Sunday, 22 July 2018

Staying the course

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In spite of its trading businesses being badly hit by the fallout from the collapse of Lehman Brothers, Deutsche Bank appears to be coming through the credit crisis with franchises intact and the firm better positioned to cope with new market realities. It has lost one domestic competitor, as Commerzbank completed its takeover of Dresdner Bank, but with the new combination focusing on domestic clients above all, Deutsche now stands as the one firm with global ambitions. Mark Baker reports.

The last year has seen the disappearance of one major player in German banking, as Commerzbank finalised the acquisition of Dresdner Bank from insurance giant Allianz. But in spite of its domestic significance – and the loss of a venerable investment banking brand in Dresdner Kleinwort – the deal has not substantially changed the competitive landscape in the country’s banking sector.

Although rivals argue that it is scarcely a German bank any more in terms of the distribution of its activities, Deutsche Bank has remained the country’s only global player in the sector. The stated strategy of Commerzbank is to focus much more on its home market and far less on the attempt to create a global footprint that was the ambition of former Dresdner Kleinwort head Stefan Jentzsch.

Senior executives at Deutsche Bank are careful not to appear to be sidelining the firm’s domestic business, but also stress that the firm’s focus is resolutely global, or at least pan-European.

“What is going on domestically is important but it does not define our strategy,” said one senior banker. “When thinking about investment banking, Germany is not as critical for us as the US is to Morgan Stanley or Goldman Sachs.”

That means that, from an investment banking and capital markets point of view, the new combination of Commerzbank and Dresdner Kleinwort will make little impact on Deutsche. In the home market, Commerzbank is likely to strengthen its corporate banking and lending activities to the mass of mid-sized German corporates, as well as to its target group of the top 90 or so firms in the country, but international business will continue to be the preserve of its rival. In particular, bankers at Deutsche say that it must ensure that it dominates cross-border work involving German clients.

And by many measures, Deutsche has had a good crisis. It has survived without the need for direct government financial assistance, although it has obviously benefited – as have large banks all around the world – from implicit government support.

The trading opportunities that were the feature of the start of 2009 also played to the bank’s strengths. The €3.8bn of fixed income sales and trading revenues that it posted in the first quarter of this year was a record for the firm, and although some analysts expressed concern that the bank was not able to maintain such a dramatic performance in the second quarter (with €2.6bn), Deutsche executives point out that these results have been achieved even as the firm has dramatically delevered its balance sheet and slashed value at risk in its trading operation. Some rivals, say Deutsche bankers, are continuing to be reckless.

The bank is also notable among global peers for having stuck with its top man. Chairman and CEO Josef Ackermann has won plaudits for his representation of the industry in his capacity as chair of the International Institute of Finance, and at the start of 2009 had his contract extended with Deutsche Bank.

Back to black

But it has nonetheless been a traumatic period for the firm. In the first quarter of 2008, it suffered the ignominy of its first quarterly group loss for five years. Although the bank had looked smart at the very start of the crisis – one of its analysts took a famously bearish view on the US housing market, and the firm traded accordingly – it later found itself suffering from having underestimated to what extent problems would rise up the capital structure of ABS exposure. When super-senior positions began to take big hits, the losses mounted up.

Write-downs of €2.7bn in that first quarter of 2008 took the firm to a pre-tax loss of €254m, with pre-tax losses of €1.6bn in just the corporate banking and securities division – effectively the investment bank. As a result of the bank’s status as national icon, the result led to much breast-beating and contrition.

But worse was to come. The collapse of Lehman Brothers in September 2008 led to a huge loss of almost €4.8bn in Deutsche’s sales and trading operation in the fourth quarter of the year, taking the firm to an overall loss of €5.7bn for 2008, with losses of €8.5bn in the corporate banking and securities division.

The strong trading performances in the first half of 2009 – far outweighing origination revenues – have put the ship back on an even keel, however. Equity and fixed income trading accounted for 75% of the corporate banking and securities revenues in the second quarter of 2009, and a staggering 95% in the first quarter.

In the first half of the year, the bank as a whole made €3.1bn in pre-tax profits, with corporate banking and securities making profits of €2.15bn. Equity trading in the second quarter, the highest revenues for six quarters, was strongly boosted by the bank’s equity derivatives performance.

The recovery in origination revenues has been much slower than on the trading side, and in some areas the bank has underperformed even taking into account the backdrop of the crisis. Equity capital markets has been one obvious area of disappointment, driven by the firm’s relative weakness in financial institutions coverage.

Even after a better performance this year, the bank is outside the top five in the European equity league table. At the same time last year it ranked in eighth place.

Senior management on the capital markets side freely concede that the firm has suffered throughout the crisis from its less strong financial institutions coverage, with ECM the most obviously affected, given how much European and US dealflow has been driven by banks shoring up their balance sheets.

