Macaskill on markets: Deutsche Bank doubles down in fixed income
Deutsche Bank finally managed to sell its Las Vegas casino – The Cosmopolitan – a few days before announcing a €8 billion capital raising that it will use to double down on its bet that it can make a viable return from a full-service global fixed-income business.
Not for the first time, Deutsche Bank is using the Goldman Sachs playbook as it battles to avoid admitting that its old business model has been overtaken by new market realities.
Goldman Sachs recently rolled out a public relations campaign designed to stress its strength in corporate finance, including a semi-sponsored profile of its investment banking co-heads, Richard Gnodde, David Solomon and John Weinberg, that would not have been published without the approval of the former traders who run the firm, CEO Lloyd Blankfein and president Gary Cohn.
And advertising designed to position Goldman’s asset management arm as a down-to-earth investor in the real economy has been running ever since the financial crisis first tarnished the firm’s reputation.
But away from its corporate citizen PR push, Goldman is also sticking to its commitment to the fixed-income sales and trading business where it was once undisputed number one, but is now simply a member of a pack that is facing serious challenges in the form of higher regulatory costs and changing client habits.
|Anshu Jain and Colin Fan work on the playbook
Goldman, by contrast, is hoping that a pull-back by competitors including Morgan Stanley, JPMorgan and Barclays will enable it to increase market share and revenues when commodity volumes revive.
It is tempting to attribute this decision in part to sentimentality on the part of Blankfein and Cohn, who both got their start at Goldman as commodity traders. It is also a relatively measured gamble on the part of the firm, however. Goldman’s top managers know the commodities cycle intimately, and there are already some signs that revenues are starting to recover – the sector was the only one within fixed income to see an increase in the first quarter on the same period in 2013 – just as a number of banks that had ramped up their cost base in a bid to catch up with Goldman in the sector complete their retreat.
Deutsche Bank is one of the firms that abandoned its commodities ambitions, after an expensive build-out, but it is desperately trying to hold the line in other areas in fixed income.
Until the recently announced capital increase this had been looking like a quixotic effort. Deutsche Bank had been struggling to cut its risk-weighted assets to meet incoming Basle III capital adequacy rules for years – mainly in fixed income – while making revenue projections that stock analysts found increasingly unconvincing. Then the new regulatory focus on gross leverage ratios placed even greater emphasis on a need to cut assets, just as revenues in core fixed-income markets such as rates and FX were collapsing.
When Deutsche Bank signalled a bid to regain lost fixed-income market share in the US that was underscored by the announcement in early May of staff hires at levels as low as vice-president (a junior title at an investment bank), its attempt to hold the fixed-income line began to smack of desperation.
But the €8 billion capital-raising exercise that was unveiled later in May was meaningful enough to let Deutsche Bank put its money where its mouth is. As with Goldman, there is a personal aspect to Deutsche’s reluctance to cut its losses in fixed income. In recent years Deutsche Bank has adopted the longstanding Goldman policy of employing co-heads for many key management positions. This provides a check to the actions of a sole head, while also providing useful cover when a senior manager resigns or is fired. Co-heads of divisions at Goldman frequently ‘retire’ under mysterious circumstances, only to emerge in other positions elsewhere, and the bank is surprisingly successful at using sleight of hand to disguise when an internal power battle has resulted in the departure of an executive.
Even at Goldman there is normally a dominant co-head where the structure is used, however, and that is also the case at Deutsche Bank. The senior partners in three key shared positions within Deutsche at the moment have backgrounds in fixed-income derivatives sales, which might help to explain their reluctance to cut back in the area.
The bank’s co-CEO, Anshu Jain, is the highest-profile member of the trio, with his early career advancement based on sales of fixed-income derivatives to hedge funds. Colin Fan, co-CEO of investment banking, was a credit derivatives salesman; and Rich Herman, who was recently appointed as co-head of fixed income and transferred to New York to regain lost market share in the US, spent his formative years at Deutsche Bank selling interest rate derivatives.
As is the case with Lloyd Blankfein and Gary Cohn at Goldman, the senior Deutsche managers are not known for a sentimental attachment to particular business lines or employees, but they might have an understandable bias towards areas where they had success in the past.
The key twin questions for Deutsche shareholders are whether the bank can regain market share that was lost to US banks and whether it is worth the fight to regain share in a market that might continue to decline. A report by Morgan Stanley and Oliver Wyman on industry trends in March estimated that five European banks – Deutsche, Barclays, Credit Suisse, UBS and RBS – lost 5% of fixed-income market share to US dealers in 2013 and predicted that another 3% of share would shift in 2014, mostly from Barclays and Deutsche Bank.
Barclays effectively threw in the towel on its global fixed-income ambitions with its recently announced shift in strategy, leaving Deutsche Bank to battle on and hope that if the Morgan Stanley prediction is right then any further US bank gains will all come from lost Barclays business.
There are continuing signs of contraction in key fixed-income sectors that could make market share recovery seem like a Pyrrhic victory, however. JPMorgan recently warned that its overall capital markets revenues might be down by around 20% in the second quarter, compared with the same period last year, which was an alarming prediction from the market leader in fixed income.
And the decline in key individual markets in recent years is stark – rates revenues have already fallen 60% from their all-time peak in 2009 and do not seem to have found a plateau yet, for example.
Deutsche Bank’s decision to stick to its guns in fixed income is certainly bold, but it is also a move that is fraught with risk.