Since taking over troubled German lender Deutsche Bank back in April, Christian Sewing has watched the recidivist lender’s troubles go from bad to worse.
On Friday, the bank’s shares reached an all-time low; they’re now down 50% YTD, making Deutsche the worst performer in a poorly performing index of the world’s largest global banks. The latest selloff was inspired by the Frankfurt prosecutor’s office deciding to raid six Deutsche buildings, including the bank’s headquarters The raid, which continued for two days, doubled as the first public revelation about the latest criminal scandal involving Europe’s biggest bank by assets, which has already paid $18 billion in legal penalties since the financial crisis. Prosecutors revealed that they were investigating at least two employees in the bank’s wealth management unit (part of the division overseen by Sewing before he took the CEO job) for allegedly helping customers set up accounts in offshore tax shelters and helping criminals launder their ill-gotten gains – allegations that prosecutors said were inspired by the infamous ‘Panama Papers’ leak. During their raid, prosecutors searched the offices of five senior Deutsche executives, including the bank’s chief compliance officer, who was rumored to be leaving the bank in a report published just days before nearly 200 police officers, tax inspectors and prosecutors showed up outside Deutsche’s international headquarters and demanded that everybody step away from their computers.
Given the abysmal week the bank just had, it’s hardly surprising that the financial media has published a barrage of negative stories featuring anonymously sourced quotes from Deutsche “investors” effectively demanding that, if Sewing can’t get his shit together in the next quarter or two, he will need to abandon the “strategic alternatives” (cost-cutting, shifting the bank’s investment strategy to emphasize growth in wealth management) that he championed as a road toward salvation (alongside cost-cutting, of course) and seriously consider a sale.
While many of Deutsche Bank’s largest investors, contacted before the raids, said they still back him, they argued he only has another quarter or two to prove his approach can work. At the same time, strategic alternatives are getting ever more painful for shareholders because of the low stock price.
The bank just finished slashing 10,000 jobs across its global operations. But after posting a Q3 decline in net income that was the largest in eight years, many investors (possibly even the activist investor who disclosed a 3% stake in the bank back in November, arguing that he was going “all in” on Sewing) will push for another wave of layoffs. And even cutting its global workforce to the bone may not be enough to bring the bank back toward profitability (particularly if it is slapped with another mutli-billion dollar fine).
Other investors are bailing out of their Deutsche Bank stakes: Chinese conglomerate HNA is reportedly still in the process of offloading its stake in the lender, held through a complex array of derivatives. And out of the top ten largest positions in DB, two are net short.
Meanwhile, Cerberus Capital, which owns stakes in Deutsche and rival German lender Commerzbank, is reportedly pushing for a merger between the two, something it believes will allow for the elimination of “redundancies” (i.e. tens of thousands of jobs) that would improve the overall profit profile of the combined lender.
But Sewing isn’t ready to give up just yet: And given the bank’s historically weak share price, a merger would almost inevitably result in DB becoming the junior partner in whatever conjoined entity would emerge. Which is probably why Sewing spent the weekend rebuffing rumors of an imminent takeover, as Reuters reported.
Speculation about a possible merger has continued despite the bank’s dismissal in September of reports that it could consider tie-ups with Switzerland’s UBS (UBSG.S) or German peer Commerzbank.
“I don’t have any indication of that,” Christian Sewing told Bild am Sonntag. “We are on track to make our first profit for three years. It is only a matter of time before this progress is reflected in the share price.”
To be sure, rumors about a possible merger, takeover or even a breakup of Deutsche have been circulating for years. But if the bank’s shares continue to flounder, its CEO may not have a choice. Several consecutive CEOs have now failed to realize their grand visions for a turnaround, and shareholders are growing impatient. With this in mind, we feel like now would be as good a time as any to take a moment to review the bank’s (limited) options for survival. To that end, we’d like to share some insights from a quick rundown provided by Bloomberg, which are quoted in full below (emphasis ours):
Sewing took over in April with a mandate to accelerate cost cuts, but he has recently emphasized efforts to invest again in growth after years of falling revenue. Still, additional savings aren’t entirely off the table. The CEO said privately that he’ll review his strategy if it’s becoming clear that it’s not working, a person familiar with his thinking has said. His current plan has set only vague targets beyond 2019 and investors will likely soon demand more detail.
