“It is different this time,” says chief executive Christian Sewing, of Deutsche Bank’s latest restructuring. Management and the board are not asking shareholders to stump up new money to meet the €7.4 billion costs of exiting equity sales and trading, cutting back in rates, eliminating 18,000 jobs and reducing the balance sheet by 20%.
Maybe that’s making a virtue out of necessity. One shudders to think how shareholders in a bank with a market capitalization of just €15 billion might have reacted if they had been asked to fund this, with the shares trading around 0.2 times tangible book value.
So, while attempting to self-fund a long overdue and sensible rebalancing of the business deserves applause, this places even more emphasis on execution risk.
Sewing is nailing his own job to achieving results most analysts describe as highly optimistic
Deutsche intends to cut annual expenses by €6 billion to €17 billion by 2022, while maintaining revenues at roughly their current rate, even after closing equity sales and trading, which previously used to bring in €2 billion a year, and losing another €500 million of rates revenue.
The bank argues that this does not require growth assumptions in the remaining businesses – in which it is more strongly positioned – of above 2% a year and maybe some modest rate rises by 2022.
But analysts worry about second-order impact on revenue losses beyond those directly associated with the activities it is quitting.
How, for example, do you disentangle rates from credit and foreign exchange? Taking positions in credit often involves a step through associated trades in government bonds. And hedging exposures there is also a driver of FX business.
It’s easy to cut loss-making or barely profitable businesses. But what if more profitable business for the bank depends on them?
As analysts at Berenberg point out: “We saw this in 2018 when Deutsche Bank removed €100 billion of leverage assets from the CIB while expecting a limited impact on revenue. Only one quarter later, it downgraded its revenue guidance, citing a greater-than-expected impact from the restructuring.”
And while Deutsche claims its underlying growth assumptions in the remaining businesses are conservative, global macro uncertainties abound.
UBS analysts, displaying a capacity for understatement, advise caution: “Cutting costs by one quarter while growing revenues by 10% over four years in the current market environment and while undergoing massive restructuring could be seen as challenging by some.”
It's easy to cut loss-making or barely profitable businesses. But what if more profitable business for the bank depends on them?
Sewing is nailing his own job to achieving results most analysts describe as highly optimistic. He says the cost-to-income ratio of 70%, implied by that ambition to cut expenses and grow revenues “is non-negotiable”. Those words will hang around his neck for three years.
Citi analysts, like their peers at other firms, say: “We would also expect to see second-order revenue attrition across the group, making the 2022 return on tangible equity target of >8% look highly improbable.”
Everyone will be following progress at the ingeniously named Capital Release Unit, now housing €288 billion of leverage exposure, or roughly one fifth of the balance sheet, and €74 billion of RWAs.
The bank says some of these assets are high-quality and short-dated, and expects to run off 50% of the credit and market-risk components of the RWAs this year and be 70% done by the end of 2020.
That still leaves a lot of operational risk RWAs, though. And after 2020, presumably, we get to the lower-quality and longer-dated exposures, and the question of what hits, if any, the bank may have to absorb to get out from under those.
Deutsche has clearly run through the whole plan in detail with its regulators, gaining recognition for efforts to run a less-risky and more-stable business in their blessing to operate at a minimum of a 12.5% common equity tier-1 ratio, as against 13.7% at the end of the first quarter of 2019.
Restructuring costs that bring losses this year and make breakeven next year look tough to achieve will eat into that spare capital quickly.
“This leaves a very thin buffer above new target >12.5% to absorb any regulatory inflation,” point out analysts at Citi. “We previously estimated that Basel IV, due to be phased over 2022-27, could hit the CET1 ratio by up to c450 basis points pre-mitigation. While this charge is now likely to be lower post-restructuring, it could still be sizeable. We therefore still do not rule out a rights issue in future and see the likelihood of ‘buybacks and dividends starting in 2022’ as very slim.”
The bank says it is different this time. But no one is going to take that on trust.