John Cryan recasts Deutsche’s stubbornly high costs as investments

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By:
Mark Baker
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Deutsche’s CEO is telling the world just how much the bank still needs to do to improve, but struggles to make investors see the cost of fixing things as investing for the future.

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If Jamie Dimon is at one end of a spectrum for bombastic bank CEOs, Deutsche Bank’s John Cryan is at the other, beyond even such understated figures as UniCredit’s Jean Pierre Mustier.

Cryan was on characteristic form on Friday as he presented his bank’s annual results – a loss of €500 million, compared with JPMorgan’s $24.4 million net profit – with his typical bedside manner, a smooth but unvarnished description of the condition of his patient, the variously ailing Deutsche Bank.

Cryan can’t brag, which puts him in a small club among bank CEOs. Even praise comes out sounding sheepish. Telling the world that Deutsche Bank is number three in fixed income sales and trading, he can’t stop himself adding that “we’re not number three by very much” – and he doesn’t mean Deutsche is nearly number two.

With M&A it’s the same – almost an accident if things go well. Deutsche was number three globally in announced M&A in the fourth quarter. Was it luck? It sounds like it might have been. It has never been a particularly strong business for Deutsche, Cryan tells us. “We happen to be in three of the five really big M&A deals…”

Regulatory settlements were better than expected, largely down to cooperation discounts granted by regulators. At least the bank does the bad stuff well.



John Cryan,
Deutsche Bank

And even market commentary sounds freshly negative. When Cryan says that credit markets “do seem overbought” and might be heading for a sharp correction, it sounds for a moment almost like original insight rather than what it actually is, merely the new consensus.


He details problems at his institution as if he is still marvelling at how unpleasant it is and can’t resist telling the world about it. A lot of effort is going into “remediating the bank’s former broad range of control deficiencies”, Cryan notes in passing. What a compendium of horror stories lurks behind that apparently offhand remark.

Less amusing, Deutsche is beset by enemies: its cyber unit protects it from “seven credible cyber-attacks per second”.

At the end of some banks’ results calls, there’s a sense of a pause in combat until next time. At the end of a Deutsche call, it can feel like the analysts might want to give John a hug.

There are three things that continue to rile Cryan in the context of how he has worked to turn the bank around – its cost of funding, its debt rating and its stock market valuation.

In a separate speech on Friday he outlined just how big that turnaround has been. In the summer of 2015, when he joined the firm, there were billions of euros of legacy balance-sheet items and a weighty burden of litigation. Regulatory capital was considered inadequate, controls were poor, IT was antiquated and the business was siloed. “Our reputation was at rock bottom.”

Phase one of the turnaround was getting the house in order, a process that continues to this day. Of the 20 cases that accounted for 90% of legal risk two years ago, 15 have been mostly or entirely resolved. There are 2,500 staff in the bank’s anti-financial crime and compliance departments.

The non-core operations unit was wound down a year ago, earlier than planned. The bank’s structure has been simplified while its technology has been upgraded. Operating systems are down to 32 from 45. The bank has exited 10 countries and cut back hard in another seven – what Deutsche bankers like to call the change in their “perimeter” happened in just 18 months, half the allotted time. 


Although it looks like costs, it’s actually catch-up – and then we can automate it 
 - John Cryan, Deutsche Bank

But that change has come at a cost: even the bank’s global transaction banking franchise ­­­– the core of its corporate and investment bank – felt the pain of it in 2017, with revenues falling 11% as other banks’ rose.

The second phase was to strengthen the bank’s capital and structure. It raised €8 billion of capital in 2017. It tweaked the organization to recreate an integrated corporate and investment bank. It scrapped the previous management’s plan to sell Postbank, and is using it to build the biggest private and commercial bank in Germany – while slashing costs. Deutsche’s retail bank has closed 190 branches.

The bank just posted its first pre-tax profit in three years, and only didn’t record an after-tax profit because of a one-off charge related to the US tax reforms that were introduced in December.

Half of its 12% fall in revenues was down to a handful of disposals – and other country exits also hurt income. Stripping out those and adjusting for a tightening of the bank’s own credit spreads sees revenues down just 5%.

Provisions were well down, as were expenses – by more than the well-publicized increase in the bonus pot for 2017. The bank’s CET1 ratio rose to 14.0% from 13.8%, mostly down to a fall in operational risk-weighted assets.

To build on these small signs of improvements, the rhythm of the turnaround story and investors’ expectations now demand that phase three should be all about growth.

But it is also all about costs.

Deutsche’s stock fell 6% on the day of the results. Cryan finds the bank’s public debt ratings disappointingly low, given the bank’s sizeable cash buffer and lower risk profile these days. He thinks the bank’s share price reflects its current state, not its future prospects.

At least one reason might be costs – or to use Cryan’s term, “investments”.

Deutsche had targeted €22 billion in adjusted costs in 2018, but now thinks this will rise to €23 billion. In the greater scheme of things, the change seems hardly significant – and is relatively easily explained by the fact that some €900 million of savings had been expected to be realised through disposals that are now likely to be delayed or even suspended, with just €300 million of savings to come perhaps in 2019.

At least those extra costs will be balanced by revenues that will flow from those businesses while they are still inside Deutsche.

Struggle

But even that kind of adjustment feeds into a narrative of a juggernaut that is still struggling to get a handle on the expense of running its business. Cost synergies that Deutsche had hoped might materialize in 2018 from the merger of Postbank into the domestic German bank have also been put back to 2019. Brexit-related costs now look likely to be higher than first planned.

Frustration was evident in the questions from analysts on Friday morning’s conference call: what is the underlying issue in the organization that makes it so hard to cut from €23 billion?

“We can cut costs,” said Cryan. “The easy way to cut costs is not to spend €2 billion this year on fixing the bank. It’s cutting back on compensation and making people feel miserable.”

Ultimately the bank is a large and complex organization and will always have a large fixed cost base – and as Cryan points out, he has to keep the lights on.

Banks are never very good at splitting out what is running expense and what is investment, Cryan thinks. The €2 billion he refers to is investment allocated to improvements in 2018.

“One of the many root causes of where we are is that we did manage the company for short-term gain,” he said. That means that a lot of costs last year represented investments in fixing things – “and I’m afraid we’re still investing in fixing things”.

There will, evidently, be no short-termism on the long path to Deutsche’s bright future, whenever that might come.

Top of his fixing list has been know your customer.

That’s taken a long time, longer than it should have done, in Cryan’s mind. But it has been complex: many clients have been “off-boarded”, and a lot of people have been hired in client data services. Once the various documentation deficiencies have been fixed, those people won’t be needed – the bank is building systems to do that work instead.

“Although it looks like costs, it’s actually catch-up – and then we can automate it,” said Cryan.

Are there any clues as to what the bright future might be that investors should now already be discounting? Cryan didn’t say “it’s the data, stupid”, but he might as well have done. When banks have lost market share it’s to people that can use data better, he said. It’s for that reason that he is trying to drive an evolution at the firm, positioning the capturing and use of data at its heart.

“We want to transform the company into something that looks more like a tech company.”

If investors are sceptical, perhaps it’s because they are hearing this line rather a lot from banks.