Deutsche good or Deutsche bad – update 04

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There has been a lot of headlines just recently about Deutsche bank. This article takes a look at the various scenarios.

  • Equity impairment (capital raise).
  • Equity repayment (sale of assets).
  • Market uncertainty (the pending fine)
  • Market clarity (what happens next)
  • Business going forwards (or loss of)
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Into the detail

Outside the plethora of media propaganda and hearsay, investors have access to Deutsche Bank financial results (annual reports) on this link.According to the first line 2015 annual report “2015 was a challenging year for Deutsche Bank“. The first obvious takeout, is that investors are in for the long run with strategy 2020 which takes on 4 key deliverables.

  1. to become simpler and more efficient. (cost)
  2. to become less risky by modernizing our technology. (cost)
  3. to become better capitalized. (cost)
  4. to run Deutsche Bank with more disciplined execution. (cost)

All the above indicate limited returns for equity risk out to 2020 assuming the bank meets its targets.

Here are the headline numbers (or not) that come out from the above.

  1. eliminate approximately 90 legal entities – so this is 45 per year or 1 every fortnight.
  2. “We aim to modernize our IT architecture, for instance by reducing the number of individual operating systems” – this is simply an open cost with no headline value leaving the investor open on risk.
  3. reduce Risk Weighted Assets (RWAs) from €410 billion to €320 billion by 2018 and €100 billion by 2020. – this is over €100 billion per year of RWA (€8.5 billion per month continuously for 3 years).
  4. no value assigned to this task again leaving the investor open on risk.

The bank will also exit from legacy Rates assets, Agency Residential Mortgage-Backed Securities (RMBS) trading and high risk-weight securitized trading. This translates to significant reduction in top line revenue. even before other activities such as Emerging Markets Debt, Rates & Credit OTC clearing are rationalized!

Image result for arrow picture  Margins will be slim.

The well reported drop in market capitalisation leaves the bank at less than 50% of it’s 2015 reported v

alue.

Is this discount enough or has the market, in fact, not priced in enough (as may be the case from the open $14 billion department of justice fine) which at the current point in time represents the entire market capital of the firm.

Forward looking business prospects

The market should be expecting loss of revenue. Last week it was reported that hedge funds were reducing exposure to the bank. Clearly, this is a move that may make sense. One expects to see other customer types act in a similar manner and headlines will show this over the coming weeks & months.

Headlines now report that Deutsche Bank has seen some outflows from its wealth management division but that withdrawals are “not significant”, citing senior executives. Fabrizio Campelli, head of Deutsche’s global wealth management business, is reported by Reuters to have said that outflows “is not something that has resulted in any material concern for us”.

The is no clarity at this point on the value of “not significant” as a percentage of clients, nor the rate of dec

line. However, over time, this will become clear, albeit potentially at a point that is too late for shareholders.

Here are the facts that are available:

  • Wealth management client assets managed by Deutsche Bank stood at EUR 361bn as of end-June, with clients in Europe accounting for just over half of that amount and Asia-Pacific clients making up 14% of assets.
  • Deutsche Bank is also said to be implementing a hiring freeze amid cost cuts. Reuters and Bloomberg report that an internal memo was sent to divisional COOs yesterday saying that hiring will be put on hold with immediate effect, excluding some control functions like compliance. (The market was expecting this).

What is obvious at this point in time is: [1] reduction in top line revenue (from a high margin source) & [2] a cost increase as producers (organically) reduce and cost centers increase.

 

When the trend is not your friend

If historic performance is anything to go by, the global long term view of DBK returns to shareholders, look at best anemic. The share price clearly indicates no value creation by management, or otherwise, for the duration of the past 20 years.  In fact, what investors have seen is continual value destruction.

The only caveat to the above has been a consistent dividend. This has now been stopped.

When the trend is not your friend

The US settlement

This morning news comes out about a DBK settling with the US Department of Justice (simultaneously Credit Suisse also settles for $5.3 bill).

As a reminder the scandal dates back to 2005 and 2007, when banks packaged up home loans and sold them on to investors.

Under the settlement, Deustche Bank will pay $3.1bn and provide $4.1bn in compensation to customers. Our simple maths comes to a total value of $7.2 bill. This was larger than the base case discussed, but still well within the total claim of $14 billion set by the US DoJ. The market has so far taken this as a positive.

The share price post the news stands at €18.5, which remains a hefty discount to book (at 36% book and 43% tangible book) with the market capital at €24.5 billion.

In summary, whilst large, the market will see this as a step forwards and removal of a large unknown.

The full article from the DBK newsroom page can be found in the link below:

https://www.db.com/newsroom_news/2016/ghp/deutsche-bank-agrees-on-settlement-in-principle-with-the-doj-regarding-rmbs-en-11789.htm

 

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