Deutsche Bank’s traders have performed strongly recently, helping the firm’s share price to recover and even prompting speculation that it could take over Credit Suisse if the long-awaited European bank merger dance ever gets under way.
News that a position taken by Deutsche Bank distressed debt trader Mark Spehn five years ago could now result in a $1 billion payoff has contributed to the feeling that the bank has got its mojo back.
Deutsche Bank declined to comment on a Bloomberg report that a position of less than $100 million that Spehn took in Israeli shipping firm ZIM’s debt and equity is worth around $1 billion now that ZIM has listed against a backdrop of sharply higher freight rates.
ZIM also declined to comment, but a rise of more than 300% in its stock since it floated on the New York Stock Exchange (NYSE) in January, plus an earlier recovery in its debt prices and pre-flotation equity value, make a $1 billion score for Deutsche Bank plausible.
Christian Sewing… is finally turning the firm around after a lost decade that took its capitalization to less than a quarter of its nominal book value
The trade inevitably drew comparisons with Deutsche’s role as one of the players in the Big Short of book and film fame, when Greg Lippmann placed default swap bets against US mortgages that partly offset bigger credit losses at the bank during the 2008 financial crisis.
The more recent Big Long bet on ZIM will certainly be welcome news for Deutsche Bank chief executive Christian Sewing, who is finally turning the firm around after a lost decade that took its capitalization to less than a quarter of its nominal book value.
His decision to focus Deutsche’s investment bank on its core strength of fixed income trading was partly vindicated by the sharp rise in revenues seen during the pandemic in 2020.
Further successes in 2021, such as the ZIM trade, may help to explain why Sewing has approved an expansion in credit sales and trading, with a series of recent hires in London and New York.
Volatile
Credit trading and associated businesses such as leveraged finance are holding up better than rates and foreign exchange dealing as market volumes return to normal patterns in 2021 and overall fixed income revenues fall from their elevated levels in 2020.
Credit is nevertheless the most volatile revenue source of the main fixed income business lines and could be exposed to disruption as the Federal Reserve and other central banks plot a gradual reduction in the support provided to markets.
A lengthy examination of the outlook for global investment banking revenues published by Kian Abouhossein and his fellow analysts at JPMorgan on June 16 provided some encouragement for European banks that are staying the course in a business that is unloved by shareholders.
Admittedly, Abouhossein predicted further gains in market share for the biggest US banks, led – inevitably – by JPMorgan. But he also anticipated a sustainable increase in investment banking revenues in the coming years and argued for a higher premium to be placed on this income.
The JPMorgan analysts changed their price-to-earnings multiple for Deutsche Bank’s investment banking revenue from its current level of 6 to 7.5 for their 2023 estimates, for example, while upgrading the same multiple for comparable Barclays earnings from 7 to 9.
Abouhossein and his colleagues also forecast that fixed income trading will remain a mainstay as growth of over 5% a year is seen for investment banking revenues compared with a 2019 base (while treating the 2020 surge in income as an anomaly).
The JPMorgan analysts said they expect fixed income to account for 44% of revenues in 2022, compared with 29% for advisory and origination, and 27% for equity trading.
That would mark a sustained recovery from the decade running up to 2020 when weak revenues and a shift in flow to non-bank trading platforms led many to write off fixed income prospects for all but the biggest US banks.
That doesn’t mean that heads of European banks like Christian Sewing or Jes Staley at Barclays should simply hire more debt traders and let them loose with higher risk limits, however.
Growth
One of the other themes pushed by the JPMorgan analysts was that long-term investment banking revenue growth would be best served by creating ecosystems that comprise four elements: a captive global client business; a hedge fund franchise that provides risk recycling opportunities; diversified sales and trading exposure that reduces revenue correlation risk; and a “Tencent-type” model that creates untapped opportunities.
The Tencent name-check refers to the Chinese firm’s impressive cross-selling via its WeChat app and other technology, and a talent for quickly replicating whatever works for its rivals.
Deutsche Bank and other European firms that are still active in investment banking generally offer some but not all of these four elements. The Tencent-type cross-selling is particularly hard to deliver.
The role played by Deutsche Bank’s distressed debt trader Mark Spehn in helping to finance the recovery of ZIM was reportedly appreciated by the shipping firm.
And Spehn is keeping up his cheerleading even as he must be considering closing out Deutsche’s exposure at a huge profit. “Good job team, keep charging ahead,” Spehn posted on Linked-In, with an encouraging muscle emoji, after ZIM chief executive Eli Glickman announced a recent investment.
“As a longstanding shareholder we have had the pleasure of watching ZIM go from strength to strength. Thank you for you and your team’s continued hard work. The result is not luck, but rather a reflection of focus and execution and I look forward to seeing what the future holds!” Spehn said in an earlier post commending the firm.
Reliance on pockets of excellence could leave Deutsche and other European banks prone to more dramatic revenue swings than their biggest US competitors
Spehn must also be looking forward to what the future holds in terms of his own annual bonus if Deutsche Bank cashes in its Big Long in ZIM, even if the days when the firm’s traders could expect to be paid 10% or more of their profits are sadly in the past.
But, however cordial the relationship between Spehn and ZIM’s executives may be, a big distressed debt and equity trading payoff may not turn the shipping firm into a fully-fledged member of the Tencent-style virtuous ecosystem that was outlined by JPMorgan’s banking analysts.
When ZIM launched this year’s IPO on the NYSE, which effectively sealed its triumphant recovery, there was no place for Deutsche Bank as an underwriter, for example.
Citi, Goldman Sachs and Barclays instead acted as global coordinators, with Jefferies and shipping boutique Clarksons Platou as joint bookrunners.
Deutsche Bank’s standalone equity capital markets business has actually done surprisingly well since the firm pulled out of equity trading and prime brokerage. But it is inevitably reliant on a few strengths, such as special purpose acquisition company (Spac) deals, which are cyclical, as the plunge in Spac fees in the second quarter of this year demonstrates.
And this reliance on pockets of excellence could leave Deutsche and other European banks prone to more dramatic revenue swings than their biggest US competitors, even if the overall market for investment banking is now in a period of sustainable growth.
