dropped 8% between 2012 and 2015 and the bank’s average return on equity has been under 4% over the last six years.
The firm’s own goals for cost savings to counterbalance this declining profitability are also lacklustre, according to the JPMorgan analyst.
“DBK has reiterated its cost target of €26.5 billion for 2016 which is flat year over year despite clean revenues declining -13% year over year in our estimates,” said the note to clients on Friday. “We see this as unambitious as DBK has €0.4 billion year over year decline in comp expense from deferred compensation amortization alone.”
Put another way, Deutsche has no real plans to decrease costs to offset lower profits even though there are clear ways to do so, which Abouhossein referred to as a “fundamental business problem” for the bank.
“We think a bank with €26.5 billion of costs and 101,000 employees plus an estimated 30,000 consultants should be able to show more cost flexibility to generate book value growth,” said Abouhossein.
As for the current situation, Abouhossein said that he doesn’t actually expect Deutsche to settle for the full $14 billion, but more likely will negotiate penalties in the $3 billion to $4 billion range, more in line with other settlements for allegations of similar nature.
However, noted Abouhossein, the bank has $9.4 billion in money set aside for litigation and around $5.4 billion is needed for other settlements, so anything above $4 billion would require a capital raise from the bank, which would be dilutive to shares and send the stock lower.
So there is some danger now, though not as great as recent price moves and commentary might imply. But without serious underlying changes to the bank, the same problems Deutsche currently faces will continue to bubble up.
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