Deutsche’s Von Moltke on how he learned to stop worrying and love the cuts

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Life for Deutsche Bank CFO James von Moltke at the moment means having to spend a lot of time defending his bank’s latest restructuring plans.

After firing off a long letter in August to refute assertions made in an opinion piece that appeared in American Banker, his ‘fireside chat’ at September’s Barclays global financial services conference had to cover similar ground.

CEO Christian Sewing announced in early July that the bank would exit most of global equities, including transferring its prime finance and electronic equities franchise to BNP Paribas, for which a master transaction agreement was announced on September 23.

It is retaining what it describes as a “focused” equity capital markets capability. It is shrinking its rates business.

It is also setting up a new corporate bank division that combines its global transaction banking business and parts of its commercial bank, and plans to make this the driving force of the restructured firm.

Risk-weighted assets (RWAs) and leverage exposure related to the businesses it is exiting have been transferred into a capital release unit (CRU), which is being wound down over the next few years.

First up in the Barclays discussion was the issue of how sensitive Deutsche’s plans are to any downturn.

In typical CFO style, Von Moltke chooses his words carefully – not for him the bravado of a Dimon or the sarcasm of a Gorman – but it’s clear he recognizes that there are headwinds in the environment and concerns about how that might affect Deutsche’s chances.

“We’ve seen a more fragile environment over several months, which has been reflected in financial markets and central bank actions to some degree,” he said.

However, while Deutsche’s broad ambitions are sizeable – to put the bank back into the top tier of global institutions – its more immediate and quantifiable targets are less so.

Von Moltke said that the restructuring announced in July was based on a forward financial model that assumed its core businesses would grow in the region of 2%.

“We thought that was modest and in line with GDP growth,” he says.

Back then, his assumptions were growth of 1% in Germany and 2% in the US, although he conceded that expectations might have tailed off a little since then.

However, he added that the bank’s revenue targets were predicated on a compound annual growth rate (CAGR) in the low single digits, which to Von Moltke felt “not especially heroic”. The core investment bank would see an impact from the decision to exit equities sales and trading, but ought to recover, he said.

Cutting to grow

Its revenue growth targets might be small, but in many ways Deutsche’s new plan is still monumentally ambitious: it is, after all, promising to increase revenues while simultaneously cutting costs and assets.

What makes it think it can make that work?

“We’ve laid out a cost trajectory that would see us taking out about €5.8 billion of expenses based on full-year 2018,” says Von Moltke.

“About one third of the cost cut is CRU-related and exits. About one third is synergies in the private bank … where the revenue sensitivity is less than in other areas. And the remainder is in infrastructure areas, so not client-facing, so there is less impact on revenues.”

He conceded that the key was to keep the front office as unaffected as possible, and added that technology investment, while adding cost, was also able to help revenues.

“The equation is not only about personnel and expense,” he adds.

We anticipated that the core investment bank might be impacted by the changes, but as we sit here today the impact so far appears to be less than expected 

 – James von Moltke

One specific example of that, Von Moltke argued, is in the corporate bank – which is where Deutsche is redeploying much of the tech investment wallet that had previously been devoted to the equities division.

Coupling the corporate bank’s deep relationships with its product capabilities and capacity to invest more in technology would make it a direct driver of new revenues, he added.

“I can think of one example where we lost an RFP in Asia with a client, and the reason was that we were behind in the tech requirement that they had,” he says. “As we invest to make up those gaps, we can be at least at or ahead of the competition.

“With a lot of the client base we will win a tie in those areas, so we have an opportunity not just to grow with the market but to regain market share.”

Unintended consequences?

The unknown at the time of the restructuring announcement was the extent to which Deutsche’s decision to pull back in areas such as equities might affect its appeal to clients in other areas – or indeed its overall perception.

When it reported second-quarter earnings in July, the bank revealed it had contacted 5,000 clients in the wake of its restructuring announcement to find out their views.

Von Moltke has now provided a little more colour on this opinion-gathering exercise.

Christian Sewing

Of the clients that used Deutsche as a markets intermediary across rates and equities, he said, the number for whom the equities exit would affect their willingness to do business with the bank in rates was a low single-digit percentage – and this feedback had been supported by their behaviour since then.

