Deutsche Bank Is Back to Square One Again

(Bloomberg Businessweek) -- More than four years after the leaders of Deutsche Bank AG unveiled their first postcrisis strategic reboot, they’re back at square one. It’s the eternal turnaround.

The giant German bank’s core problem is the same—costs are too high, revenue is too low—but there are fewer levers for Chairman Paul Achleitner and Chief Executive Officer Christian Sewing to pull now that merger talks with Commerzbank AG are off. The combination could have helped Deutsche Bank by taking out its biggest domestic rival and lowering its own funding costs by expanding its deposit base. But the obstacles to forging one sturdy institution out of two weak ones proved insurmountable. In a joint statement, the banks’ CEOs cited execution risks, restructuring costs, and the higher capital requirements the combined bank would face.

As the prospective merger collapsed, Deutsche Bank reminded its stakeholders how challenging the repair job is: Revenue in the first three months of 2019 fell for the ninth straight quarter, and, more important for an executive team committed to cost-cutting, expenses climbed as a percentage of total sales. The bank’s shares are so battered they trade for about a quarter of the value of its net assets—far less than its biggest competitors.

But Deutsche Bank has virtually no proposal for what to do next, with the risk of a potentially catastrophic downgrade in its credit rating looming. The bank has repeatedly said it will protect its rating. Its leaders reaffirmed cost-cutting targets, saying they are dependent on a benign market to reach their profitability goal. Beyond that, no one will speak about new initiatives, apart from saying they’re looking at “alternatives” to the current plan. Since the bank has plenty of capital and cash, a plodding, grinding campaign to reduce expenses seems to be the strategy. At least that’s what some unimpressed analysts and shareholders fear. “We think [Deutsche Bank] will continue to lose market share in trading as it needs to continue to cut expenses amid elevated funding costs,” wrote Credit Suisse Group AG analyst Jon Peace in a note. Deutsche Bank stock was above €20 when the board started hatching turnaround plans in 2015. Its shares trade at about €7.25 now.

The biggest puzzle is what to do about the investment bank. That operation supplies half the company’s revenue and at one point provided fuel for Deutsche Bank’s ascent into the upper echelon of global finance. Today, it sucks up so much capital and its costs are so high that some wonder whether the division should be jettisoned or shrunk.

With a Commerzbank deal gone, Deutsche Bank’s only move is “a more radical investment bank restructure, with a potential exit from the U.S. region and the equities product line,” Citigroup Inc. analysts wrote in a note on April 29. Such a move would be difficult. Restructuring costs would hit upfront, and revenue would be squeezed at first, potentially exacerbating rather than fixing Deutsche Bank’s core problem. In any case, that option seems off the table. Achleitner and Sewing say the trading and corporate finance businesses are crucial. “Every executive has to constantly adjust to a changing market environment,” Achleitner told the Financial Times. “But in this regard, we are not talking about strategy, we are talking about execution” of the existing plan.

The lender’s asset management arm, DWS Group, is said to be in talks with competitors including UBS Group AG’s money management unit about a tieup. Deutsche Bank will hold its annual general meeting in less than four weeks. It has used the event for major announcements.

Meanwhile, the bank is being sued by its most famous client: Donald Trump. He and three of his children filed a complaint in a New York court to block Deutsche Bank and Capital One Financial Corp. from complying with U.S. congressional subpoenas targeting their bank records.

One bit of good news for Deutsche Bank out of the failed Commerzbank talks is it will probably hang on to customers it already has. The risk of losing corporate clients who do business with both banks was one of the reasons Sewing walked away from the deal. The clients were concerned about going from two providers to one, a senior Deutsche Bank executive says, asking not to be named discussing details of the negotiations.

Predicting Commerzbank’s future is more straightforward. With its core of Mittelstand clients—the privately held companies that are the backbone of Germany’s economy—the bank represents an appealing takeover target. ING Groep NV of the Netherlands and Italy’s UniCredit SpA are said to be interested in an acquisition.

But any campaign to take over Commerzbank, which is 15 percent owned by the federal government in Berlin, would come with political baggage. German politicians have criticized the proposals for a foreign acquirer, and the lack of a European deposit insurance scheme poses a challenge for a cross-border takeover. That’s why ING and UniCredit could be the top contenders: Both have large operations in Germany.

A deal for Commerzbank could start a domino effect. European executives and policymakers have long emphasized the need for bank mergers to take on the U.S. behemoths that have gained market share since the financial crisis a decade ago. “Consolidation seems inevitable,” says Alex Eventon, a portfolio manager at Resco Asset Management, a hedge fund in London. “I don’t think it is specific to Commerzbank. It will be the elephant in bank boardrooms across Europe.”

It’s a prospect that motivates even Deutsche Bank’s leaders. But without a plan to reverse their declining fortunes, they could be standing on the sidelines during the industry shakeup. “As soon as the share price rises,” Sewing told a German interviewer, “a bank like ours will have a strong voice in potential mergers at the European level.” If that day never comes, the task remains to arrest the slow-motion erosion of Deutsche Bank’s franchises.

To contact the editor responsible for this story: Howard Chua-Eoan at hchuaeoan@bloomberg.net

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