P&L Check Now or Never for Deutsche Bank

Deutsche Bank’s investors are running out of patience after years of disappointment. CEO John Cryan must deliver the recovery he’s pledged for so long.
There's light at the end of the tunnel. Let's hope it's not the incoming train.

In his two years at the helm of Deutsche Bank, John Cryan has pinpointed and analyzed its shortcomings with merciless precision. Even his critics aren’t denying that he has done a good job diagnosing the many ailments of the country’s chronically-troubled flagship bank.

But identifying the problems isn’t enough. They’ve got to be solved, and that hasn’t happened yet. Investors are tired of the lawsuits and losses, of the strategic U-turns and the endless stream of negative headlines. They’re putting the taciturn Brit under mounting pressure to show results in his bid to restore the bank’s health.

Restructuring plans have come and gone without being followed through.

When Mr. Cryan first took over in July 2015, he was right in his analysis that Deutsche Bank didn’t really have a strategy problem — it had an implementation problem. Restructuring plans had come and gone without being followed through, he noted. Two years ago, the bank still planned to sell its retail unit Postbank and to omit dividend payouts for at least two years. And there was no talk of a capital hike.

How times have changed. Mr. Cryan’s management team decided in March to abandon the sale of Postbank, to instead list a minority stake in fund management unit Deutsche Asset Management and to resume dividend payments. Earlier this year it completed a capital hike of €8 billion, or $8.9 billion, the bank’s fourth since the 2008 financial crisis (see graphic below).

There may be good reasons for these U-turns, but investors including the ruling family of Qatar and Chinese conglomerate HNA (its newest shareholder), which each own close to 10 percent, are clamoring for concrete progress. They’ve made clear both to Mr. Cryan and to Supervisory Board Chairman Paul Achleitner that it’s time to shift from clearing up to delivering solid, profitable growth.

“Our view is that Paul Achleitner should tell the management to stop tinkering with the strategy and to successfully implement the agreed measures at long last,” said Hans-Christoph Hirt of the influential British shareholder consultancy Hermes EOS.

That’s going to be tough. Last fall’s crisis of confidence, when the share price plunged to record lows amid investor fears that the bank’s legal costs would end up crippling it, led to the loss of valuable market shares that the bank still hasn’t recouped. Analysts are deeply worried about that.

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Mr. Cryan had promised to make 2016 the clean-up year. That had a major impact on Deutsche Bank’s results: It posted a loss of €1.4 billion, albeit down from the loss of €6.8 billion in 2015, and set aside another €2.4 billion to cover litigation, though this was also down sharply from the previous year. At an annual meeting with shareholders on Thursday, Mr. Cryan once again insisted that “we have the worst behind us.”

But the numbers don’t truly reflect how disastrous last year was for the bank, which was embroiled in a dispute with the US Department of Justice (DOJ) over claims that it sold toxic mortgage-backed securities ahead of the financial crisis. When news broke in September that the US was starting negotiations with a demand for $14 billion, the bank fell into a crisis of confidence so deep that market rumors began swirling that it might need a government bailout. The share price slid to an all-time low of €9.90 and nervous customers withdrew billions from the bank, which hit its investment banking business as well as Deutsche Asset Management.

While many US banks raked in profits in a year-end boom on hopes of a business bonanza under freshly-elected US President Donald Trump, Deutsche Bank lost market share and earned a tiny profit of €16 million in its Global Markets division. Net revenues in its traditionally strong bond trading division shrank by 10 percent to €7.3 billion. The pretax loss fell from 2015 only because litigation charges and write-downs were smaller. Deutsche Bank slipped down the investment banking rankings. Data from industry monitor Coalition showed Deutsche in sixth place among the world’s top investment banks in mid-2016, down from being among the world’s top three in 2014.

Its asset management division suffered from the uncertainty around the bank. Investors withdrew a net €41 billion last year. Luckily for Deutsche, most of the funds lost were low-margin products. Nevertheless, the unit performed relatively well, posting an adjusted pre-tax profit of €794 million.

On the plus side, Deutsche was able to settle the US mortgage probe for $7.2 billion. It will only have to pay out $3.1 billion in the form of a civil monetary penalty; the rest will be consumer relief such as loan forgiveness, which tends to end up much cheaper. It also settled a money-laundering scandal in Moscow by paying €587 million. So Mr. Cryan and his team have managed to offload two of the biggest remaining legal risks hanging over the bank.

At Thursday’s shareholders meeting, Mr. Achleitner even promised the bank would recoup some of the costs by holding former executives to account. The bank’s supervisory board, which Mr. Achtleitner leads, was in advanced talks with former executives and he expected a deal in the coming months on “a substantial contribution from those involved.” The chairman did not name any names. The bank’s former CEOs between 2002 and 2016 were Jürgen Fitschen, Anshu Jain and Joe Ackermann, although there were more than a dozen other board members active during that period.

A further piece of good news was the 24-percent decline in costs last year to €29.4 billion as the workforce was reduced to 99,744. Mr. Cryan has pledged to cut adjusted costs to €22 billion by 2018 and €21 billion by 2020, but he has a long way to go to achieve that goal. Last year’s sharp fall in costs resulted partly from a big decline in bonus payments, but it won’t be able to repeat that because it’s worried it will lose its best employees if it does. It has already promised to return to its normal remuneration programs this year.

