Why Deutsche Bank Can’t Just Shake Off Its Problems
(Bloomberg) -- It would be an understatement to say Deutsche Bank AG is going through a difficult period. It chalked up its third straight annual loss in 2017. The new chief executive officer, Christian Sewing, has unveiled the bank’s fourth turnaround plan in as many years, yet its shares have fallen to a record low. Almost daily, senior executives are being pushed out or are jumping ship. The U.S. Federal Reserve has placed the lender on its list of troubled banks. And its U.S. unit was the only bank to fail the Fed’s annual stress measuring the adequacy of its capital and risk controls, pushing back the day when shareholders will see any upside from its biggest foreign operation.
1. Why does Deutsche Bank seem mired in problems?
Chief Financial Officer James von Moltke says the bank is suffering from “a vicious circle of declining revenues, sticky expenses, lowered rating, and rising funding costs.” It’s repeatedly tried to revive growth, without success. The bank’s problems include outdated information technology, weak leadership and heavy fines -- $17 billion in the last decade -- for misconduct. Adverse market conditions, such as 2017’s long stretch of low volatility, which limited opportunities to profit from trading, and a recent credit rating downgrade have compounded the home-made problems.
2. Why can’t the bank turn itself around?
One of the biggest problems has been its inability to cut costs more quickly than it has lost revenue. The investment banking unit, responsible for more than half of the bank’s total revenue, has steadily lost market share to rivals who were quicker to fix balance-sheet and governance weaknesses after the 2008 financial crisis. Because the European Central Bank intends to hold interest rates near zero at least through mid-2019, revenue at the bank’s retail unit is likely to stay depressed. The situation is made worse by the structure of Deutsche Bank’s home market, where numerous smaller banks keep margins razor-thin.
3. Why are the bank’s funding costs higher?
Market perception of the lender’s creditworthiness has fallen steadily this year. The cost to insure against a default on Deutsche Bank’s debt has doubled since the beginning of 2018. Unlike a similar spike in 2016, when credit investors expressed concern over the bank’s capital levels, the latest rise in funding costs reflects doubts that the bank will show healthy profits anytime soon. An ongoing restructuring will hit the bank’s results this year while achieving longer-term profit targets will be “challenging,” Fitch Ratings said in a recent decision to revise the bank’s credit rating outlook to negative.
4. What’s the bank doing to recover?
CEO Sewing has accelerated cost cuts and scaled back global ambitions. He’s severing business ties with hedge funds and he’s reducing corporate finance units in the U.S. and Asia. He’s also slashed 1,000 jobs since April and vowed to cut 3,000 more by year-end. The retrenchment has made a lot of expensive but important fee-earners redundant or vulnerable to poaching by rivals. At home, Sewing is merging two domestic retail units to cut annual costs by 900 million euros -- some 4 percent of Deutsche Bank’s costs -- within a few years.
5. Has anything gone right?
The bank still enjoys strong brand recognition around the globe, many employees express deep loyalty and there are no immediate threats to its viability since it raised 8 billion euros in equity capital from shareholders last year. The German government has also expressed support for the bank’s new management, saying that the country needs “strong international banks.” Other milestones include partly floating the bank’s asset management division on a stock exchange and completing the legal merger of its two domestic retail units. It has also now settled most of the biggest legal cases against it.
6. What should we watch out for?
For the quarter ending June 30, the bank expects another drop in revenue. For all of 2018, revenue is on course to hit its lowest level in a decade, according to the consensus forecast compiled by Bloomberg. Sewing has staked his reputation on cutting costs, minus one-time expenses, below 23 billion euros ($26.8 billion) this year. Another important benchmark will be whether Sewing can cut headcount below 93,000 this year and still keep restructuring costs below 800 million euros, as promised. A profit for the year is possible if the bank avoids further large fines, though it still faces various investigations including a U.S. Justice Department probe of its role in handling suspicious money transfers out of Russia.
7. How much time does the bank have?
Not a lot. While several large investors have said Sewing has at least a few months to deliver on his promises, they also say he has little margin for error, according to people familiar with their thinking. That applies even more to Supervisory Board Chairman Paul Achleitner, who has presided over a 62 percent drop in the bank’s shares since taking over in 2012. Achleitner drew harsh criticism from shareholders at the bank’s annual meeting in May, when investor advisory firm Glass Lewis said he has “one last chance” to fix the bank.
8. Is there a Plan B?
Some analysts and investors favor a transformational merger, such as with cross-town rival Commerzbank AG. That seems unlikely for now. Deutsche Bank is too busy with its current restructuring. Its low share price means any merger would buy them a much smaller stake in the resulting company. However, people inside and outside the bank see a merger as an attractive longer-term option. Another scenario, recently floated by an investor and dismissed by the bank, envisaged a split of the retail operations from the investment bank and selling or merging the individual parts with other banks.
The Reference Shelf
- Bloomberg Markets has an in-depth report on Deutsche Bank under a former CEO.
- A Bloomberg explainer on Deutsche Bank’s declining bonuses.
- A Bloomberg News article explores a single day of wild trading at Deutsche Bank.
- Large numbers of Deutsche Bank executives and traders are jumping ship, including most of the convertible-bond trading desk. Some are landing at other investment banks.
- What a Deutsche Bank-Commerzbank merger would look like, in four charts.
- U.S. Federal Deposit Insurance Corp.’s 2017 global capital index showed Deutsche Bank as the most leveraged of the world’s 30 largest systemically important banks.
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