Cerberus takes stake in Deutsche Bank as Cryan talks up its repositioning

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By:
Peter Lee
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Deutsche says it welcomes any investor who sees potential in the German bank’s share, but holders are growing impatient for delivery.


John-Cryan-side-on-concerned-R-600
Deutsche Bank CEO John Cryan


News that Cerberus Capital Management has taken a 3% stake in Deutsche Bank provoked a flurry of renewed interest in German banking stocks, just as chief executive John Cryan was reassuring investors at a UBS conference that the repositioning of Germany’s largest lender is largely done or at least on track.

The IPO of Deutsche Asset Management unit is set for the first quarter of 2018; the merger of domestic banking operations with those of Postbank for the second. Meanwhile, the restructuring of the investment bank continues, a little too slowly for some.

A spokesperson for Cerberus says: “We have a constructive view of European fundamentals and believe Germany is a highly attractive place to invest, in particular. Within Germany, we believe there are attractive long-term opportunities in retail and corporate banking due to Germany’s robust economy, high savings rate and a number of other factors.”

That sounds straightforward enough and if Cerberus wants to bet on German banking ahead of rising rates in the euro area, Deutsche Bank is certainly a cheaper relative value play than Commerzbank.

However, because Cerberus had already acquired a 5% stake in Commerzbank over the summer, speculation is now inevitable that the new investor – renowned as a private equity investor, rather than a shareholder activist – might have some kind of consolidation play in mind.

Indeed, Cryan told investors at the conference to look forward to mergers and acquisitions among German banks in the months ahead.

“I do think there will be a round of consolidation, maybe starting next year,” he says, although seemingly referencing Germany’s many smaller banks now struggling to meet the costs of heightened regulation and digital transformation that the bigger banks have the scale to absorb.

Work cut out

In truth, Cryan still has plenty of work cut out. Having decided to keep Postbank rather than sell it, Deutsche hopes to merge its own German retail operations with those of the former German postal bank next year, even though it will still maintain and market both brands.

That should at least improve back office efficiency.

“Our cost income ratio of 84% is not something of which we are particularly proud,” Cryan says. “It comes in part from doing lots of different things in lots of different places, but we need to get that significantly improved. You can’t keep just 16 cents of every dollar you earn, you have to do better. And the way to do that is to improve working practices, not make yourself smaller.”

He runs through a list of the bank’s strengths almost as interesting for what he doesn’t mention as for what he includes.

The bank is stronger than widely recognized in North America, especially handling non-dollar business for US companies; it has decent businesses in Asia; at home it is particularly good at collateralized lending and payments, notably cross-border payments that bring into play its strong capability in foreign exchange and related hedging. In markets trading, once the engine of the whole bank, Cryan now highlights credit trading and credit solutions as the mainstay of the investment bank.

Criticism of the current Deutsche management centres on the fact that it has seemingly sought to improve the same complex portfolio of businesses it inherited – while exiting some locations and off-boarding many clients – without taking tough decisions radically to restructure the business.

In a recent report, analysts at Morgan Stanley argue: “Deutsche Bank’s restructuring is proving longer and more burdensome than expected for the investment bank, as shown by -33% year-on-year [in dollar terms] in FICC [for the third quarter], the worst performance in the peer group, bar UBS.”


If we can’t make money with 21 million customers in our home market, we really do want to review the model 
 - John Cryan, Deutsche Bank

Deutsche Bank claims in its defence that this most recent quarterly decline in its once-signature business was pretty much in line with the market, only looking worse because of recent reporting changes that sift out certain financing revenues from the markets business.

However, the Morgan Stanley analysts are hardly alone in saying the investment bank remains challenged, “with revenues unlikely to see significant uplift absent higher volatility”.

Cryan is pinning his and investors’ hopes on doing a better job in Germany, saying: “If we can’t make money with 21 million customers in our home market, we really do want to review the model.”

He points out to the very low loss experience in German banking, almost non-existent in German mortgages for example, which because they are very low risk are also low return.

The argument here is that requiring German banks to hold the same capital against mortgages as international peers in Europe and North America imposes the same treatment on assets that carry very different risks.

Deutsche Bank raised $8 billion in capital earlier this year, but has not ploughed a cent of it into loan growth, with RWAs only kept stable by inflation of operational risk components. Deutsche was forced to raise the capital to improve its ratios to comfort investors and regulators, not to put it to work chasing returns.

He is frustrated that this is not fully reflected yet in Deutsche’s cost of funding.

“I still think we’re 25 basis points wide of where I’d like to be,” he says. “When you’re a credit extender in a market with basically zero rates and very tight credit spreads at this point in the cycle, having a 25bp excess cost of funding is something you need to attend to.”

Euro rates

Deutsche must hope that euro rates will rise and the yield curve steepen so that it can start to make money from its plentiful deposits. Now they are almost a burden, with the European Central Bank charging a (negative) -40bp and charges for deposit insurance adding another 15bp or so to that cost.

If hopes of recovery in Europe prove false and, instead of rising, rates fall further into negative territory, Deutsche Bank will suffer. It has decided not to invest in hedging this risk in its deposit book.

Deutsche Bank and Cerberus Capital Management will both be desperately hoping that doesn’t happen.

Cryan was revealing in outlining the reasons for the IPO of Deutsche Asset Management. Partly this was to show the independence and separation of the unit, to reveal its value but also to incentivize new hires. Deutsche is competing for investment talent with independent asset managers paying partly in stock. Awards of bank equity, with five-year cliff vesting and potential clawbacks, is not a great lure these days.

Do recent changes to the share register put Cryan and the board on notice?

“That’s speculation,” says one Deutsche Bank source. “I think it’s too early for a merger. There’s a lot under way next year. Five years from now, who knows?”