Deutsche Bank is facing a momentous challenge just as chief executive Josef Ackermann finds himself embroiled in the second part of a time-consuming court case. The overhaul of the German operations is bearing fruit, an emphasis on cost-cutting appears to be taking root and a new sense of pride and achievement is evident. But the need for a retail network outside Germany, the US challenge and a couple of badly performing major units require the full attention and strategic skills of a round-the-clock CEO.
Yet Mr Ackermann, chairman of the group executive committee, is spending up to two days a week in Düsseldorf and, as The Banker went to press, prosecutors were tabling fresh allegations which could see the case, regarding bonuses awarded at Mannesman in 2000, last until the autumn. While in London commentators assume it is a show trial that will deliver an innocent verdict, in Germany it is exactly the opposite. “The outlook is not too good,’’ says a local lawyer. The German press is hostile to the Swiss-born CEO. His jokey “V” for victory sign while waiting for the judge was widely publicised, although it was in fact part of a private conversation.
Josef Ackermann: the German press is hostile to the Swiss-born CEO
Meanwhile, Rolf Breuer, chairman of Deutsche’s supervisory board, who was responsible for the first phase of transformation, is also involved in a court case regarding media company Kirch.
In addition, Jochen Sanio, head of BaFin, the chief financial regulator, recently issued a thinly veiled warning in an interview in Wirtschaftswoche magazine that a guilty verdict would lead to 56-year old Mr Ackermann losing his job.
Although the bank says he would in such a case appeal – which could take years – and the board is planning for a succession just in case. There is no substitute for having the captain at the helm.
This is especially true for a management structure – much changed from a few years ago – where a system of competing fiefdoms plays a big role. The seven business heads on the powerful group executive committee meet once a month.
“Think of it as a holding company structure where you have a strategic CEO and delegates who run their respective businesses. Versus other institutions, we are one where the business leaders have enormous day-to-day independence because of Joe’s personal style and because of the way we’ve evolved,’’ says Anshu Jain, head of global markets and arguably the most influential member of the committee because of the outstanding performance of his business.
The fixed income, sales and trading unit was responsible for one-third of Deutsche’s total revenues in 2003 and some analysts argue it was responsible for two-thirds of the bottom line – a claim that the bank will neither confirm nor deny.
The bank posted a 163% rise in underlying pre-tax profit to d3.6bn in 2003 on the back of underlying revenues up 9% to d21.9bn.
But the decisions needed are strategic: what should Deutsche do next?
In search of a merger
The bank admits discussions with Citigroup, although it says the press has misinterpreted the seriousness of the talks. It has been talking to European banks as well. A European bank chief executive says: “They see their salvation as a leap into a merger. The natural deal is with Credit Suisse.’’
However, the Bundesbank has made it clear it sees a need for a German champion and Deutsche fills that role, while top executives dismiss the idea that Deutsche Bank is being polished for sale. Some group executive directors are also wary of appearing on the acquisition trail.
“We have critical mass in all our businesses so going forward we can concentrate primarily on internal growth,’’ Clemens Börsig, chief financial officer, told the Banker in the bank’s twin towers in Frankfurt. “As to external growth we have very strict criteria, for example, strategic fit and the numbers must add up. There aren’t that many opportunities around these days.’’
But for the two main areas that board members admit are weaknesses, acquisition looks like the only solution. The US is the first. To be among the top three investment banks in the world, an aim held by Deutsche, a large US presence is crucial because of the size of that market and higher fee levels. “The US alone accounts for 60% of profits in the institutional capital markets,’’ confirms Mr Jain in his office off the bank’s trading floor in the City of London.
Global standing
The 1999 acquisition of Banker’s Trust went only part of the way to filling that gap and organic growth cannot make up the slack. When it comes to league tables, in the US the bank is typically about number 11 in M&A and number eight in equity capital markets, compared with a place in the top three in several European countries. In fact it was number one in European investment banking in the first quarter of 2004, according to Dealogic. The US affects Deutsche’s global standing (see Dealogic tables overleaf).
Another member of the group executive committee, speaking on condition of anonymity, is adamant that investment banking mergers do not work. In the US, breaking into the top three slots is extremely difficult, but below there is a lot of change, he says.
As to whether Deutsche Bank is the name for a global bank, the board is currently listening to a consultant’s report on the issue.
Retail is the second challenge. Mr Jain says: “The absence of retail outside a handful of countries is our chief missing piece, particularly for me in fixed income. We have got a strong retail presence in Germany, Italy and Spain, but little elsewhere. As spending power gets channelled more to retail, retail gets more sophisticated and becomes a bigger consumer of structured products, hedge funds, alternative assets and so forth.’’
