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Friday, June 12, 2015

Market Forces Axe Deutsche’s CEOs


By Brad Hintz and Roy C. Smith
 From eFinancial News, June 10, 2015
Deutsche Bank’s Supervisory Board’s decision last week to oust its co-chief executives, after their ”new” strategic plan bombed at its annual general meeting on May 21 should have been no surprise.  The plan reaffirmed the bank’s status quo commitment to capital markets that everyone knew had failed and nearly destroyed Germany’s largest and once most esteemed universal bank.
The surprise was that the market reacted so sharply (the share price dropped by 9% immediately after the meeting), and that the Supervisory Board, headed by former Allianz CFO and Goldman Sachs partner Paul Achleitner, was actually listening. 
Since the financial crisis the CEOs of eight of the top ten originators of capital market transactions have now been replaced (three of them replaced twice) because their boards wanted to show accountability or the need for a strategic change of direction.
This may be the first such change motivated by a clear sign of impatience by market investors. The co-CEOs were, of course, already under considerable pressure from regulators, labor unions and litigants, but in the end, the Board’s action, so soon after the AGM, was triggered by recognition that market forces could not be ignored any longer.
John Cryan will take over at Deutsche Bank at the end of the month – the same time that Tidjine Thiam will do the same at Credit Suisse. Both have been appointed to bring an unbiased mind to the problem of sorting out their bank's future. Should they split up the bank, which we recommend Deutsche Bank do in Financial News on April 29th, or drastically cut back on “risk-weighted-assets” and resize the capital markets business - like UBS and Barclays are doing.  
Credit Suisse’s asset management business gives Mr. Tijane some time to consider further changes, but Mr. Cryan cannot delay. Investors are anxious to know how Deutsche Bank will improve shareholder returns (currently 8% less than the bank’s cost of equity capital) and what business lines it will focus on in a totally changed capital markets business environment.
The key issue for investors is the enormous discount to break-up value that the current market price of the bank represents. Deutsche’s current depressed price to book valuation represents the market’s continuing dissatisfaction with the risk-adjusted earnings potential of its capital markets business.
Deutsche Bank’s current capital markets business has been made unviable by regulatory changes that have permanently changed the core business model of investment banking, reducing returns on assets and limiting risk-taking.
Balance sheet intensity remains high at the bank relative to its competitors. This constrains returns on equity. “Liquidity coverage ratios” and “net stable funding” targets have substantially increased the liquidity costs of OTC market-making. New leverage targets are pressuring matched book, inventories and unclear derivatives positions. Moreover, the Volcker rule in North America, new standardized risk weightings, and more stringent EU and US stress tests are expected to further squeeze operating performance.
However, institutional investors can be confident in the earnings potential of Deutsche’s other businesses -- transaction processing, asset management, wealth management, and trade finance activities. In these areas, the bank is globally positioned and has a loyal corporate client base.
Since the crisis, Deutsche Bank has delayed making difficult decisions. Now it is up to Mr. Cryan to make them. Though General Electric has decided to sell off most of its GE Capital unit, and American Express spun off its Lehman Brothers subsidiary in 1994, no major bank has been willing to go that far. Mr. Cryan will have to take a hard look at spinning off the capital markets unit, or explain to investors why he didn't do so.
Deutsche Bank’s long suffering shareholders want a return to steady profitability and dividends. In his new role, Mr. Cryan will have to devise a credible plan to do so, and then execute it. Neither are easy assignments; we wish him good luck.


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