After the U.S. close last night, Deutsche Bank (ticker: DBK GR) announced a series of write-downs, an increase in its litigation reserve, and a Management Board recommendation to reduce (or possibly eliminate) its dividend in 2015. Most of the announcement was anticipated and/or priced in with the exception of the announcement the bank might eliminate its dividend. As a result, at the time of writing, the stock is actually up.

Big picture; European banks represent a very inexpensive group of banks in the middle of a credit recovery, and as a result, are experiencing a rapid normalization of profitability. The announcement by DBK does not impact our investment thesis on European banks.

Attractive yield

Some quick takeaways (in no particular order).

#1) Last month we travelled to Europe, where we met with ~20 European banks, including DBK while in Germany. During our meeting with DBK, executives discussed the upcoming strategic plan announcement, noting they believed the market expected it to provide targets for, and the path towards, improved cost to income ratio, capital and a sustainable ROE.

#2) We don’t see the DBK announcement as having broad applicability across the sector and the announcement is not overly distressing (i.e. write-down of Chinese bank investment, impact on Postbank are DBK-specific). However, we were a bit surprised at the potential to completely eliminate the dividend for 2015, notwithstanding the pressure on certain global banks to reduce leverage ratios (note: like DBK, many European bank dividends are announced annually). Important to note, low dividend yields are pretty common among the global banks. For example, despite having higher capital levels than European banks … and … having fully recovered from the credit cycle, Bank of America and Citigroup have dividend yields of ~1.3% and ~0.4%, respectively.

#3) Recall that write-downs of investments and goodwill like those announced by DBK are pretty common, and do not impact regulatory capital, since intangibles are already a deduction in all relevant capital ratios. With respect to litigation, global banks continue to build these reserves, but they are not a significant part of our investment thesis. The dividend cut actually reduces the probability for a dilutive capital raise (although not to zero), which helps explain why the stock is up. To reiterate, we do not believe the European banks possess – as a sector – material EPS dilution risk (and to the extent capital pressure exists, it is greatest on the global investment banks, especially those deemed systemically important). This is not news, and our portfolios are constructed with this in mind.  

#4) We have noted often that our emphasis is on regional banks in Europe, where the economic leverage to rising GDP is greatest. While universal banks will be part of any European financials fund, we remain structurally underweight exposure to capital markets.

Bottom line: DBK announcement has no material impact on our investment thesis.

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