Rival Citibank, for example, has access to large numbers of retail consumers.
The problem for Deutsche Bank is obvious: taking a gamble – which any acquisition or merger is – is impossible without a full-time CEO.
The Mannesman trial has put six former directors of the telecoms group in the dock over the award of almost d60m of executive bonuses in 2000, shortly after the takeover by the UK’s Vodafone. Mr Ackermann as a non-executive director approved the bonuses. The judge’s interim verdict that none of the defendants had a criminal case to answer was ignored by the prosecution which has insisted on grounds for further accusations involving the bonuses. Deutsche’s CEO is declining all interview requests at this time.
The former CSFB banker also appears crucial to Deutsche for other reasons.
“I think Mr Ackermann is very important to Deutsche as he is the only man who can bridge the gap between the London investment bankers and Germany. He can speak the language of the parochial Deutsche Bank stick-in-the-muds and the kick-ass Anglo-Saxons,’’ says a London-based analyst.
New generation of executives
Even allowing room for the exaggerated stereotypes, the comment rings partially true. But according to a highly-placed executive within the bank, there has been a generational change in many of the bankers in Germany: “Many from 1995 are retired, so now there is a new generation with university degrees, educated abroad, who run German [local] offices like Hanover.’’
Also, the German operations have been transformed in recent years and the accepted wisdom, that if Deutsche could it would exit Germany, looks mistaken.
This is not to say there are no disadvantages. The German retail market’s fragmentation and unfair competition restricts pricing power. The country’s corporate tax rate is high (Deutsche’s was 43% last year) and it is both difficult and expensive to make redundancies.
“Germany is of vital importance to us,’’ says Mr Jain. “The onerous part is being a national champion. There is pressure on us to lend and to support other banks. But sitting inside my franchise, Germany is a jewel. It is the world’s third biggest economy where we still have a tremendous franchise. One of the value propositions that allows us to get into the US and UK board rooms is our ability to deliver Germany.’’
What the bank has been doing in the last years is to discontinue lending to companies when the relationship is unprofitable. A very public spat with Volkswagen in 2003, when Deutsche dropped out of a syndicated loan for the car manufacturer, proved the point. Deutsche’s historic client list was 10,000, almost all of whom the bank loaned money to. The bank whittled this down to 2000 and aspires to cut this to 500.
Ultimately, the aim is to extend less loans and to sell more equity, high yield and other instruments to German corporates. The bank is proud of where is stands on value at risk when it comes to sales and trading as – unlike its US rivals, bar Morgan Stanley – it is in the left top quadrangle for high revenues and low risk. A top executive believes the risks in sales and trading activities are overrated and that loans can be more risky.
In 2003, total loans fell 14% while non-performing loans fell 40% to d6.6bn. The bank has further to go in this area. It says introducing market-based loan pricing is an ongoing process in its global banking division. This division was combined with global transaction banking, where the bank has a leading market position in cash management, trade finance and various other services. Underlying pre-tax profit for the newly merged unit fell 56% mainly due to the sale of its custody business, says the bank.
Meanwhile the Mittelstand (mostly family-owned German small to medium-sized enterprises), especially the upper end, provide an opportunity to cross-sell Deutsche Bank products. This is not to say the business unit is yet profitable – Deutsche does not reveal the numbers – but it is on its way. And there is obviously still tension. “The global banking division takes in Germany. They are like poorer country cousins who are not paid well and have hair in unlikely places,’’ says a top Deutsche banker.
Clemens Börsig: ‘strict criteria for external growth’
Anshu Jain: ‘absence of retail is our chief missing piece’
Private and business clients
The Deutsche Bank structure involves two overreaching units, Corporate and Investment Banking (CIB) and Private Client Asset Management (PCAM). Of the seven business divisions, Global Corporate Finance (GCF), Global Equities (GE) and Global Markets (GM) are in CIB, while Deutsche Asset Management (DeAM), Private Wealth Management (PWM), Private & Business Clients (PBC) and Global Banking Division/Global Transaction Banking (GBD/GTB) are in PCAM (see table page 23).
As for the much-maligned retail segment, grouped with the mass affluent and professional businesses in the private and business clients unit (PBC), it has a new lease of life following some years of flip-flops from the bank on whether it wanted to stay in that business.
