How Deutsche Bank Drifted Into Its Whirlpool of Woes

(Bloomberg) -- At this point, Deutsche Bank AG’s biggest problem may simply be how many problems it has, how long they’ve gone on and how they’ve fueled one another. Four years of sliding revenue has spawned four failed turnaround plans and the steady departure of senior executives. That’s alongside an equally steady stream of lawsuits and investigations, topped by a raid on the bank’s headquarters in November. Its next obstacle may be the solution the German government seems to have in mind -- merging it with its troubled cross-town rival, Commerzbank AG.

1. What’s gone wrong?

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 reverse the slide, without success. Problems include outdated technology, a talent drain and heavy fines -- $17 billion in the last decade -- for misconduct. Adverse market conditions, which limited opportunities to profit from trading, and a credit-rating downgrade have compounded the homemade difficulties. The bank’s shares lost more than half their value in 2018.

2. Why can’t the bank turn itself around?

It’s been cutting costs to pare down to a more profitable size, but it’s been losing business even more quickly. The corporate and investment banking unit, responsible for more than half of total revenue, has lost market share to rivals that were quicker to fix balance-sheet and governance weaknesses after the 2008 financial crisis. The issues facing Deutsche Bank are also affecting many European banks: Because the European Central Bank is expected to hold interest rates near zero into 2020, revenue at bank retail units is likely to stay depressed. For Deutsche Bank, the situation is made worse by the structure of its home market, where numerous smaller banks keep margins razor-thin.

3. Why are the bank’s funding costs higher?

The market perception of Deutsche Bank’s creditworthiness took a hit in 2018, causing a doubling of the cost to insure against a default on its debt. Unlike a similar spike in 2016, the rise reflected doubts that the bank will show healthy profits anytime soon, rather than qualms about its survival. At the start of 2019, the cost declined, though it remained higher than European peers.

4. What’s the bank doing to recover?

Chief Executive Officer Christian Sewing, who took over in 2018, has accelerated cost cuts and scaled back global ambitions. That’s freed up funds to plow into areas he hopes will grow, such as transaction banking, which includes trade finance and other services for corporate clients. There’s also a plan to move into higher-yielding assets with the help of Cerberus Capital Management, one of the bank’s top shareholders. The bank aims to cut its global workforce to 90,000 employees by the end of 2019, after slashing more than 9,000 jobs since the end of 2015. At home, Sewing is merging two domestic retail units to cut annual costs by 900 million euros ($1 billion) -- some 4 percent of Deutsche Bank’s costs -- within a few years.

5. Has anything gone right?

Sewing restored the bank to its first annual profit in four years in 2018 and he’s cut costs even more than promised. Revenue in retail and transaction banking rose in the fourth quarter. Sewing generally has the support of shareholders and the bank still enjoys strong brand recognition around the globe. 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 in 2017. The bank has also now settled most of the biggest legal cases against it. It has also won a commitment for a new investment from Qatar; two other Qatari investment vehicles already own a stake in it.

6. How much time does the bank have?

The next few months are critical. Bank executives are concerned they may not be able to avoid a radical solution such as a government-brokered merger with Commerzbank unless they can show improvement in the first quarter of 2019, people familiar with their thinking have told Bloomberg. Sewing has pleaded for patience with his current plan, which is centered on cost cuts and efforts to stabilize market share. But the bank suffered another setback in November, when a group of about 170 law-enforcement officers searched its headquarters and other offices in a case tied to the Panama Papers. Deutsche Bank is being probed for allegedly helping clients set up companies in tax havens as well as whether it properly scrutinized the money it was moving for Danske Bank A/S, which is embroiled in a money-laundering scandal.

7. Is there a Plan B?

Some analysts and investors favor a transformational merger, such as with Commerzbank. The German government has been studying ways to encourage that combination in a bid to add scale and slash expenses. While a deal is viewed by some as an imperfect solution, the German government is worried that it may be impossible for Sewing to turn around Deutsche Bank before a potential economic slowdown exacerbates the situation. The country still owns a large stake in Commerzbank after a bailout. It doesn’t own a stake in Deutsche Bank, but Finance Minister Olaf Scholz has said repeatedly that he wants strong international banks to support Germany’s export-oriented companies.

8. Would that work?

Many critics say merging two weak banks won’t make a strong one. The two banks lack synergies in several markets, and would likely face stiff political resistance to any plan to make deep staff cuts in overlapping areas. While the combined bank could lead to cost savings and an expanded customer base, it would still face external hurdles, like the overcrowded state of German banking, where uncompetitive or state-supported banks make it hard for rivals to make money.

9. Are there other options?

Other scenarios, including a merger with a European competitor, have been discussed as well. A regional peer could complement Deutsche Bank in markets it’s not in internationally while also bringing cheap deposits. But such a plan would likely face strong resistance from the German government, which would be reluctant to lose the bank it sees as its "national champion" to foreign ownership. The slide in Deutsche Bank’s stock price limits options for a tie-up.

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