Cryan needs to deal with Deutsche’s long-term dilemma

By:
Peter Lee
Published on:

Concerns over Deutsche Bank’s current financial position are a distraction. CEO John Cryan's biggest challenge is to restore trust in the bank’s brand before its core clients are tempted by the overtures of Deutsche’s competitors.


john-cryan-160
John Cryan has deliberately set out to talk less grandiloquently and less often than his predecessors as CEOs of Deutsche Bank used to about the bank’s strategy. 


Asked to explain his vision at the bank’s annual press conference in late January – perhaps the only interesting question in two and a half hours – he shrugged. “We are a bank. We are a regulated entity. We don’t have much latitude in what we do. We’ve organized in four divisions. We think they all work well together; they have a logic in being together.” 

It’s understandable, laudable even, that Cryan would rather stick to executing the plan in hand in a determined and disciplined way. But failure to articulate a vision, at a press conference in which he returned time and again to low morale among employees, felt like a mistake.

Cryan’s advisers perhaps told him as much. A week later a memo to employees, from which most observers concentrated on his assertion that Deutsche remained ‘rock solid’ amid concerns that it might not be able to meet coupon payments on its AT1 debt, sought to address what Deutsche might be in the longer term. 

Cryan said: “We want to be the most-respected financial services provider across all customer segments in Germany, our vital and strong home market; the number-one bank for our corporate, institutional and fiduciary clients in Europe; and the best foreign bank in the United States and Asia.”

It’s early days, but it’s becoming apparent that even that worthy aim of just executing the strategy that his predecessors set out last April and that he himself approved from his seat on the board, might be harder than Cryan realized. 

Net revenues
Deutsche Bank 

Deutsche-Bank-Net-revenues-300
Source: Deutsche Bank

Deutsche Bank is coming late to this task. It is finding, as others have before it, that as it cuts costs, revenues disappear and there is no neat and linear improvement in the cost/income ratio. The bank is now talking about investing in areas where it has already lost too much market share and where it wants to rebuild revenues: areas such as cash equities, where it is now recruiting in research and sales, and in advisory, which is a capital-light business but in most years a lousy cost/income one.

The bank is determined to get risk-weighted assets down, but weak earnings in its core operating business and poor capital generation don’t give it much capacity to take the hit of dumping assets at a big loss, so progress is slow. It can deleverage and shed high-capital-consuming assets that at least earn revenue, but almost as fast as it does so, regulators hit it with higher operational risk-weighted assets (RWAs) in recognition of past regulatory and compliance failures. 

Seven months into a five-year plan, with the two toughest years ahead, and Deutsche appears to be running full pelt only to stand still.

CET 1 ratio vs SREP requirements 
CRR/CRD IV CET1 ratio

CET 1 ratio vs SREP requirements 600
Source: Deutsche Bank

It needs to get its CET1 capital ratio up to 12.5% in 2018, just to be marginally above the 12.25% demanded by regulators. That would leave it with a much thinner buffer than most banks aim to work with. Today it stands at 11.1% and it might be down to close to 10.5% by the time Deutsche Bank next reports first-quarter 2016 earnings. It wants to reshape the retail bank by listing or selling Postbank, improving the leverage ratio and deconsolidating €40 billion of RWAs in one shot. Deutsche Bank shareholders shouldn’t hold their breath as equity prices, particularly those of European banks, collapse. 

Deutsche Bank wants to grow transaction banking and asset management, in which it is strong in no-growth Europe, by picking up market share in the US and Asia where competition is most fierce.

And it has to do that while fixing the investment bank that still dominates the group. This is the business on which Deutsche grew, from a fading European commercial bank in the mid-1980s into a global giant, over the 20 years leading up to the financial crisis. The still unfolding regulatory response since the financial crisis has set out to crush investment banking. Cryan’s predecessor, Anshu Jain, gambled that as others got out, Deutsche Bank could both grow market share and benefit from fatter margins and he resisted voices on his own board urging him to cut back investment banking.

