The Deutsche Bank crisis of 2019 is about ten years too late

Over the weekend there was a flurry of news from my old employer Deutsche Bank. We knew that something was afoot and investigated the situation on the 17th of June.

Deutsche Bank is preparing a deep overhaul of its trading operations including the creation of a so-called bad bank to hold tens of billions of euros of assets as chief executive Christian Sewing shifts Germany’s biggest lender away from investment banking.The plan would see the bad bank house or sell assets valued by the German lender in its accounts at up to €50bn after adjusting for risk.

On Sunday we discovered that there has been some number-crunching in the mean time and that there had been quite a bit of inflation. From the Financial Times.

Deutsche Bank has unveiled one of the most radical banking overhauls since the financial crisis, closing swaths of its trading unit, cutting 18,000 jobs and hiving off €74bn of assets as it calls time on its 20-year attempt to break into the top ranks of Wall Street.

So the bad bank will be nearly 50% larger as we wonder if we are being told the amount they think they can get away with rather than the amount required. One piece of comfort although it will of course be cold comfort for those who will now lose their job is that the number of losses had been estimated at 20,000. Also conveniently from a German perspective many of the job losses will be abroad in London and New York.

The axe will fall hardest on the investment bank, where the balance sheet allocated to trading will be slashed by 40 per cent.

I have long thought that Brexit would be used as cover for this but I guess as it has dragged on Deutsche Bank decided it could not wait.

Ch-ch-changes

There will be quite a pivot in business strategy according to the FT.

The struggling German lender confirmed it would close down its lossmaking equities trading business and shrink its bond and rates trading operations in a long-awaited announcement on Sunday afternoon. The axe will fall hardest on the investment bank, where the balance sheet allocated to trading will be slashed by 40 per cent. Job cuts will start first thing on Monday morning in London and New York, and three top executives have been replaced.

Actually the FT forgot about the office in Tokyo where I once worked as my thoughts go to the Sanno Park Tower as it will have opened first.

Also we can look at the impact of the latest plan for the bad bank.

Deutsche will create new bad bank — dubbed a “capital release unit” — comprising €74bn of risk-weighted assets, equivalent to €288bn of leverage exposure on the balance sheet. The lender expects asset disposals will allow it to return €5bn to shareholders either via special dividends or share buybacks from 2022.

If we start with the way that the balance sheet exposure is much higher than the asset size this points to the bad bank finding it will not be short of financial derivatives. The actual impact if this is hard to say without knowing what they are. There have been plenty of numbers circulating about the derivative exposure of Deutsche Bank going as high as 74 Trillion. But the real issue is what is the risk from that? Many of the longer-term derivatives are not especially dangerous but in the new era are not especially profitable either. This is a fundamental issue as we find ourselves reminded that this should have been done at the beginning of this decade rather than now.

There is a price to be paid for all of this.

Around €3bn of upfront restructuring costs will push the bank into a second-quarter net loss of €2.8bn, with the total bill expected to hit €7.4bn by 2022.

More troubling perhaps is this bit.

Managers will target €6bn of cost cuts over the next three years to reduce annual expenses to €17bn. After the overhaul is complete the bank will be left with around 74,000 employees, down from 91,500 currently.

Up until now Deutsche Bank has not been that successful at cost-cutting or to be it another way if it had been able to do so we would not be where we are now.

Share Price

This rallied initially this morning as long-suffering shareholders got some concrete news. The share price rallied to 7.5 Euros but then went to down on the day and is pretty much unchanged on the day at 7.2 Euros as I type this. So the news overall has brought a bounce as we note that the share price had fallen below 6 Euros although as I pointed out on the 17th of June it is all relative.

Back at the peak the share price was more like 94 Euros according to my monthly chart. From a shareholder point of view there has also been the pain of various rights issues to bolster the financial position. These tell their own story as the sale of 359.8 million shares raised 8.5 billion Euros  in 2014 whereas three years later the sale of 687.5 million was required to raise 8 billion Euros. The price was in the former 22.5 Euros and in the latter 11.65 Euros.

The FT has also crunched some numbers.

of scant comfort to investors who have sunk €30bn into the bank over the past decade only to see its share price plunge.

There will not be any dividends for the next couple of years either.

Some Gallows Humour

From Reuters on the 27th of June.

Deutsche Bank AG on Thursday passed an annual health check by the Federal Reserve, clearing a second hurdle at a critical time for the German lender in tests administered by the U.S. central bank that measure banks’ ability to weather a major economic downturn.

However, the Federal Reserve placed conditions on Credit Suisse’s U.S. operations after finding weaknesses in its capital planning processes.

Comment

If we stay with Reuters then the next bit lasted for all of a fortnight.

The results provide a boost to the Wall Street operations of Deutsche Bank, Germany’s largest lender, which have been plagued by litigation, underperformance and regulatory investigations.

If we step back for some perspective there are two main factors here I think. The first comes with a heavy dose of irony as the central banking efforts to help and subsidise the banking sector or what they consider as “the precious” have crippled it. The second is that Deutsche Bank has taken so long to face up to its problems properly, after all the credit crunch was more than a decade ago now.

The banking sector was given various heroin style hits by the interest-rate cuts, then QE and then by credit easing. In the Euro area there were more hits as the deposit rate went into negative territory. But the main side-effect for the banks was that their business model began to disappear. The simplest version on this was paying depositors less than the official interest-rate which had long given them their own version of seigniorage. As they fear dropping most deposits below 0% they instead make a loss on this. Also they end up paying money to the central bank of which there is an example below from the Swiss National Bank.

Income from negative interest remained unchanged year-on-year at CHF 2.0 billion.

Banks can still make money out of fees and lending but they need to offset problems elsewhere these days. Perhaps that is why the Swiss National Bank decided this about its equity investments.

The SNB does not invest in the shares
of any systemically important banks worldwide nor does it invest in the shares of any mid-cap and large-cap banks or bank-like institutions from advanced economies;

The next issue is one of timing where Deutsche Bank has been allowed to roll on in some ways just as before. My own country the UK has not been perfect by any means as for example Royal Bank of Scotland was bailed out and at current prices it is only worth about half what was paid. But there was at least some change whereas Deutsche Bank has continued hoping to be the last (wo)man standing. Sadly for those losing their jobs this is now over. However as ever those responsible for this have been well paid and in some cases continue to be so. In the credit crunch era accountability is only for the like of us not for them.

Upside down
Boy, you turn me
Inside out
And round and round
Upside down
Boy, you turn me
Inside out
And round and round ( Diana Ross )

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