Deutsche Bank: not necessarily too little but arguably too late.

Deutsche Bank’s grand restructuring plan comes with significant execution risk. Even assuming everything turns out as planned, the fact remains that most of the big European banking groups are years ahead in their redesigns. Competitive success for Deutsche Bank is not a given.

Scope downgraded Deutsche Bank on 28 May, saying “the road to successful business-model recalibration and a return to sustainable profitability is still steep and fraught with uncertainties”. Sunday’s announcements don’t change that.

“We anticipated drastic action when we downgraded our rating to BBB from BBB+, leaving the bail-in debt at investment grade (BBB-),” said Dierk Brandenburg, team leader for financial institutions at Scope Ratings. “Our Stable outlook anticipates that Deutsche will manage through this period with a minimum level of recurring operating profits as it cuts costs and repositions the balance sheet.”

The bank is targeting a group RoTE of 8% by 2022 and a cost-income ratio of 70%. The RoTE target for the heavily-filleted investment bank (even without loss-making equity sales and trading) will be no more than ‘more than 6%’. Those numbers may be ambitious from where Deutsche Bank stands now. But even after taking out EUR 6bn of costs and 18,000 heads, Deutsche group’s cost-income ratio will still be high for the industry.

The large US universal banks are operating with efficiency ratios in the mid-50s; the large UK banks straddle the high-50s to low 60s area. The large French banks tend towards the mid-70s but are pushing for cost efficiencies. Deutsche Bank will therefore sit at the upper end on a comparative basis. As for returns, the big international US universal banks are operating with returns in the low to mid double digits, thanks partly to higher interest rates. Most of the large European banking groups have returns in the high single-digits to low double-digits. Deutsche Bank will therefore be at the low end.

CEO Christian Sewing’s letter and Deutsche Bank’s accompanying statements were replete with references to fundamental, radical and significant. But what Deutsche Bank plans to do in the next two to three years is no more than what US and European banks have been doing in cascades ever since the end of the global financial crisis more than 10 years ago.

In essence, that means re-allocating capital to areas of strength where you have competitive advantages and to businesses you believe will be sustainably profitable over the long term; right-sizing your cost base to the addressable opportunities; exiting business-lines that lose you money and investing heavily in technology.

Deutsche Bank is doing now what it failed to do in recent restructuring attempts. Only time will tell if it is different this time and whether the new stand-alone corporate bank will earn its keep. Shifting the fixed-income trading business from an institutionally-focused flow monster to a more tailored corporate-focused credit and FX business will not be a trivial matter and will partly depend on how successful the corporate bank is.

Weary stakeholders have been asked to take the content of the restructuring on trust and shareholders will forego a cash dividend for two years, although AT1 holders have been assured that there will be cash to pay coupons (not least due to regulatory changes that significantly broadened the definition of distributable reserves in Germany). Shareholders won’t be called upon to fund another equity cash call – untenable at the level the shares have been trading – but shareholders and subordinated debt holders will have to live with a slimmer capital stack. Having said that, the banks’ senior creditors and counterparties benefit from a substantial buffer of MREL debt.

“Capital levels will remain stretched and barely above regulatory minimums for the coming years, giving the bank very little leeway to catch up with its competitors among peers as well as tech companies that are entering the market at increasing speed,” said Brandenburg.

The Capital Release Unit is bigger than predicted but the extent to which it can free up EUR 5bn of capital to be returned to shareholders starting in 2022 remains to be seen. “Rather than freeing up capital, the asset-reduction plan could end up consuming capital if the bank is forced to sell below book,” said Brandenburg. “It’s worth remembering that when UBS went down a similar route some years ago, it benefited from very good liquidity conditions. It is less certain that financial conditions will be as favourable over the coming years.”

Deutsche Bank was at pains to stress that the CRU is not a bad bank, saying the assets to be transferred are high quality, low return and in many cases short duration. That representation presumably excludes the long-dated derivatives and other difficult-to-value complex assets being transferred.