Macaskill on markets: Life after bonuses for Deutsche Bank?
Deutsche Bank’s co-chief executive John Cryan may find the bonus obsession of his investment bankers hard to understand. He will need to keep them motivated if he is to have any chance of pulling off a hugely challenging turnaround plan for the bank, however.
In July 2007 Deutsche Bank hired the Rolling Stones to play at a dinner for its derivatives clients in Barcelona for a reported fee of over €4 million. Mick Jagger was a cricket-watching acquaintance of Deutsche’s then head of global markets and future co-CEO Anshu Jain, who commissioned the performance, but that didn’t stop the Stones from securing an eye-watering rate for an 80-minute show.
Jagger also couldn’t resist tweaking his hosts with a sarcastic thanks for the invitation: “The best part is, it’s coming out of your bonuses.”
Jagger was wrong though – it wasn’t coming out of their bonuses, or not in the near term. Deutsche’s investment bankers were paid around €4.4 billion in bonuses for 2007, with an overwhelming majority of the money going to the sales and trading staff in Jain’s global markets group. This total was close to a record set the year before, despite clear signs that a long credit boom was heading towards a likely bust. Even after the global credit crisis finally struck in 2008, Deutsche still only cut its bonus pool for the year for its investment bankers by around 50%, though Jain and other executive committee members were forced to follow CEO Josef Ackermann into giving up an annual discretionary payment.
Deutsche has been having a credit crisis of its own so far in 2016, as it approaches the 10th anniversary of its record bonus bonanza of 2006.
This DB-specific crisis of confidence is now threatening the bank’s ability to pay meaningful bonuses to its employees and that in turn could affect the firm’s chances of reversing a downturn in revenues.
Deutsche faces multiple overlapping threats to market confidence in its long-term viability. The catalyst for a collapse in its share price in February and a sharp widening in its credit default swap spreads was a report by CreditSights casting doubt on Deutsche’s ability to pay the coupons on its contingent convertible (CoCo) debt.
Euromoney commented 18 months ago on the contradictions inherent in the sale by banks of CoCo bonds at yields far lower than their real cost of capital, despite the fact that the deals are effectively equity-like in nature, albeit with some debt characteristics.
When this contradiction was resolved by an upward spike in the yield of Deutsche’s 6% coupon CoCo bond to over 13% in February, the proximate cause was the analysis by CreditSights of how much “available distributable income” the bank has to pay future coupons.
It turns out that available distributable income under German accounting rules is both vaguely defined and poorly understood in the markets. Deutsche Bank was already trading at a share price far below the nominal book value of its assets, indicating a lack of confidence among investors in its valuation policies. So it was perhaps no surprise when assurances by CFO Marcus Schenck and co-CEO John Cryan that Deutsche was good for any coupon payments served to fuel market alarm about the firm’s creditworthiness, rather than allaying concern.
Deutsche is likely to be able to shift money from different reserve pools to pay the coupons on its CoCo bonds that are due in the coming months and into 2017. It is also likely to be forced to cut deeper into discretionary payments to its employees to keep the coffers stocked, however. That in turn threatens to affect the fragile morale of those employees, just as higher credit counterparty charges for derivatives undermine the ability of the bank to maintain volumes in the trading businesses that remain the engines of its revenue creation.
When Deutsche announced a €6.8 billion loss for 2015 at its full year results in late January there was a widespread view that Cryan was trying to pack as much bad news as possible into one set of annual results so that he could deliver a rebound in performance after taking sole control of the bank in 2016.
There is no reason to assume that Deutsche will make a profit in 2016, though. The real surprise in its fourth quarter results was how sharply revenues had fallen at its investment bank, both on an absolute basis and relative to peer group performance.
It would only take a mild dip in sales and trading revenues from 2015 levels and further litigation charges to push Deutsche into another loss in 2016. Fixed income market leader JPMorgan indicated in late February that overall sales and trading revenue could fall around 20% in the first quarter, which doesn’t augur well for results at Deutsche, given its own additional challenges.
With an IPO of Postbank looking unlikely before 2017 or 2018, and additional scrutiny on maintaining enough money to pay CoCo coupons, there may accordingly be limited scope for Deutsche to pay employee bonuses and shareholder dividends for some time.
Deutsche was able to partly reverse the selling of its stock and its credit spread widening in late February by announcing that it would buy back some of its own debt. Acceptance of the offer to buy back up to €3 billion of senior unsecured bonds, which did not cover its CoCo issues, was limited. The firm interpreted this as a sign of “improving market sentiment and an investor preference to retain exposure to Deutsche Bank”, and said it would register a gain of around €40 million in its first quarter results from buying back some debt at levels below the issue price.
It would not take much for investors to rediscover their abhorrence for retaining exposure to Deutsche, however. This will make the bank’s next two quarterly result announcements crucially important for its medium-term viability. If weak revenues renew doubts about Deutsche’s capacity to cover its commitments, there could be further hedging of CoCo and other debt holdings in the form of short stock sales and purchases of default swap protection.
Throw in the towel
That could prompt some key employees to throw in the towel and depart, if they conclude that the value of their already-battered existing and expected share awards from bonuses is in a downward spiral.
Any sign that Deutsche is in enough trouble to require support from the German state could turn a move by employees towards the exit into a stampede, as it would indicate that bonus payments of any form were likely to be suspended and place a ceiling on the bank’s share price.
The European Central Bank could solve many of Deutsche’s problems by widening its asset purchase programme to include vanilla corporate debt, in turn pushing down credit spreads.
Extension of ECB asset purchases has so far been staunchly opposed by the in-house Bundesbank veterans who see themselves as guardians of central banking probity, however.
The spectre of effective nationalization of Germany’s biggest bank might persuade them to re-examine their most cherished principles, but they would surely not wish to be seen as architects of a bailout for the bonus payments of Deutsche Bank’s sales and trading staff.