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How long until the Deutsche naysayers pipe down?

Deutsche Bank, according to recent wisdom, trades too many bonds. Or rather, it doesn’t trade nearly as many as it had planned to. Global fixed income volumes are on the floor, banks cannot hold much inventory, margins are under pressure. Clients are over-broked, prop trading is over, and you still have to pay everyone. But is the German giant ramming that back down critics' throats?

The big losers from this state of affairs are held to be Barclays and Deutsche Bank — titans of the rates business and broader fixed income, but constrained by regulation. Leverage ratios, in particular, are held responsible. While the US universal banks shift their mortgages over to Fannie and Freddie, freeing them to allocate capital to slugging it out over low margin flow trading, Barclays and Deutsche must hang on to their huge books of low risk UK and German mortgages, squeezing their leverage ratio and restricting their competitiveness.

Primary exponents of this theory are the team at Morgan Stanley, which, in collaboration with Oliver Wyman, have published an influential Blue Paper (and update) on the state of the industry, arguing “Given our view that pressures on European FICC banks will persist, we think both Deutsche Bank and Barclays are value traps and we prefer winners at a reasonable price.” The top pick of the Morgan Stanley team is UBS.

The trouble is, it does not seem to be borne out by the numbers.

Deutsche’s fixed income and FX trading revenues were down 10% in the first quarter of the year, and almost exactly flat in the second quarter.

Not exactly the stuff of which dreams are made, but the US banks, supposedly the winners, got badly beaten up on the same comparison. JP Morgan was down 21% in the first quarter and 15% in the second, Citi was down 18% in the first and 12% in the second. Goldman was down 11% in the first quarter and 10% in the second quarter.

Deutsche does not give much more hard detail about how it kept revenues flat against such a tough backdrop, but the qualitative commentary it does offer helps understand what has happened.

And it really is exactly what you would expect.

Rates and FX — high volume, low margin, crippled by leverage ratio, and increasingly executable by robots, the juicier derivative parts of the business forced onto swap execution facilities — was down. Low volatility means no need to trade these products, and tight bid-offer whenever anyone does.

RMBS, flow credit, distressed products and credit solutions, however, all did well, with Europe a particularly strong region for the distressed business.

One thing these business lines have in common is that they actually require the resources and skills that investment banks have within their fixed income divisions. Electronic trading, central limit order books and other cost and margin-squeezing innovations might work in rates or FX, but illiquid credit products need skilled practitioners, and risk-ready balance sheets. Pure play brokers and algorithms have no place here.

It is also exactly what you would expect a bank to do once the leverage ratio starts to bite. If all assets are treated equally, use precious balance sheet to put on juicy illiquid trades, not Bund repos.

Of course, a couple of adequate quarters does not a strategy make. But from here, Deutsche looks like it is making all the right moves in fixed income. Flow monster is a phrase to rightly jettison, but there’s still plenty of room to be a big bond bank in the new era.

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