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So what exactly is the new revised strategy that will finally put Deutsche on a path to growth this year? It involves more drastic cost cuts, closing unprofitable divisions, raising fresh sources of cash, and relying less on global investment banking and more on its German home base.

Selling 20-30 percent of Deutsche Asset Management in an initial public offering is one of the pillars of Deutsche’s revised plan. Financial sources said a listing in the first half of 2018 looks realistic if market conditions are right. It’s going to take that long because of the reorganization involved in separating the unit from its parent. Deutsche AM is believed to be lobbying to get its own IT system and is already developing an online financial advisory service.

The unit’s chief executive, Nicolas Moreau, is aiming for international growth and wants to turn it into one of the world’s top 10 fund management companies. It’s well-positioned in the German market where it caters to small savers, and its best-known brand is the DWS line of actively-managed funds. Now it wants to expand into new markets in Europe such as Italy, Spain, the Netherlands and Switzerland. The Frenchman, who joined Deutsche AM from insurance giant Axa, also wants to expand globally in its business with institutional investors.

To be sure, Deutsche AM has neglected a number of trends due in part to Deutsche Bank’s U-turns. It only got into the exchange-traded fund business, in which funds mostly track market indices, last year, and they only account for around €100 billion of Deutsche AM’s total assets under management of €706 billion.

The net outflows have stopped this year, as Deutsche Bank has regained a measure of investor confidence by settling legal disputes and securing fresh capital. But the net inflows were modest at €5 billion in the first quarter of 2017. Analysts and investors want to the group achieve a marked earnings and revenue improvement this year. They want it to reclaim market share in its core businesses and to start raking in profits again, though the results in the first quarter weren’t particularly encouraging. Total revenues shrank by 9 percent to €7.3 billion — many analysts called that a disappointment. Evidently, it will take time to repair the damage done by last fall’s slump in the bank’s fortunes.

Regulation is a problem for all banks, but Deutsche Bank is especially vulnerable because of its size.

More broadly, cutting costs remains the name of the game. Despite all its efforts to date, Deutsche Bank still had to spend 98 cents last year to earn €1. This cost-income ratio is a key barometer of a bank’s efficiency, and Deutsche Bank has performed poorly on it for years. The big US rivals such as Bank of America, JP Morgan or Citigroup last year had ratios of between 58 and 65 percent, and many European competitors such as BNP or Britain’s Barclays are far more efficient than Deutsche Bank. Mr. Cryan was able to report some success on that score. In the first quarter, the bank reduced its non-interest costs by 12 percent to €6.3 billion. Analysts praised him for that.

Another plus is that Deutsche Bank has strengthened its equity capital, which has long been its Achilles’ heel. The capital hike this spring has boosted its core tier 1 equity ratio to 14.1 percent from just 11.8 percent at the end of 2016. That’s good by comparison with European rivals, with France’s BNP at just 11.6 percent and Spain’s Santander at 10.7 percent. The ratio was also boosted by the bank’s reduction in risk-weighted assets by around 10 percent to €358 billion.

The growth of its capital cushion has evidently boosted confidence in the bank — that’s reflected in the halving of risk premiums on Deutsche’s bonds since the settlement of the US lawsuit and the successful completion of the capital hike. But there’s uncertainty over the impact of ongoing reforms of international banking rules on Deutsche Bank’s business and balance sheet.

To be sure, regulation is a problem for all banks, but Deutsche Bank is especially vulnerable because of its size. It’s one of the world’s most systemically important banks because it has fingers in so many pies, is strong in investment banking and uses its own models to calculate many of its risks. Those are areas that are about to be regulated more tightly to prevent a repeat of the financial crisis.

Chief Financial Officer Markus Schenck recently calculated that the reforms will end up increasing the bank’s risk assets by €100 billion — that’s a huge sum considering that its risk-weighted assets totaled €358 billion at the end of March. The higher the figure, the more capital the bank needs to find to back it.

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The ultimate goal in all of this? Rewarding the bank’s patient shareholders. In recent years, the share has been anything but a profitable investment, as Deutsche Bank itself calculated in its annual report. It said that an investor who purchased Deutsche Bank shares for €10,000 at the start of 2012, used dividend payouts to buy new shares and took part in the capital hikes would have seen the value of their investment decline to €6,776 by the end of 2016.

Deutsche already surprised investors by resuming a dividend payout far sooner than planned, paying €0.11 per share for 2016 and a retroactive €0.08 for 2015. That will cost it a total of €400 million. It may seem absurd that a weakened bank which has just had to ask shareholders to cough up a further €8 billion should go to such an expense. But it was forced to do so following a ruling by the Frankfurt regional court in a case brought by several shareholders.

Deutsche Bank has pledged to pay out a similar dividend for 2017 and to return to a “competitive” payout from 2018 onwards. That will likely please shareholders including Qatar and China’s HNA, but Mr. Cryan has his work cut out if he wants to keep that promise.


Yasmin Osman is a senior banking correspondent for Handelsblatt and Michael Maisch is Handelsblatt's deputy finance editor. Both are based in Frankfurt. To contact the authors: [email protected] and [email protected]