The result was that revenues in equity origination were very low in 2008, with the bank notching up just €336m for the whole year (compared to €861m in 2007). This year promises to be better, with €300m already achieved in the first half.

Financial institution coverage has historically not been a strong area for Deutsche, meaning that the bank has missed out on a large chunk of work thrown up by the crisis. It is also not a strong sovereign house, but while senior bankers at the firm argue that the extent of sovereign activity would have been hard to predict ahead of the crisis, it was already known that the FIG franchise needed bolstering.

Nevertheless, management is adamant that the situation has now been tackled – albeit belatedly. They point to hires this year in FIG and also a substantial amount of work that is being done behind the scenes in leveraging the bank’s expertise in other sectors to the benefit of CFOs at FIG names who want advice about other industries more than they have ever done in the past. For these reasons, bankers reject the accusation that the firm has missed the boat.

“We may have missed one boat, but there are several more in the harbour,” said one senior executive. “There is another 18 to 24 months’ worth of equity work to happen in FIG.”

The firm’s corporate coverage, and particularly in DCM, has for a long time been a franchise to beat. At the time of writing, it is so far this year neck and neck with Societe Generale for top place in euro-denominated corporate debt. It is also third in all investment grade euro bonds, second in subordinated financials, third in supras, second in agencies and third in all international bonds.

Other highlights have included the firm’s historically strong high-yield business, which has remained a dominant force in spite of the near-shutdown of the market in Europe and the US in the depths of the crisis. The firm is the leader in non-US dollar deals, with a 17% market share, ahead of Calyon with 8%. It is also top in European deals, with a 15% share. Even in US dollar deals it ranks fourth, fractionally behind Citigroup.

In spite of strong performances across most business lines, and decreasing ABS-related losses, risk management remains cautious. At the same time as revenues are recovering quarter-on-quarter, credit loss provisions are continuing to mount. Across the whole firm, provisions hit €1bn in the second quarter of 2009, almost double the previous quarter and only fractionally less than the whole of 2008.

The end of Dresdner Kleinwort

At Commerzbank’s new London offices, executives celebrated at the start of September the official rebrand of the firm’s corporates and markets division, encompassing the areas that the firm has retained from the old Dresdner Kleinwort. The Allianz-sponsored Formula 1 car has been removed from the lobby, and no trace of DK branding remains in the building.

But the event had more significance than a mere marking of an anniversary. If there is one message that Michael Reuther, CEO of corporates and markets at Commerzbank, is keen to press over all others, it is the importance of the London office as a key element of the bank’s investment banking strategy.

Frustrated at constant sniping from some quarters – mostly disgruntled former Dresdner employees, say survivors of the merger – Commerzbank's management has been at pains to emphasise that the disappearance of the venerable Dresdner Kleinwort name does not represent a total retreat of the operation into Commerzbank's home market.

As evidence of that, Commerzbank is retaining 600 front-office investment banking staff in London, mostly focused on equity derivatives structuring and commodities, FX trading and institutional sales, and ECM and DCM syndicate desks within corporate finance.

Reuther argues that far from the scare stories regularly circulating during the process, the integration of the two firms has focused on retaining talent where it already existed – whether in Frankfurt or London and whether at Dresdner Kleinwort or Commerzbank. Significant numbers of senior fixed-income staff, for example, are from the DK side. It also made sense to retain the ECM syndicate and convertible bond expertise that was in London, argue Commerzbank corporate finance executives.

Nevertheless, for all the talk of the importance of the London office, Commerzbank executives willingly agree that the overall operation will be resolutely German-focused in terms of clients. The bank reckons it has lent about double the amount to German corporates than Deutsche Bank has, but activities such as UK corporate broking and stock research are gone.

A tighter focus and more sensible control over the allocation of capital will allow the bank to take advantage of cross-selling opportunities that exist, argues Reuther, rather than tying up capital in trying to create a more global operation, as Dresdner had attempted to do. That said, the bank still retains about 100 front-office staff in New York, the same number in Central Europe and Asia, as well as the core of 800 in Frankfurt.

Bankers at the firm talk of a stronger pipeline than either of the two institutions would have had combined, but also concede that much of that remains to be proved publicly. Reuther also points to the potential to take advantage of the institutional sales capability of DK – a factor he has highlighted since the merger was first proposed.

Nonetheless, the bank can also point to concrete successes that have already been seen, such as being on the €5bn KfW benchmark deal in May, a first for the firm.

Reuther's strategy is aimed squarely at profitability – an unsurprising ambition but one that he says has too often been forgotten in a quest for market share or global spread. With ABS losses continuing – although lessening dramatically – the corporates and markets division recently announced second-quarter losses of €231m. That was a big improvement on the first quarter but is evidence of how far there is still to go.

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