It is easy to say he got that call badly wrong, not quite so easy to say what he should have done instead.

James Chappell, analyst at Berenberg, sums up the dilemma neatly: “A successful transformation of any banking franchise requires a core business to fall back on and enough capital to change. In Deutsche Bank’s case, its core business is investment banking, which represents 50% of equity, 75% of leverage assets and 50% of profits. However, investment banking is in structural decline.” 

The most worrying aspect of Deutsche’s results announcement at the end of January was not the reduced store of ADIs from which to service AT1 coupons, or the fines or restructuring costs it took last year. It was the shuddering drop-off in underlying investment banking revenues in the last two quarters. At a time when it needs its core business to produce profit and generate the capital buffer to shrink its balance sheet, the trajectory suggests that revenues might fall faster than costs, producing not profits but losses.

And here’s where Deutsche’s biggest problem lies. Well intentioned though Cryan’s determination is to focus on execution rather than strategizing, at the moment, when the morale of the bank’s staff is close to rock bottom, there is a big, existential unanswered question hanging over the bank.

Say it does get through the next two years without another huge fine or another big loss, say it manages to work through the restructuring, simplify the bank, get out of the bad markets, cut costs. What then?

What is Deutsche Bank for? Who needs it? What does it do and which customers does it serve that no other banks can reach as easily and serve better?

Rivals scent blood. US investment banks are – almost in a re-run of the early 1990s – using the profits from their high-margin oligopoly at home to win out globally in investment banking. European rivals are suddenly ready to pounce as well. 

The head of investment banking at a leading European competitor to Deutsche Bank tells Euromoney: “The biggest change for me came in the second half of last year, when German corporates actively began to engage with us in a way they hadn't before. Deutsche has lost that cachet of being the bank you had to deal with if you were a big German client. Some clients almost express shame at the state the bank finds itself in.”

There is a feeling in certain quarters in Germany, especially among public-sector financiers, that the bank that bears the country’s name long ago sold its soul to the Anglo-Saxon locusts that have ruined it.

Cryan at least speaks German. His name elicits almost universal respect among senior executives at rival banks; Deutsche Bank’s name, not so much.

A board director of another large European bank tells Euromoney: “I think for many years up to the crisis its German clients could always tell themselves that Deutsche Bank was the Mercedes-Benz S-Class of European banking. It’s now dawning on them that it may be more Volkswagen Polo.”

Little known outside the banking industry, Cryan has such a high standing within it that almost none of his peers question the new chief executive's ability to stick to the plan and restructure Deutsche Bank, something that his more renowned predecessors could not achieve. A former UBS colleague assures Euromoney: “Not only is John very smart, clear thinking and determined, even more importantly he is absolutely straight, honourable and honest.” 

It is perhaps characteristic of the man that while Deutsche bankers, like most of their peers, have traditionally boasted about their wonderful technology as they built platforms that truly altered markets, such as Autobahn, Cryan has come clean about the awful muddle of its legacy IT systems and dependence on end-of-life software.

Soft spoken and with a subtle British sense of humour that his audience doesn’t always pick up on – trust us, he doesn’t really want to run Wells Fargo – Cryan might need to take a lesson or two in how to bullshit. 

At the analyst call on January 28, he almost audibly shifted tone as he went from the tell-it-to-the-analysts-like-it-is part of his formal remarks to the don’t-forget-to-give-the-troops-something-to-cheer closing section. “The core strength is Deutsche Bank’s brand and client engagement that continues to be extremely… strong. I have been very impressed with the depth of client relationship,” Cryan said, rather going through the motions. 

But later, during the gruelling two-and-a-half hour annual press conference that always follows the full-year results, Cryan let slip his observation that: “The Deutsche Bank brand isn’t resonating with clients, quite so readily.”


Litigation reserves

Deutsche-Bank-Litigation-reserves-300
Source: Deutsche Bank





Contingent liabilities 

Deutsche Bank Contingent liabilities 300
Source: Deutsche Bank