“Yes, we anticipated that the core investment bank might be impacted by the changes, but as we sit here today the impact so far appears to be less than expected,” he says.

The bank’s FICC business, he maintained, was a “truly excellent world-class franchise” when it came to credit trading, a business unaffected by the recent changes.

FX was a big part of the franchise and equally unaffected – the bank recently rose from eighth to second place in Euromoney’s annual foreign exchange survey – and was one of the ways in which the investment banking and corporate bank would have strong ties in the future.

In rates, Von Moltke acknowledged that the bank needed to take action to make the business as profitable as possible, as it had struggled to do this in the past against the resources it consumed.

“We’ve been at work to reshape the franchise, leverage our investments in technology, to be as STP- and tech-oriented as we can be, and on the other side leverage the franchise we have in complex and structured products,” he says.

Von Moltke wouldn’t elaborate on the third quarter’s progress in capital markets revenues ahead of its next earnings report on October 30, but emphasized that the goal was to stabilize revenues “over the next several quarters”, track the market and then rebuild market share.

In recent quarters, revenues had grown by 1% to 2%, in line with the long-term trajectory, he said.

Some 70% of the bank’s revenue base, however, was in the more stable businesses of private banking, corporate banking and asset management, he reminded investors.

Progress so far

Von Moltke avoided a direct answer to the question of whether the bank would be able to rule out a capital increase in the next two years, preferring to focus on the fact that Deutsche had always said the restructuring would be executed via existing resources.

Effectively, the bank is financing its plans through deleveraging, hence the critical nature of the CRU and its run-down.

“We are confident that we can do that,” he says. “We have the levers in our hands.”

The bank has said it will aim to stay above a common equity tier-1 ratio of 12.5%, marking a lower point than its previous target of 13% and the 13.4% it posted at the end of the first half of 2019.

The leverage ratio is targeted at 4% this year and 4.5% next year, and Von Moltke thought that this was comfortably on track, given that the bulk of the €280 billion of leverage exposure within the CRU would have been removed by the end of 2020.

We always said that the US would remain a critical part of the business, and to us as management there are obvious reasons why that is the case 

 – James von Moltke

Deutsche Bank’s restructuring plans in July showed the bank’s predictions for its RWA reductions within the CRU – with operational risk notably slower to run off than credit and market risk.

The bank has estimated that while CRU credit and market RWAs will fall from €38 billion to €6 billion in 2022, operational RWAs will fall from €36 billion to €28 billion.

Von Moltke noted it, but was untroubled.

“It’s a function of the advanced model for operational risk RWA,” he says.

Over time, the bank’s loss history would change, and therefore so would the inputs into the RWA model.

“Equities was only a modest loss history, but as you exit equities those events fall out of your history, and that improves operational risk RWA,” adds Von Moltke.

US commitment

Some former Deutsche bankers remain surprisingly defensive about their old shop, and one thing guaranteed to upset them and those still at the firm is the oft-repeated suggestion that the bank is on the point of exiting the US.

Certainly there has been change in the Americas operation recently, with new head Christiana Riley taking over from Tom Patrick and a few high-profile investment bankers having left.

However, the bank is adamant it remains committed to the region, and Von Moltke thinks talk of any withdrawal shows a misunderstanding of how the bank plots its course.

“There has been lots of speculation, but in many respects the idea that it would be geographical strategic decisions rather than business-line decisions always missed the mark,” he says.

“We always said that the US would remain a critical part of the business, and to us as management there are obvious reasons why that is the case.”

Among those are the country’s importance to Deutsche’s corporate bank, the unit from which the bigger rebuild is supposed to be driven.

The bank is a dollar clearer. In the investment bank, it covers industry verticals globally, and the US is an important market in all of those. Dollar capabilities are a vital part of its institutional franchise too. And to serve corporate debt issuers, the bank must be able to offer dollar issuance and dollar swaps.

Viewed in that light, Deutsche would need to want a far more radical shrinking of multiple business lines to consider even a partial withdrawal from the US – and it’s clear that Von Moltke believes that it would struggle to serve its global clients at all if it were to do so.

It’s a stark example of the theory of critical mass, and of the challenges that Deutsche has wrestled with for years: cut right, and the result is efficiency; cut too far, and the result is failure.

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