Further reductions to the U.S. operations would be welcome, two large investors said asking not to be identified discussing individual investments. Wherever the bank will shrink, it won’t be at the expense of revenue, Chief Financial Officer James von Moltke has said.
A German Merger
This is the option that’s been most hotly debated in the past year. Cerberus Capital Management, the biggest private investor in rival Commerzbank AG, a year ago revealed owning a large stake in Deutsche Bank, too. A deal would enable the newly formed bank to cut possibly tens of thousands of jobs, hundreds of branches and an uncounted number of IT systems, positioning it for higher profit in the overbanked German market.
Many top executives agree it could make sense for the two to join at some point, according to people briefed on their thinking. But they also say a tie-up would be difficult as long as both banks are locked in multi-year turnaround programs. The long, painful decline in the share price of Deutsche Bank, the larger of the two, is another obstacle, though it may make a deal more palatable to Commerzbank.
A European Deal
Many people inside Deutsche Bank prefer a merger with a bank outside Germany that would complement the German lender rather than making big parts of it redundant. The bank’s top executives and its supervisory board went through several scenarios at their annual strategy meeting in September, though in the end decided that the time isn’t right.
The biggest obstacle to such a scenario, again, is Deutsche Bank’s low share price. Any deal at the current valuation means Deutsche Bank may end up as the junior partner. UBS’s market capitalization, for example, is more than twice as high. A higher share price would open more strategic options for Deutsche Bank, a key reason why top management is opposed to making a decision too soon, according to one of the people.
A less disruptive approach to grow some revenue would be a joint venture. Sewing has repeatedly touted the idea over the past few months as an alternative to bank consolidation and a way for European banks to bulk up retail platforms against a potential threat posed by large Internet firms such as Google, Amazon and Facebook.
Deutsche Bank has already teamed up with other firms to create online product offerings such as the digital identity management app Verimi. But that is a very small start. If Sewing really sees joint ventures as an alternative to mergers, he must have bigger things in mind.
While Sewing is trying to win over shareholders by showing his current plan is starting to bear fruit, he’s been discussing changes that would make a deal simpler to execute. The lender has been weighing a move to split its core businesses under a holding company, a measure that would make it easier to break up in a crisis and more agile in potential mergers, people with knowledge of the discussions told Bloomberg in September. Implementation would face many regulatory and operational hurdles, however, and CFO von Moltke said the discussions were “not strategic.”
A holding structure would also make it easier to split up the bank into a retail lender and an investment bank. A proposal to do so was tabled at the last annual general meeting in May. Although Deutsche Bank’s management board recommended voting against the proposal, arguing that splitting the bank would damage the business, it still received more than 5 percent of the vote.
There’s still a chance that no change in plan will be needed. Some regulators and several investors agree that it will be hard for the bank at the current juncture to pull off a deal that radiates strategic vision rather than desperation, the people said. If Sewing manages to stabilize earnings – despite the fresh headwinds – investors may regain confidence.
While this latest investigation into Deutsche is the most prominent facing the bank right now, it is by no means the only one. The bank still has a massive derivatives exposure of roughly 48 trillion euros – equivalent to more than 3x the GDP of the European Union.
More than two years ago, Deutsche Bank Chief Risk Officer Stuart Lewis assured investors during a widely circulated interview not to worry about the bank’s derivatives exposure (which was cited as one reason why the IMF had, at the time, just labeled it the most systemically risky bank in the world). “We are not dangerous”, he said.
Clearly, the market disagrees.
Just remember, DB is not LEH…