Negative energy, nuancing and the race to get fixed

9 min read

Credit Suisse pulled what many in the market considered the proverbial rabbit out of the hat on Thursday, eking out a net profit attributable to shareholders of SFr170m in the second quarter. Even though that’s 84% down on the year-ago quarter, it beat the SFr302m loss in the first quarter. BNP Paribas was also out this morning, with, in summary, a set of okay/ho-hum numbers (FICC something of a highlight, up 16.7% year-on-year).

Generally speaking, the way Credit Suisse’s earnings were positively nuanced in reaction came in stark contrast to the way in which Deutsche Bank’s numbers were greeted Wednesday. I guess reactions are invariably always based on a combination of prior and future expectations. Expectation management remains crucial. Witness UBS, out on Friday with no real expectations around second-quarter numbers (i.e. expectations managed well) hence no drama, I imagine, even if the numbers err to the downside as expected.

I do find it fascinating that while Credit Suisse is clearly still in the midst of its restructuring, just as Deutsche Bank is, people at the margin seem far more inclined to buy Tidjane Thiam’s narrative that the strategy is working than they do John Cryan’s. And that’s despite that weirdness that emerged at CS in the first quarter around who knew what about what positions and despite Thiam’s own caution expressed in the earnings release around prospects for the second half of the year.

DB continues to be surrounded by an aura of negative energy such that even at this early stage there appears more willingness to welcome progress made in CS’s geographical divisions, as well as efforts around the Global Markets accelerated restructuring plan, and endeavours to focus IBCM more tightly around ECM, advisory and leveraged finance. I say it’s far too early to declare victory but progress is progress so you can’t knock it.

In-tray from hell

Who knows where the Deutsche Bank story will end? The group’s long-run but clearly still-ongoing travails may almost have become the stuff of legend, but if nothing else you can’t fault Cryan’s endurance and perceived resilience in the face of the onslaught of negativity that’s accompanied his tenure from day one. In the face of the powerlessness of the bank to push back against the vagaries of the cycle and the economy, and given the herculean task the DB chief still faces to turn the ship around, you’ve got to wonder how much stamina he still has to continue the fight.

The 97.6% year-on-year decline in DB’s second-quarter net income is in some respects the least of Cryan’s problems, given the one-off nature of some of the extraordinary charges. Second-quarter pre-tax numbers fell by two-thirds to €408m, dragged down by a €285m goodwill impairment charge and €207m in restructuring and severance charges.

Things could have been a hell of a lot worse were it not for the €1.1bn year-on-year reduction in litigation charges to just €120m. Cryan wants to get shot of his biggest litigation headaches this year (mis-selling US MBS; FX manipulation; alleged money laundering for wealthy Russian clients through equity mirror trades). He obviously knows where the bank is with all of that but I wonder if his desire to get it all off the table in short order isn’t somewhat fanciful, short of writing a big cheque to make it all go away. We’ll see.

Other issues on the table are more intractable or problematic. The IPO of Postbank could be off the table now until 2018 in the wake of lacklustre interest and the poor capital markets backdrop, setting back regulatory capital generation plans. Underlying business performance, more of a tell-tale sign of future performance, is decidedly mixed. Revenues excluding non-core and the sale of Hua Xia fell 20%, and parts of investment banking and global markets are under-performing: the fortress debt trading business saw a 19% decline year-on-year.

The bank once again failed its US CCAR test on qualitative grounds; and the IMF noted in its financial sector assessment programme that among G-SIBs Deutsche Bank appears to be the most important net contributor to systemic risks (followed by HSBC and Credit Suisse).

Not the kind of in-tray you’d wish on any CEO. And there are still whispers in the background about DB potentially being forced to accompany UniCredit into another pesky capital raise. In the run-up to the release of EU stress test results on July 29, Deutsche Bank was widely expected to be one of the banks in the red zone (although CFO Marcus Schenck is hopeful that he’ll get some wiggle room on capital distributions). Estimates of DB’s capital shortfall are in the €7bn area.

No U-turn

Yet a stoical Cryan brushes all of that off and says he’s satisfied with the progress the bank is making and is certainly not up for making any U-turns (“we will not deviate from tough decisions just to flatter earnings in the short term”). Not many others out there share his sense of satisfaction, though. The shares, still trading at an eye-watering discount to book, were bumbling along around 5% lower in Wednesday’s morning session and were looking flabby into Thursday as investors struggled to garner any enthusiasm.

For all of Cryan’s supposed sense of contentment at progress, his comment that the bank will need to be “yet more ambitious in the timing and intensity of our restructuring” if the current weak economic environment persists will have struck fear into many souls, particularly in the corporate and investment bank, where many people still expect more open-heart surgery if the CEO is to achieve his targets.

The economic environment in Europe is not pretty and looks unlikely to change any time soon. Monetary policy actions will continue to respond to the gloomy conditions; zero interest rates and a negative-yielding universe just render the task of making money tough for all banks.

But unlike its US peers, whose natural exposure is by definition to the much more robust US capital market, Deutsche Bank is stuck with a hazardous home region in Europe (the UK vote to leave the EU being a wildcard factor at this point). Reading between the lines of his terse comments in the second-quarter earnings statement and his reported comments on the analyst call, it’s almost as if Cryan is softening up the market ahead of a new (maybe ugly) chapter in the restructuring battle.

DB is maintaining its commitment to investment banking and global markets (not that the CEO has any choice, given the lack of any other viable options) but continued calls for more aggressive cuts in the latter refuse to go away. The group’s cost-income ratio in the three months to June was a toppy 91%, higher than the previous quarter and the year-ago quarter. Deutsche Bank just has to take the axe to its cost base, especially in the face of a poor outlook for revenues.

The DB versus CS race (and versus Barclays for that matter) to see who can get fixed first has become one of the investment banking industry’s most widely watched spectator sports. I’ll comment further on Barclays and Jes Staley’s efforts once the UK bank reports on July 29. Last October, I wrote a commentary entitled “Thiam ahead on points as Credit Suisse reveals all”.

Since then, people tell me I’ve been a little mean to Thiam but I think it’s fair to say CS did fall back after the initial strategy was revealed, as those internal ructions emerged and people warmed to Cryan’s kitchen-sinking approach to problem-solving. Could the pecking order once again be changing?

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