Macaskill on markets: Deutsche Bank and the art of the retreat

News and opinion on finance

Deutsche Bank chief executive Christian Sewing had a couple of pieces of good news when he unveiled the firm’s full-year 2018 results at the beginning of February. Deutsche had delivered an annual profit for the first time since 2014 and its ‘jaws’ were positive, meaning that costs fell faster than revenues during the year.

It was a minor triumph that was undercut by an alarming trend in the fourth quarter of 2018, when the cost-to-income ratio for the corporate and investment banking unit pushed back above 100%, meaning that Deutsche’s core division wasn’t even covering its absolute costs – never mind generating a return in excess of its cost of capital.

Sewing was predictably soon confronted with another challenge, in the form of a report that important investors would like him to accelerate cuts in Deutsche’s US investment bank.

The rationale for this move is obvious. While Deutsche’s global investment bank has been struggling to retain market share recently, its US sub-division has been a perennial underperformer, regularly losing money while consuming substantial amounts of capital and making an outsize contribution only as a source of many of the bank’s regulatory and reputational scandals.

But an orderly withdrawal from a vital capital market like the US is hard to execute.

Deutsche has been sending mixed signals about its commitment to the region. A reduced presence in US rates trading, with an accompanying fall in risk-weighted assets, was a goal that was announced publicly and hailed as one of the successes of 2018. Increasing revenues in areas such as FX trading remains a target, however, and officials point out that six managing directors were hired from rival firms to boost corporate finance and advisory coverage in the US in the second half of 2018.

Deutsche has some activist investors run by financial market veterans among its current shareholders, alongside long-standing and long-suffering owners such as Qatar.

Cerberus failure

Private equity firm Cerberus, which disclosed a 3% stake in Deutsche in November 2017, has one of the more intriguing roles as an investor. Its purchase has been an outright failure as an investment to date. 

Cerberus disclosed its stake when Deutsche shares were just over €15; by late February this year the stock was at €7.5, meaning that Cerberus is sitting on a paper loss of roughly 50%, setting aside any derivatives hedges that would have involved a further cost.

A few months after its Deutsche stake became public, Cerberus hired former JPMorgan chief operating officer Matt Zames as president. Zames joined Cerberus soon after he was discussed as a candidate for chief executive of Deutsche – and around the time that Sewing got the nod for that job.

A role at Cerberus did not distance Zames from involvement with Deutsche, in fact quite the opposite, as the private equity firm quickly took a role as an advisory consultant to the bank, in a highly unusual relationship for a big investor.

Cerberus was joined at the end of last year as an investor in Deutsche by Hudson Executive Capital, a hedge fund founded by another JPMorgan veteran, former CFO Doug Braunstein.

Hudson took a similarly sized stake to the Cerberus investment – a 3.1% holding – and announced its shareholding when Deutsche stock was around €9, meaning that it is sitting on a more modest current paper loss of just over 16%. 

We’re committed to being a bulge-bracket investment bank anchored in New York and London 

 – Jes Staley, Barclays

Zames and Braunstein both had senior roles at JPMorgan’s investment bank, which has been the chief beneficiary of the fixed income and equity market share lost by Deutsche and other European dealers.

Neither Zames nor Braunstein is widely credited as an architect of JPMorgan’s success however, which came while chief executive Jamie Dimon remained in firm control of the bank’s overall strategy and Daniel Pinto ran its investment bank. 

Zames is a former interest rate swap trader who developed a reputation as an abrasive manager while at JPMorgan, although he enjoyed the confidence of Dimon for a while, in part by helping to manage the fallout from the $6.2 billion London Whale credit derivatives trading loss.

Braunstein is a former M&A specialist who had an extremely rocky tenure as chief financial officer at JPMorgan, in part because he seemed to have a poor grasp of what was happening as the London Whale episode unfolded in 2012.

Cerberus and Hudson declined to comment on whether or not the two JPMorgan veterans are currently exerting pressure on Deutsche to accelerate cuts in its US investment bank.

Both of the former bankers know that disentanglement from long-dated complex trading positions can be challenging. Deutsche first established itself as a big US fixed income dealer with tactics including tightly priced, large, long-dated interest rate derivatives trades with counterparties such as the mortgage agencies Fannie Mae and Freddie Mac, for example. 

A recent report on the firm’s struggle of almost a decade to close a $7.8 billion US municipal bond plus default swap trade from before the financial crisis was a reminder of the sheer effort needed to unwind some complex positions.

And Deutsche also faces the starker existential issue of whether or not it can continue to cut costs without faster erosion in its revenues from relatively straightforward business lines where it hopes to maintain scale, such as FX trading, debt origination and advisory work.

Barclays stock

If a retreat from New York by Deutsche does pick up pace, then investors in Barclays stock will be among the keenest observers of any benefits or costs.

Barclays is currently run by Jes Staley – yet another JPMorgan veteran – who has been pursuing the opposite strategy to Deutsche and some other European dealers by increasing risk limits in a bid to win back lost fixed income and equity trading market share.

This has resulted in some success. Staley was keen to point out that in dollar terms Barclays increased markets revenues by 12% in 2018 when he recently announced its annual results; and he highlighted that this was better than the 5% aggregate rise for the top US banks, as well as a contrast to the average 5% drop for the firm’s European peers. 

“We’re committed to being a bulge-bracket investment bank anchored in New York and London,” Staley added.

This was an apparent rejoinder to calls by activist investor Edward Bramson for a reversal of the Staley policy of pursuing investment banking market share. Bramson, who has a 5.5% stake in Barclays, currently seems to be losing traction in his attempt to force a change in strategy at the bank.

But if Barclays suffers any setbacks in its trans-Atlantic trading comeback bid, then Bramson can be expected to renew his call for change – and to deploy lessons he can glean from any retreat from New York by Deutsche. 

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