Although last year underlying pre-tax profit fell 14% to d459m, this included restructuring costs. “If you take that out, for PBC we had a significant increase of d770m [in underlying pre-tax profit]. We have brought down our cost/income ratio and we won’t cut more [employees] so the improvement has to come on the revenue side,’’ says Rainer Neske, head of the unit and a member of the group executive committee.
PBC has doubled the mobile salesforce who live off commission only. In 2002-2003 it made 3400 staff redundant and cut German branches from 1042 to 770.
Mr Neske also emphasises that a 6%-7% share of the retail market may not seem much but, when it comes to more profitable segments, the market share is higher. “In banking for professionals it ranges between 15% to 20%,’’ he says, adding that in private banking “we are still number one in Germany”.
Along with PBC, Asset and Wealth Management is the other component of PCAM. PCAM is the business division responsible for 29% of pre-tax profit, compared with Corporate and Investment Banking, the other major division, responsible for 71% of pre-tax profit.
Those numbers show that there is still a lot of work to be done. PCAM is one of the biggest fund managers in the world, larger than Citigroup and Credit Suisse, with d872 in invested assets. These grew an uninspiring 2% last year.
“In PCAM, we think private banking is the clear under-performer – they make far too little money given the d160bn funds under management,’’ says Stuart Graham, European banks analyst at Merrill Lynch.
“The cost/income ratio was over 90% for most of 2003, and we suspect it was above 100% in the Alex Brown business. We question where the private banking business is going. Organic growth will be a long haul and there is nothing obvious – or cheap – to buy which would transform the business line. We also think there is work to do on the institutional asset management side – they still need to knit together the different equity franchises, where they appear too silo-based. Overall, PCAM’s assets are of good quality but the profitability is disappointing,’’ Mr Graham adds.
Private wealth management
Potentially good businesses in PWM (for clients with assets over d5m) and the asset management units have mixed performances. Asset and wealth management minus severance payments together saw a 50% increase in underlying pre-tax profit to d739m in 2003, but the bank will not reveal how this divides up.
In the absence of an acquisition, PWM is looking to selectively hire senior relationship managers and upgrade its product mix and pricing structure. Competitors are not yet trembling in their boots. “They haven’t been able to attract new clients, they have a high cost base and their performance is not good,’’ says a member of the board of a Swiss competitor. “There are lots of CVs flying around from Deutsche Bank employees in private banking, but a lot have already left.’’
Pierre de Weck, who was brought in to sort out PWM, has a very mixed reputation in the business. He left UBS acrimoniously, having run the private equity business which saw huge write-downs.
In Deutsche’s asset management unit are grouped businesses with very different performances. One, its passive management business, was sold at the end of 2002. Another, DWS – Europe’s largest mutual fund group with a 25% market share in Germany – is outstanding in terms of performance and profitability.
However, London-based DeAM is a different kettle of fish. It is reorganising the UK business, which has around d578bn of assets under management, in a bid to improve performance. It is currently seeking to reduce its reliance on balanced fund management which has been losing popularity.
“Morale in London is rock bottom,’’ says a DeAM fund manager, who is expecting more redundancies. “Managers here are giving off an inconsistent message. [Tom ] Hughes [member of the group executive committee and head of asset management] is a nice guy but, as an ex-investment banker, he does not know the business.’’ Another fund manager suggested that “Ackermann is very distant from asset management”. Rumours that DeAM might be sold are denied by management.
Then there is the acquisition of US fund manager Scudder Investments in 2002 for $2.5bn. “Scudder has been a complete disaster. [We calculated that] if we had poached the fund managers we are left with [as opposed to those who were fired or have left] we could have paid $53m for each,’’ says a fund manager at the bank.
Mr Börsig disagrees: “We knew exactly what we bought. A strong brand, a broad product range and a loyal customer base, but an underperforming business which needed restructuring. We got what we wanted at an attractive price. The restructuring was successfully executed. A few managers left us by design.”
Lofty ambitions
What the bank really wants, though, is to become a top 10 financial institution by market capitalisation. Mr Ackermann believes that the aim of a 25% return on underlying pre-tax equity in 2005 will deliver this. The ratio stood at 13% in 2003 and 4% in 2002.
“If you believe management can achieve its target of d6.5bn in 2005 pre-tax profits, when the stock is trading at a [price/earning ratio] of less than 10 times, the shares are cheap,’’ says Alastair Ryan, European bank analyst at UBS. “We don’t think they’ll get there, but we do think they are making substantial progress towards their goal and this has not been discounted by the markets.’’
UBS forecasts pre-tax profits of d5.6bn in 2005, higher than the many other analysts who come in at d4.8bn-d5bn.
