Today is Deutsche Bank’s results day. Shares in the bank are down 6% since it divulged a €1.9bn net loss in the fourth quarter of 2016, which isn’t great since Deutsche’s most prized staff now need a 28% increase in the share price by 2021 if this year’s retention bonuses are to be worth anything at all.
Maybe things will improve? As Deutsche Bank CEO John Cryan said this morning, the bank spent last year preparing rather than reaping its harvest and the losses shouldn’t be replicated in 2017.
Even so, Deutsche’s disclosures portray a miserable fourth quarter at the end of a miserable year. If it’s going to turn things around in its investment bank, it will need a dramatic break with the past.
1. Every single business in the investment bank under-performed last year
Goldman Sachs didn’t have a great 2016. Deutsche Bank, however, had a worse one. Deutsche’s investment bank under-performed the market in every single business area except equity capital markets (ECM) (where it was in line with rivals’ dire performance). Goldman Sachs, at least, partially redeemed itself in debt capital markets (DCM) in 2016.
2. Deutsche Bank missed out on the Q4 fixed income trading boom
Given that Deutsche has traditionally been a fixed income-focused house, the real cause for concern was its failure to gain an entrance to the 2016 fixed income trading party. Fixed income trading revenues at Deutsche fell nearly 11% in 2016 compared to 2015, despite the positive effects of both Brexit and Donald Trump. Among the other banks to report so far, only UBS revealed a similar fixed income decline – and UBS made the decision to slash its fixed income business in 2012, leaving it unable to capitalize on last year’s events. Deutsche didn’t, and yet still managed to lose out.
Naturally, concerns about the DOJ fine dating back to September contributed to Deutsche’s problem. “Our revenue situation suffered from the bad news,” Cryan confessed today. Worryingly, though, the bank’s rates revenues were flat year-on-year even as other banks’ rates desks reported bumper results. What went wrong there? To the extent that Deutsche’s fixed income trading business did well at all in the fourth quarter, it was thanks to credit, where the bank said revenues were “significantly higher.”
Deutsche’s Europe-focused equities business also missed out on strong conditions in the U.S. The bank said lower client activity in Europe contributed to its 23% decline in equities revenues in Q4. Reduced prime brokerage activity as hedge funds worried about Deutsche’s stability played a part, but the worry now will be that Deutsche will struggle to benefit from strong U.S. volumes this year.
3. And pay per head in global markets was cut by 19%
Is Deutsche in the downward spiral of dreadful performance and dreadful pay? The bank would argue not: several times this morning, Cryan emphasized the bank conducted a “risk assessment” before reducing its performance related bonuses to zero for 2016. The risks are real though. Yes, Deutsche is paying “retention bonuses” for top performers, but there’s skepticism that these are worth anything. Cryan has reassured staff that Deutsche will pay normal bonuses for 2017, but following a 20% average pay cut in global markets last year, the question is how much more Deutsche’s top traders will take.
4. The ratio of unproductive to productive staff has continued increasing
Compounding the problem is the fact that with all the fines for past misdemeanours, Deutsche’s management have felt a need to substantially increase compliance and control staff. As a result, there are now nearly 4 non-productive people to each revenue earner in the bank’s global markets business. The bar to profitability is set higher than before.
5. In the short term, Deutsche Bank will add more compliance staff. In the long term, it will cut them all back
Nor will there be any respite from burgeoning back and middle office staff numbers in 2017. Deutsche says it plans to add another 600 people to its compliance team this year. Someday soon, however, it will cut them all back again. Cryan said the new controls added by the bank are usually, “manual,” and, “by definition temporary.” Soon, Cryan said the bank will introduce, “industrial solutions,” that are, “more lasting.”
In other words, all those new compliance and control jobs at Deutsche Bank will soon be automated.
6. But Deutsche did actually succeed in cutting global markets headcount in both the front and back office
Despite its best endeavours at cutting headcount in the global markets business, Deutsche has failed miserably to make much headway in recent years. 2016 may finally have marked a turning point in this respect: the bank actually succeeded in trimming headcount in both the front and back office last year.
7. The question now is whether Deutsche Bank’s cuts to risk weighted assets, VaR and headcount have damaged its trading business
The real issue is whether Deutsche’s dismal year and dire fourth quarter were symptomatic of a longer term malaise that won’t be undone now that the DOJ fine has been resolved. There are some bleak signs here.
For example, while Morgan Stanley has successfully cut risk weighted assets in its investment bank and increased fixed income trading revenues, Deutsche has failed to do the same. A 2% drop in risk weighted assets at the German bank in 2016 was matched by a 14% drop in changing revenues. Risk weighted assets at the bank are expected to rise at Deutsche under Basel IV, but this may not grant much reprieve to its traders. What Deutsche really needs to do is to increase its “balance sheet velocity” in the style of Morgan Stanley, and there’s not much sign of that happening yet.
The good news is that Deutsche said today that things are improving: “January is looking better” and clients are returning now that the DOJ cloud has blown away. The bad news is that, “not everything comes back in one day.”
8. For the moment, job cuts are over. In the long term, jobs will go to automation
Deutsche has announced the job cuts in its investment bank already. Cryan said several times that the bank can’t award bonuses while its cutting “colleagues,” but he also said that “from today” there will be no more workforce cuts.
This doesn’t apply long term. “Digitalization is core to our strategy,” added Cryan. “Over a long period of time, that will have an impact on jobs.”
9. Meanwhile, trading systems are being rationalized and Sam Wisnia’s new derivatives pricing and risk system is saving the day
Meanwhile, Deutsche is sorting out the systems in its sales and trading business. The bank decommissioned seven operating systems last year and booked €322m of depreciation costs for “self developed software.” It still has a long, long way to go: Deutsche still has 38 different operating systems; ultimately, it wants just four.
As we’ve reported before, Sam Wisnia, whom Deutsche hired from Goldman Sachs in 2014, is considered key to its future. Wisnia is developing a new Goldman-style risk and pricing system for the German bank, which Cryan today spoke of in glowing terms. “The new derivatives platform enables us to value and control and manage collateral for a broad range of derivatives,” said Cryan, “It makes us incredibly more efficient and is a big cost saver. It standardizes the way we look at derivatives across asset classes and improves our controls and saves costs too.” We presume Wisnia’s getting paid then…
10. Deutsche is fully committed to the U.S.
Lastly, Cryan was asked whether Deutsche was still committed to the U.S. now that Trump’s in charge. The inevitable answer was that it is and that the U.S. market is absolutely key to Deutsche’s identity as a German bank with global reach. Cryan tacitly criticized both Trump’s travel ban and Brexit however, saying that the bank is committed to “freedom of movement” and to diversity.