The third quarter of 2007 was a period of exceptional turbulence in financial markets. Problems originating in the ‘sub-prime’ mortgage market in the United States caused widespread dislocation across the global financial system. In investment banking, our performance was significantly impacted by this extremely challenging environment; however, our ‘stable’ businesses performed well and we reaped the benefits of some recent investments. As a result, I am pleased to report that, overall, our businesses turned in a satisfactory result in the quarter.
During the summer, rising defaults on ‘sub-prime’ mortgage lending in the United States led investors to become increasingly risk-averse toward a variety of debt instruments, notably those backed or collateralized by residential mortgages, and other types of debt. Investor concerns also affected demand for loans which financed leveraged buy-out transactions. A flight to quality by investors around the world created a shortage of liquidity in some financial markets, which in turn created difficulties for the banking sector. In the United States and Europe, central banks moved quickly to intervene in order to ensure continued liquidity and smooth functioning of financial markets; however, both equity and debt markets saw periods of high volatility. Toward the end of the third quarter, we saw some initial indications that stability, liquidity, and investor confidence appeared to be returning; nevertheless, the potential impact of the sub-prime mortgage crisis on financial markets and on the wider economy, particularly in the United States, continues to weigh on market sentiment.
Deutsche Bank reported income before income taxes of € 1.4 billion for the quarter, down 19 % versus the third quarter 2006, including € 85 million from the Corporate and Investment Bank (CIB) and € 569 million from Private Clients and Asset Management (PCAM). In addition, we realized gains on the partial sale of holdings in Allianz and Linde of € 305 million and we created value from recent strategic and real estate investments of € 301 million. Furthermore, the net effect of income taxes on the quarter was positive due to several specific factors. As a result, net income for the quarter was € 1.6 billion, up 31 % versus the third quarter last year.
For the first nine months of 2007, revenues were up 10 % to € 23.5 billion, pre-tax profit up 14 % to € 7.3 billion, and net income up 30 % to € 5.5 billion. Diluted earnings per share were € 11.13, up from € 8.05 in the first nine months of 2006. Pre-tax return on average active equity was 33 %. Per our target definition, which excludes significant gains and charges, pre-tax return on average active equity was 29 %.
In CIB, Corporate Banking & Securities (CB&S) business reported a third-quarter pre-tax loss of € 179 million, after taking charges of € 1.6 billion on our trading activities, principally in relative value trading in both credit and equities, structured credit, and residential mortgage-backed securities. In addition, we took charges on leveraged loans and loan commitments of € 603 million, over and above write-downs already taken in the second quarter. On the other hand, trading revenues in interest rate and foreign exchange products, and in corporate finance advisory, were at record levels. CIB’s other business, Global Transaction Banking (GTB), turned in a strong performance. Pre-tax profit was € 263 million, up by 55 % versus the third quarter 2006, reflecting healthy year-on-year revenue growth across Trade Finance, Cash Management and Trust & Securities Services, combined with sustained cost discipline.
In PCAM, Asset and Wealth Management (AWM), pre-tax profits rose 45 % to € 265 million, reflecting strong performance fees in both the Retail and the Alternative Asset Management businesses, and substantial year-on-year profit growth in Private Wealth Management. AWM also attracted net new money inflows of € 13 billion during the quarter, bringing total inflows for the first nine months of 2007 to € 32 billion. Private & Business Clients (PBC) produced its best-ever quarterly pre-tax profits of € 304 million, while simultaneously continuing to invest in our platform, both in Germany and in other key markets, notably Poland and India. PBC also attracted net new money of € 4 billion during the quarter.
This quarter’s results show clearly that our strategy of investment in our ‘stable’ businesses, thereby creating a well-diversified earnings mix for Deutsche Bank, is correct. GTB and PCAM contributed combined profits of € 832 million in the quarter, up 35 %, despite exceptionally turbulent market conditions. For the first nine months, our ‘stable’ businesses contributed pre-tax profits of € 2.4 billion, up 17 % and sustaining their growth momentum of recent years.
Our commitment to tight capital management served us well. Our Tier I capital ratio increased to 8.8 % at the end of the quarter, up from 8.4 % at the end of the previous quarter, and thus at the upper end of our ‘target’ range of between 8 and 9 %. In August, Standard & Poor’s, the rating agency, upgraded Deutsche Bank’s long-term debt rating to AA, Fitch Ratings having already raised our outlook to AA- (positive) in July. Both agencies recently re-affirmed these ratings. What is more, we enjoyed excellent access to liquidity during this period of market turbulence, thanks in good measure to a strong, stable funding base which is well-diversified as between short-term and longer-term funding.
Looking forward, challenges undoubtedly remain. Difficulties in the U.S. residential mortgage market may persist, impacting the wider economy. Financial markets are likely to remain more cautious in their appetite for risk. However, this is also a time of opportunity for Deutsche Bank. As a market leader in investment banking, and a major global asset gatherer, we stand to benefit from the flight to quality. We have forged deep client relationships, and while clients’ priorities may change, our ability to act as trusted advisor and partner will remain. Our capital strength and well-diversified funding base are valuable competitive advantages in an environment where liquidity and capital commitment command a premium in the eyes of clients. Investors continue to search for yield, and we continue to see demand for good-quality assets at prices which reflect a reasonable balance between risk and reward. Our sales and trading business model, with its emphasis on intellectual capital, continues to be a critical part of our platform. Nevertheless, we may make some adjustments in individual business lines in order to re-focus resources toward those areas with the greatest growth potential – for example, in high-growth emerging economies.
Longer-term trends also continue to move in our direction. Globalization of the world economy will continue, and may actually accelerate as emerging economies grow faster than other, more mature nations. With our broad global network, and strong position in emerging markets, we are well-placed to take advantage of this trend. The world’s capital markets will continue to grow, favoring the top investment banks, including Deutsche Bank. Retirement planning and individual wealth creation continue to drive growth in invested assets, which plays to the strengths of a leading global asset gatherer like Deutsche Bank.
Strategically, our path is clear: we stay the course! Our management agenda is unchanged. We have made a positive start to the fourth quarter, and assuming markets function at normal levels, we re-affirm our commitment to delivering on our 2008 financial targets. Our determination to create the greatest possible value for our clients, our employees, and for you, our shareholders, remains as strong as ever.
Yours sincerely,
Josef Ackermann
Chairman of the Management Board and
the Group Executive Committee
Frankfurt am Main, October 2007
