If any doubt lingers that traditional securities trading has faded from a fabulously profitable, glamorous enterprise to a shadow of its former self, the latest news from Deutsche Bank makes this new reality all too clear.
On June 7, Germany’s largest lender announced that its co-CEOs, Anshu Jain and Jurgen Fitschen, would resign from their posts. The new CEO (who technically will share the job with Fitschen until he departs next May) will be John Cryan, a member of the Deutsche Bank supervisory board and former CFO of rival UBS.
What’s remarkable about the shift is that while Deutsche Bank’s leadership will change, the board intends to follow the same basic strategy that failed under the previous regime: bolstering, one might even say doubling down, on investment banking, its primary pillar and Cryan’s area of expertise. Within investment banking, deutsche is wagering heavily on an antiquated area where modernization isn’t its friend: fixed income trading.
Appointed in 2012 to succeed the legendary Josef Ackermann, co-CEOs Jain and Fitschen set ambitious financial goals, and missed all of the big ones by a spectacular margin. In April, the duo unveiled a strategic overhaul with significantly reduced goals. At Deutsche Bank’s annual meeting in May, investors expressed deep disappointment with the plan; only 61% of shareholders endorsed it in a non-binding vote, which clearly shocked the board into action.
Two main factors account for Deutsche Bank’s chronically poor results. First, since the end of the financial crisis, a series of fines, settlements, and restructurings have inflicted billions upon billions of euros in charges on the bank. Those charges were far bigger than the bank’s leaders, analysts, or almost anyone else expected. In the past three years, the bank has paid a total of around $9 billion to settle a Libor-rigging action and lawsuits over its underwriting of mortgage-backed securities, as well as its role in the collapse of the Kirch media empire in 2002. It also dumped troubled portfolios of commercial real estate loans inherited in the acquisition of government-owned lender Postbank in 2008.
The new Basel III capital rules triggered additional losses. Once profitable swaps and assorted derivatives contracts sprung losses when new rules mandated that banks back those volatile contracts with heavy reserves. The tighter regulations forced Deutsche Bank to sell derivatives portfolios at heavy losses.
Similar travails afflicted most big banks in the post-2008 financial order. But Jain and Fitschen wouldn’t have whiffed so badly if Deutsche Bank’s basic operating businesses had posted strong results. Instead, they performed poorly, exploding the forecasts. In 2012, the co-CEOs announced three goals for 2015. First, they promised to achieve a 12% return on “book equity,” as stated on the balance sheet. Second, Jain and Fitschen pledged to reach an impressive ratio of operating costs to revenues of 65%. The third target: Hiking its regulatory capital level to 10% by the end of the three-year window, without raising any new capital.
As for return on equity, Deutsche Bank was faring so poorly in April that the co-CEOs lowered the goal in a big way. The new target is 10% on tangible equity, a lower number since it excludes goodwill. It’s the equivalent of 8% on book equity, four points below the previous bogey. Further infuriating shareholders, they pushed back the deadline to achieve this easier target by five years, to 2020. So far, progress is nowhere in sight. In 2014, Deutsche Bank posted a return on equity of 2.3%. “It will probably be in the low-single digits for 2015 as well,” says Dirk Becker, an analyst with Kepler Cheuvreux in Frankfurt. On the second objective, the expense ratio is now running not in the 60% range as planned, but in the 80s.
The duo did achieve a capital ratio of 10%. But they flopped again, since getting there required raising around $13 billion in new equity capital, diluting shareholders, who’ve fled the stock. Since 2007, Deutsche Bank’s share price has dropped from $150 to $33, erasing $100 billion in market value.
The poor performance of investment banking, and growing doubts that this will change any time soon, most seriously calls the bank’s current strategy into question.