What's Wrong With European Banks? Deutsche Bank, Credit Suisse Continue On Bumpy Road

A one-two punch from the European banking sector hit investors Wednesday and Thursday as Deutsche Bank announced a massive third-quarter net loss of 6.2 billion euros ($7 billion). Meanwhile, it was reported that Credit Suisse would be shoring up cash to meet steep capital buffer requirements.

It’s not the first time the two investment banking giants, among the oldest and most venerable in Europe, have disappointed investors in recent years. But their stumbles suggest that seven years after the global financial crisis, some of the world’s top banking firms have yet to adjust their lumbering businesses to new regulatory regimes and market realities.

While U.S. banks have come roaring back to health in recent years -- Wall Street profits were up nearly 30 percent in the first half of 2015 -- some European behemoths continue to struggle with dampened deal-making activity and an inability to jettison troublesome assets and lines of business from a previous era.

Deutsche Bank Blues

Deutsche Bank’s losses stemmed mainly from goodwill writedowns in the firm’s past acquisitions -- a 2.3 billion-euro ($2.6 billion) impairment in its investment banking unit, formerly Bankers Trust, as well as a 3.5 billion-euro ($3.9 billion) writedown in its retail arm Postbank, acquired in 2010. Deutsche Bank set aside an additional 1.2 billion euros ($1.3 billion) for litigation costs, which co-CEO John Cryan said would “continue to burden us in future quarters.”

The bank has incurred more than $11 billion in legal fines since 2008.

The unscheduled announcement late Wednesday may have caught investors off-guard, but it did not come entirely out of the blue. Germany’s largest lender is midway through a top-to-bottom overhaul of its businesses, accelerated by the summer appointment of Cryan, who is tasked with recalibrating the company’s stalling profit engines.

Goldman Sachs analysts met the news as a sobering reminder of Deutsche Bank’s uphill battle. “We do not see this as a ‘clean up’ but rather an indication of what the ‘fixing’ of Deutsche Bank will entail over the 2015-18 period,” the analysts wrote.

That has meant deep structural changes as well as various “housekeeping” matters within the sprawling firm. The massive writedowns -- essentially revisions of future profitability expectations -- fall into the latter category.

Deutsche Bank’s performance has fallen short of expectations amid post-crisis regulatory reforms designed to rein in risk-taking. The bank’s 12-month return on equity stands at a mere 2.3 percent, while executives have cited as “challenges” the continuing stubbornness of central banks like the Federal Reserve hunkering down at near-zero interest rates.

The multibillion-euro writedowns were a long-overdue acknowledgement of what investors have indicated for several years. Deutsche Bank’s price-to-book ratio -- a comparison of how much the company says it’s worth and how the markets price it -- has remained below 1.0 since 2007, lagging well behind its competitors.

UBS, for instance, has a price-to-book ratio of 1.34, compared to Deutsche Bank’s 0.46. The bank’s stock performance has trailed 37 percent behind the broader FTSE index of European banks since the start of 2012.

Credit Suisse In Transition

Deutsche Bank’s counterpart Credit Suisse has faced similar difficulties in the past several years. While most European lenders with sizable investment banking arms have struggled in the past five years with weakened trading activity and stiffer regulations, Credit Suisse has been seen as moving especially slowly to catch up to a new reality.

With Deutsche Bank and others, Credit Suisse is losing business to American competitors. In the year ending in June, the firm’s investment banking revenue fell $538 million.

In a report released earlier this week, ratings agency Moody’s listed Credit Suisse and Deutsche Bank among three others as European investment banking mainstays weighed down by legacy assets -- capital-intensive assets and risky exposures that are a holdover from headier days.

“The still-high stock of capital markets assets will continue to affect these five investment banks' profits and cause earnings volatility to remain high," said Andrea Usai, one of the study’s co-authors, in a release.

On Thursday, the Financial Times reported that Credit Suisse was looking for capital to add to its reserves. The news that the Swiss lender was seeking additional capital reflects more than its continuing difficulty to keep up with reforms that increased the amount of cash global banks needed to keep to stay solvent in a downturn. Credit Suisse plans to accelerate its firm-wide restructuring, a process that could knock against its capital reserves.

By the end of June, Credit Suisse placed 15 out of 16 of the top European banks in its capital reserves, with a 10.3 percent core capital ratio. Swiss rival UBS, which had to be bailed out during the financial crisis, posted a much healthier 13.5 percent ratio.

Like Deutsche Bank, Credit Suisse is also under new management. CEO Tidjane Thiam took the helm in June to reverse several years of underperformance. Though the bank has made cuts to various trading divisions, including its commodities arm, the bank has fallen behind rival UBS more than 30 percent since 2012.

Thiam has centered his ongoing strategy around shrinking investment banking in favor of expanding promising business lines in fixed-income and Asian markets. But the speed of the pivot will depend on how quickly the bank can shore up capital to make good on inevitable losses stemming from restructuring.