Deutsche, though, has record of disappointing the market, as Morgan Stanley points out in a research note: “But we’ve been here before (remember the erstwhile target of d5.9bn for 2003). On that occasion over-enthusiasm for the revenue opportunity (especially in equities and on reinvestment returns) caused a miss. Are they making the same mistake this time around with the debt markets?’’ (see box on page 22)
Deutsche has also failed to get its shares up to d100 despite 2002’s Project d100. “Project d100 was launched when the share was at d55. It is now d75 and d100 is a small step away. It should be superseded by Project d150!’’ says Mr Jain.
To reach d6.5bn in 2005 the bank is assuming a cost reduction of d800m, lower provision for credit losses of d400m, a negative d300m due to currency movements and d2bn of revenue growth. The underlying cost/income ratio stands at 79%, down from 89% in 2001. The bank’s undeclared aim is for it to fall below 70%, a steep ambition, when it has holes to fill, such as cash equities and M&A advisory.
But it will be helped by its still large asset base. Deutsche, even now, has major industrial holdings such as car manufacturers DaimlerChrysler and Fiat, worth a total d4.6bn, although this is sharply down from d6.1bn in 2001. The bank is expected to continue the disposal programme that had slowed down on the industrial front in the last year, although it sold its global securities services unit to US company State Street in late 2002 and in February 2003 sold down d1.5bn of the private equity business.
Remarkable turnaround
What must not be lost sight of is Deutsche’s astounding transformation. There is one telling statistic: in 1989, 85% of revenue came from Germany. In 2003 this plummeted to 33%.
In 1985 Deutsche and Dresdner were mentioned in the same breath as rivals. The former is now, arguably, a bulge bracket bank, while the latter has been left far behind.
In The Banker’s Top 1000 list, due out in July, we anticipate Deutsche Bank’s position at number five in terms of assets will not change significantly. Yet its d803bn in assets is not matched by a similar position in terms of market capitalisation. There it is only number 17 with $48.3bn at the end of the first quarter, according to Thomson Datastream.
In 2003 the share price increased about 50%. This was due to renewed investor optimism about its transformation plus a share buy-back programme. But whether “the Robert Redford of investment banking,’’ as Mr Ackermann is called by a colleague, will have enough time to bolster the share price to where Deutsche Bank can be an acquirer, is another matter.
Deutsche responds to its critics The bank is too dependent on fixed income when that market has peaked: “Our business is primarily dependent on customer flows, and those in turn are disproportionately influenced by volatility. We have a model that makes money if bonds are going up or down, as long as they move,’’ says Anshu Jain, head of global markets.
A top US former competitor says Deutsche “suffers because in more traditional business like debt underwriting, treasury, etc, people come and go. It pays more than anyone else, but it does not integrate them”:
Mr Jain says: “Most debt houses either emphasise bulk distribution of relatively simple products or concentrate on exotic products where the margin is greater. We think that is a false choice.
“Our business model is all about presenting clients with a compelling value proposition right across the product spectrum. It’s true that, in terms of profitability, 70%-80% of a well-run fixed income franchise’s bottom line will come from getting derivatives right. That’s why we are an undisputed market leader in derivatives.’’
Deutsche might sell its asset management business because of lacklustre performance: A top Deutsche banker says: “It’s three businesses. One piece is excellent and we are trying to raise the performance of the other two. DWS is world class. Scudder is an acquisition which will take time to judge. Institutional fund management, which is what DAM does, is hard, a difficult business to make money in. We need to create efficiencies there.”
The fragmented management structure puts paid to synergies on the cost and revenue side: The bank argues it has a culture of compartmentalisation, which has been partly overcome in recent years. As it works towards a one-bank culture, cross-selling is on the increase. The fact that most of the bank’s top people are significant shareholders gives an added incentive, says a member of the group executive committee.
Deutsche is not a well-oiled machine. In February this year employees were told what their bonus was. But at the last minute Josef Ackermann said Corporate and Investment Banking had put salaries up too much. So bonuses were delivered but it was only a couple of weeks later they got letters detailing the increase in their salaries:
A senior banker says it disconnected the bonus and salary because the former deals with last year and the latter with 2004. He argues more time was spent on salary adjustments as part of cost discipline.
Deutsche’s preferred use of underlying pre-tax profit is an accounting distraction from the constant series of one-off items: Clemens Börsig, chief financial officer, says, “The use of underlying figures in addition to reported numbers was necessary to make our disclosures more transparent as we had to deal with a series of one-off items.
“Since the second quarter of last year those one-offs are out. Now underlying and reported figures have come very close.”