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 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 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 has said the bank is suffering from “a vicious circle of declining revenues, sticky expenses, lowered ratings 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 The bank’s problems include outdated information technology, weak leadership and heavy fines -- $17 billion in the last decade -- for misconduct.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 homemade 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 total revenue, has steadily lost market share to rivals that 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 in 2018, causing a doubling of the cost to insure against a default on its debt. 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, and achieving longer-term profit targets will be “challenging,” Fitch Ratings said in June, when it revised 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 reducing corporate finance units in the U.S. and Asia. He’s slashed 2,400 jobs since April and vowed to cut 1,600 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?
Sewing is on track to deliver on his 2018 cost-cutting target, and the bank still enjoys strong brand recognition around the globe. This year’s job cuts have cost 200 million euros ($229 million) less than expected. Many employees express deep loyalty. There are no immediate threats to the bank’s 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 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 two domestic retail units. The bank has also now settled most of the biggest legal cases against it.
6. What should we watch out for?
With costs coming down, Sewing now expects the bank to be profitable this year. However, management hasn’t dared to say when exactly it expects revenue to stop falling. Von Moltke has conceded that generating a 10 percent return on tangible equity may take more time than previously planned. The bank’s staff will also be keen to hear details of the weak investment banking result on their pay as the bank has said there will be no large bonuses if performance doesn’t warrant them.
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 steep 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. Other scenarios including European competitors have been discussed as well. All of that seems unlikely for now because Deutsche Bank is too busy trying to make itself profitable again. The low share price means any share-based merger would buy it 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.