Since the failure of merger talks with Commerzbank, there has been speculation that Deutsche Bank would embark on a major restructuring in the hopes of restoring its fortunes. Now, details are beginning to emerge. According to the Financial Times, the bank’s chief executive, Christian Sewing, plans to create a “bad bank” into which will be placed up to €50bn ($56.18bn) of poorly performing assets, mostly from the troubled U.S. investment bank. The bank also intends to make further deep cuts to its investment bank, and pivot to a new focus on transaction banking and wealth management.
The new “bad bank” is Deutsche Bank’s second attempt to eradicate the legacy assets that have weighed on its balance sheet ever since the financial crisis. Between 2012-16, the bank disposed of over €100bn ($112.36bn) of toxic and loss-making assets, including a Las Vegas casino that was sold to Blackstone for $1.73bn. But it was left holding €10bn of assets that proved impossible to sell.
In 2016, the then Chief Executive, John Cryan, revealed that the bank had €60bn ($67.42bn) of poorly-performing legacy assets, many of them derivatives, some of which will not mature until 2030. Most of them were never in the original “bad bank.” It is these assets that will go into the new “bad bank.”
But they should have been disposed of long ago. Although the assets generate cash flow, profits were taken on them up front – along with big bonuses for the traders concerned. These things aren’t ever going to make any money, and they tie up expensive capital. So why has it taken so long for Deutsche Bank management to admit that they must go?
The reason appears to be cash. Three years ago, income generation in other areas of the business was so poor, and costs so high, that Deutsche Bank desperately needed the cash flows from these legacy assets. Banks, like outsourcing companies, are cash flow sensitive: lack of cash can quickly bring them down. So even an unprofitable asset is worth hanging on to if the business is income-poor.
But Deutsche Bank is no longer short of cash. It has repeatedly tapped its shareholders for money, and years of cost-cutting has shored up its net income. It now has cash and near-cash reserves of some €260bn ($292.13bn). It doesn’t need cash flows from legacy assets. And it also has more than enough capital to take the hit from disposing of the assets at a loss. So creating a new “bad bank” could simply be carpe diem; the assets had to be disposed of at some point, and now that Deutsche Bank has strengthened its cash and capital buffers, there is no point in waiting any longer – especially as the ECB has signaled that interest rates will be in negative territory for the foreseeable future, which will gradually erode the bank’s cash reserves.
Further deep cuts to the investment bank are also hardly news, since surgery was clearly signaled by Christian Sewing at the AGM in May. “I can assure you: we’re prepared to make tough cutbacks,” he said. Though exactly where these cutbacks will fall is as yet unclear. Sewing spoke positively about some aspects of the Corporate and Investment Banking division: Corporate Finance, FX trading, global credit trading and U.S. commercial real estate were all cited as examples of business lines that benefited customers and delivered an “appropriate” return on equity. Absent from his warm remarks were the loss-making equities business and U.S. rates trading; both of these seem likely to face the hatchet. As my colleague Mayra Rodriguez Valladares observes, this bloodletting will principally affect the jobs of Americans.
The investment bank was the only area where cutbacks – or even significant restructuring – were mentioned. Presumably this is supposed to be enough to restore growth. To be sure, the investment bank is extremely expensive to maintain. But cutbacks in investment banking have been the main dish for successive chief executives over several years now – and yet the bank remains poorly profitable across all business lines. I see no reason why this time should be different.
But what of the pivot to transaction banking and wealth management? Focusing on transaction banking does make some sense: it has been the best-performing division for several years now, though it has hardly set the world alight. Interestingly, Sewing noted that transaction banking – Deutsche Bank’s original franchise – had been neglected in recent years, an omission he planned to rectify:
We have to admit that within the Corporate & Investment Bank we frequently paid too little attention to the transaction bank and its growth opportunities. We’re changing this now. Under Stefan Hoops’s leadership, the transaction bank will be given the freedom and the resources to fully exploit its potential – for example in many Asian markets.
Germany’s export powerhouse has pivoted to China in recent years. It seems that Sewing wants a piece of the trade finance action. But the bank should have done this three years ago. Now, exports to China are slowingas Chinese demand shrinks. Expanding transactional banking into an increasingly difficult global trading environment does not exactly look like a brilliant growth strategy.
But even if the bank does capture a larger part of international transaction banking, this is traditionally a low-return industry. It is unlikely by itself to deliver the 10% return on tangible equity Deutsche Bank is looking for. Hence Sewing’s additional focus on wealth management. He says he aims to turn DWS, Deutsche Bank’s wealth management division, into “one of the world’s top 10 asset managers.”
This looks like a desperate reach. DWS has only just started attracting net inflows again after experiencing significant outflows in recent years, and although its “growth initiatives” look promising, they are mostly joint ventures. Despite the 18% return on tangible equity Sewing claimed for it, DWS looks weak. And it is facing fierce competition from larger and stronger firms with a better track record. The international wealth management industry is becoming ever more crowded, as banks and financial institutions pivot away from riskier activities in favor of managing the wealth of the risk-averse middle classes. Admittedly, middle-class wealth is growing, especially in many Asian countries: but financial institutions wanting to manage it are proliferating even faster.
Sewing also said that Deutsche Bank was aiming to achieve €900bn in “synergies” from the (long overdue) integration of Deutsche Bank’s retail division with its ill-fated PostBank acquisition. This is not so much a strategic aim as an admission of defeat. Deutsche Bank is compelled to maintain its retail banking franchise, not only to please German politicians (though this is important), but because it couldn’t sell PostBank. But the retail bank is struggling to make headway against Germany’s dominant not-for-profit banks, and as I’ve noted before, synergies in German M&A are notoriously difficult to achieve. The 12% return on tangible equity that Sewing has set as a target for the integrated retail bank looks a considerable stretch.
As far as I can see, none of this adds up to the drastic surgery that Deutsche Bank needs. Despite the proposed cuts to the investment bank, Sewing is still trying to shore up the tattered old universal banking model, rather than defining a radical new vision. I detect the dead hand of chairman Paul Achleitner on his plans. Achleitner has never wanted to abandon universal banking.
After the Financial Times’s revelation, the share price briefly rose. But it then sank back again. Investors, it seems, are as unimpressed with the management’s latest failure to bite the bullet as I am.
The fact is that Deutsche Bank has few real strengths and no clear competitive advantage in any division. Radical new vision or no, I can’t see a future for it as an independent business. And there is no possibility of private sector rescue, nor of public sector aid. Management has simply delayed the inevitable, yet again. Eventually, Deutsche Bank will break itself up.