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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