Abigail with attitude: Deutsche and Morgan Stanley's earnings challenge

Abigail Hofman
Published on:

The financial landscape is changing and certain macro themes are beginning to emerge.

For several years now, the regulators have been the bugbear of the big banks. Once the world stabilized, the regulators started to crack the whip on numerous issues such as pay, capital ratios and proprietary trading. In 2013, a new ogre emerged in the form of litigation risk. This is making big inroads into banks’ profitability and it is difficult to be sure when and where such contingent liabilities will end. Bank investors should beware.

However, I can see other more positive developments. Growth is returning to most of the main economies. This will be good for the big banks. "As the economy goes, so go the banks," a hedge fund manager ruminated. As yield curves steepen, banks will be able to make money on the differential between short-term rates (where they can fund themselves) and longer-term rates (where they can lend or invest).

Also, growth implies ‘animal spirits’, which in turn means that traditional corporate finance could increase substantially. Last year there were IPOs from numerous companies including Twitter and Hilton, and blockbuster deals such as the Vodafone/Verizon transaction or the Dell management buyout.

If equity markets are buoyant, brokers are back. The retail investor, always a lumbering beast, has woken up and started to believe that the cult of equity may not be dead after all. On the other hand, the 30-year bull market in bonds is over. Fixed-income markets no longer have the wind at their heels. And it will probably be difficult to make money in emerging markets this year as investors worry about current-account deficits, tapering and whether or not the Chinese growth trajectory can be sustained.

The fourth-quarter earnings from two very different financial institutions, Morgan Stanley and Deutsche Bank, encapsulate these over-arching themes. Morgan Stanley illustrated this change in revenue mix: it beat expectations for investment banking but missed analyst forecasts, not for the first time, in its fixed-income business. The share price rose 4% on the day the results were announced as the firm raised its margin goal for the wealth management business and said the bank was on course for a return on equity of 10%.

Morgan Stanley’s investors must be crossing their fingers that James Gorman is able to deliver the “jam tomorrow” that he promises today
Morgan Stanley’s investors must be crossing their fingers that James Gorman is able to deliver the “jam tomorrow” that he promises today
If you dig deeper, the firm’s net income declined to a meagre $192 million, largely because of a charge of $1.2 billion for litigation expenses relating to residential mortgage-backed securities and the credit crisis. Investors and analysts nonetheless chose to focus on Morgan Stanley’s wealth management operation, where the pre-tax margin increased to 19%.

Chief executive James Gorman stated that this margin could go as high as 25% by the end of 2015. At $33 Morgan Stanley’s shares now trade at a premium to tangible book value.

Last November, JPMorgan agreed to pay $13 billion to settle allegations that it had mis-sold mortgage-backed securities.

Morgan Stanley’s investors must be crossing their fingers that Gorman is able to deliver the "jam tomorrow" that he promises today.

Is Anshu Jain a worried man? The news from the German bank continues to be disconcerting, bordering on the dreadful. In mid-January, Deutsche Bank released its fourth-quarter earnings, unexpectedly ahead of schedule. The results were definitely disappointing: analysts had expected a juicy profit for the quarter and the bank delivered a net loss of €1.2 billion. Various factors contributed to this mess: litigation costs, impairments on bad loans, restructuring and extreme weakness in debt trading revenues. Indeed revenues in the debt sales and trading area were down 30% and lagged behind competitors such as Citi, Bank of America, Goldman Sachs or JPMorgan. Deutsche, once considered a true ‘flow monster’ no longer looks such a monster.

Deutsche’s co-chiefs, Anshu Jain and Jürgen Fitschen, are in the process of a three-year restructuring plan. In September 2012, after 100 days of surveying their empire, the recently appointed chiefs, revealed Strategy 2015+. This claimed to reaffirm Deutsche Bank’s "commitment to the universal banking model". The strategy referred to the "need for further deleveraging, organic capital growth and operational excellence" and talked about positioning Deutsche "at the forefront of cultural change in the banking industry".

Some 18 months later, the bloom has definitely come off the rose and the ambition to achieve a post-tax return on equity of 12% or more by 2015 looks just that: ambitious. However, I expect analysts and investors will wait a few more quarters before giving up on the Jain/Fitschen duo, even though some are muttering that, as many of the current problems stem from the investment banking business, Jain should walk the plank.

Did anyone, apart from me, notice the announcement, last September, that Fitschen’s contract, which is due to expire in May 2015, has been extended until March 31 2017? When the co-chiefs were appointed in the summer of 2012, many expected that the 60-something Fitschen would step down in 2015 and Jain would sail on as sole CEO.

A year later, the supervisory board appears to have had a change of heart and is hedging its bets. I smiled wryly at the spin the PR puppets put on this: "Jürgen Fitschen and Anshu Jain together requested the renewal. They would like to continue their outstanding work in a partnership in the coming years for Deutsche Bank. We are very pleased about that. It is the right signal for our company as well as for the finance industry."

That last sentence strikes me as distinctly grandiose. Is it really a good thing for the finance industry that Jain is juggling so many issues? And therefore, the board has seen the need to retain the services of 65-year-old Fitschen, a man who would normally be slowing down if not retiring from active business life?

How was your month? Please send news and views to abigail@euromoney.com