Deutsche Bank Gambles on a Big Dividend

NEW YORK ( TheStreet) -- Investors are breathing a sigh of relief after Deutsche Bank ( DB), Europe's largest bank by assets, rebuilt its capital position even as it suffered a $3 billion fourth-quarter loss.

The earnings indicate that, in the near term, Deutsche Bank's profit will be hit by restructuring efforts such as a planned 90 billion euro reduction in risky assets, layoffs and an exit from some capital-intensive businesses. They also show strong initial results by the bank's co-heads, Jürgen Fitschen and Anshu Jain, in achieving restructuring and recapitalization targets, after their June 2012 appointments.

Still, Deutsche Bank's capital position -- and the quality of its assets -- remains the biggest question hanging over the European banking conglomerate, according to analysts. The Frankfurt-based bank reached a Basel 3 tier 1 capital ratio of 8%.

So why is the bank paying out a relatively large dividend compared with U.S. peers such as Bank of America ( BAC) and Citigroup ( C), which may appeal to the Federal Reserve to improve on the 1-cent quarterly payouts they've made since repaying government bailout funds?

Consider that Deutsche Bank's 75-cent dividend for 2012 -- and a similar forecast for 2013 -- is roughly equal to the bank's annual profit for the year, after the fourth-quarter loss.

In 2012, Deutsche Bank earned roughly $1 billion in profit and will pay out about the same amount in cash dividends.

In contrast, Citigroup, which is in a similar position of disposing legacy assets and building capital to meet stricter rules, paid out roughly $120 million in 2012 dividends on $7.5 billion in earnings.

Bank of America, which had multiple quarters ruined by legal settlements and asset writedowns in 2012, paid out just over $400 million in cash dividends on net income in excess of $4 billion.

The U.S. lenders' earnings relative to dividend payouts far exceed those of Deutsche Bank, as do their capital positions. Currently, Citigroup's Basel 3 tier 1 capital ratio stands at 8.7%, while Bank of America's is at 9.25%, based on fourth-quarter results.

At Deutsche Bank's 2012 share-price low of around $30, its annual dividend yield stood at roughly 3%, in line with that of Wells Fargo ( WFC), one of the best capitalized banks in the U.S.

After making better-than-expected progress on its capital in the fourth quarter, Deutsche Bank's Basel 3 tier 1 capital ratio now stands at 8%, with a forecast it will rise to 8.5% by March. The bank said, in an earnings release, that the 2012 rise in its regulatory capital equates to an equity raise of about 8 billion euros.

European competitors such as UBS ( UBS) and Barclays ( BCS) also pay smaller dividends and hold higher Basel 3 capital ratios. Like Deutsche Bank, UBS and Barclays face earnings pressure from restructuring efforts and legal settlements.

Deutsche Bank cut its dividend sharply from $4.5 a share prior to the crisis, but has paid out roughly $1 a share annually over the past three years, when accounting for exchange rates.

Deutsche Bank's fourth-quarter results, nonetheless, helped to alleviate some concern among analysts who follow the bank.

Shares of Deutsche Bank rose nearly 3% in afternoon trading on the New York Stock Exchange, putting six-month share price gains in excess of 70%.

JPMorgan analyst Kian Abouhossein upgraded Deutsche Bank from "underweight" to "neutral," citing the bank's improving capital position. Still, the analyst notes "curve balls" on Deutsche Bank's capital position and the need for a capital infusion into its U.S.-based investment banking business.

"The issue remains capital risk curve balls as well as a Basel 3 tier 1 gap to peers," writes Abouhossein.

While Abouhossein adds that Deutsche Bank's valuation discount due to its capital position should improve, given co-CEO Fritschen and Jain's work, the analyst highlights mark-to-market writedowns on risky pre-crisis mortgage and buyout loans as a continued risk for the bank.

Others remain concerned about the bank's current progress on capital.

A proposal under consideration by the Federal Reserve to boost the cash balances of foreign banks operating in the U.S. might disadvantage conglomerates like Deutsche Bank, according to a Thursday analysis by Fitch Ratings.

"Deutsche Bank's capitalisation is weaker than most of its global peers on a "look-through" Basel III common equity Tier 1 ratio and adjusted-leverage basis," wrote Fitch Ratings, in a note that expressed optimism the bank's capital position will continue to improve.

MacQuarie Bank analyst Piers Brown told Bloomberg that a sizeable part of Deutsche Bank's 80 billion euros in asset reductions involved changes to its accounting models rather than actual disposals.

"There is a lot of inherent suspicion about models currently. It is not helpful that a lot of the improvement is coming through that," Brown told Bloomberg.

A look at Deutsche Bank's capital and earnings relative to U.S. peers indicates the banking conglomerate is still allowed to take a far more aggressive stance on cash dividends. The figures also may indicate a continued divergence in the seriousness of stress-test methodologies and post-crisis recapitalization efforts in the U.S. and Europe.

While the Fed's tests propelled U.S. lenders into dilutive equity offerings years ago, some still expect large equity offerings remain in the cards.

Abouhossein of JPMorgan, Fitch Ratings and a Reuters Breakingviews analysis both highlight a shortfall at Deutsche Bank's U.S. investment banking subsidiary as a particular concern.

In July 2012, Credit Suisse ( CS), another European mega bank that continues to operate in the U.S., surprised investors by announcing a $15 billion capital increase in the summer and slashed its dividend, as many analysts had expected.

The Fed recently said U.S. banks' stress tests will be released in March, while the European Banking Authority is expected to release 2013 stress tests for EU-based lenders in the fall.

As U.S. lenders appeal to raise their cash payouts to shareholders, investors across the Altantic may want to question whether the status quo is sustainable.

-- Written by Antoine Gara in New York

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