Bank of the Year 2003
Transformation is an over-used word. Only rarely does it genuinely encapsulate the essential nature and extent of major change. For one firm, however, the word perfectly describes the shift from a lumbering, inefficient, directionless, commercial bank to a lean, aggressive, focused universal bank with a global bulge-bracket pedigree in trading, distribution, capital markets and client solutions. Deutsche Bank is IFR’s 2003 Bank of the Year.
The transformation of Deutsche Bank’s corporate and investment bank started in earnest in 2002, with Josef Ackermann at the helm. He drew on the energy and dynamism of his inner circle of Anshu Jain, head of global markets (which incorporates all fixed-income businesses including debt capital markets); Kevin Parker, head of global equities (equity cash and derivatives); and Michael Cohrs, head of global corporate finance (M&A, equity capital markets, leveraged finance/high-yield, credit/distressed trading, and mortgages).
In 2003, Deutsche developed a relentless and urgent drive to succeed. It was aggressive, fast moving, innovative, and highly results focused. Since taking over, Ackermann has cut the loan book by 38%, reduced risk-weighted assets by 24%, pared industrial holdings by 22%, and slashed direct private equity exposure by 62%. The way the bank sold down its private equity portfolio exemplifies Deutsche’s avant-garde approach to the business, and provides a fascinating insight into how it thinks about the business.
In July, the bank securitised 63 private equity partnerships totalling US$465m using credit derivatives technology. The Silverleaf securitisation was the first bank balance sheet securitisation of private equity. It featured a novel total rate of return swap to create US dollar and euro fixed and floating-rate debt tranches, and was also used as the base for valuing loans against other private equity portfolios.
In similar vein, the creation of a loan exposure management group was key to the 30% reduction in the bank’s provision for credit losses. The group charges business lines the difference between a proposed lending commitment and a default swap spread, and uses the shortfall to purchase protection on the credit.
Portfolio risk valuation techniques developed by the credit derivatives group mean that this process is not limited to corporates with visible debt curves. “We put a shadow price on every piece of credit extension in the world – including lending to German Mittelstand corporates,” said Anshu Jain.
Creating progressive and innovative solutions for its own problems, and generating novel solutions for clients with an uncompromising focus on the bottom line, epitomised Deutsche Bank’s performance. The fruits of Ackermann’s actions in 2002 certainly paid off in 2003. “We have become more efficient without retreating from any major markets. We’ve strengthened our position in Europe, the US, Japan, Australia and Asia,” he said.
“We have drastically and dramatically reduced our loan book and de-risked our corporate and investment banking business. As a result, we have increased ROE because there is less capital allocated to low-yielding businesses and more to high-yielding businesses, such as sales, trading and leveraged finance. And we are getting into more strategic dialogue with key customers.”
The big change in Deutsche’s investment bank in 2003 was the alignment of core businesses along a single strategic track. On the strength of its performance in 2003, the bank looks to have embodied the drive, vision, passion and commitment necessary to be a bulge-bracket player in global corporate and investment banking.
“We’ve focused on our core businesses, and redirected resources towards them,” said Jain. “We were very active in taking the bitter medicine early, and there have been big gains in efficiency at the bank level. We feel like we own the place,” he said, referring to the degree of business ownership bestowed on the CIB executive committee, and the level of collegiality its members have had to develop.
This collegiality extends to cross-subsidisation. “If the opportunity is big enough, we’ll cross-subsidise if it makes sense to the component parts. I’m happy to write a cheque to another division if it helps them secure a piece of business,” Jain said.
Conscious that as many as 20 organisations can now claim to offer one-stop client solutions, the bank pushed hard to develop the next generation of products. “In the most sophisticated, most complex and intellectually most demanding areas, we have clearly outperformed the market. And we’ve achieved that with a risk appetite below that of our peers,” said Ackermann.
Building market share
Whether it was OTC derivatives, credit default swaps, FX, government and agency trading, equities, debt and equity capital markets, mortgages, credit trading, leveraged finance, high-yield, emerging markets, convertible new issues and trading, or securitisation, Deutsche Bank became a leading player in 2003.
Although concrete numbers are hard to come by, Deutsche believes it is the world’s number one equity house by revenue (from broking, cash and derivatives trading and prime brokerage), and the world’s leading fixed-income trading shop.
If its leading position in pan-European equity trading (and a host of individual countries including the UK and Germany) is not that surprising, the fact that the bank vies with Nomura for top spot in domestic Japanese equity trading (according to the Tokyo Stock Exchange) is amazing. “We’re going great guns there and are beautifully positioned,” said Kevin Parker.
One of the things Parker was most gratified by in 2003 was his decision not to invest heavily in the US cash equities business. “The US market is up between 18% and 46%, depending on which index you follow, but revenues in the US fell 20% in 2003,” he said.
“We identified the trends, and figured US equities were a falling knife. There are some very powerful secular trends at work in the US,” he said, referring to the mutual fund investigations and the research fallout, “which are altering the basic value proposition of the business.”
Deutsche concentrated its efforts in equities on strategic products – derivatives (Deutsche is IFR’s Equity Derivatives House of the Year), convertibles, programme trading, and transition management. “In 2003, we were short the cash, long the strategic business,” Parker said in summary.
The latter is truly value added. A typical mandate would be to co-ordinate a globally executed swap to new managers on behalf of a plan sponsor worth multiple billions of dollars, and potentially involving 15 to 20 countries. Deutsche was the leader in transition management in 2003.
On the debt side, Deutsche’s US$28.8bn average daily volume of European government bond trading put it ahead of all comers. The bank is also possibly the biggest trader of US Treasuries, with average daily turnover of US$58.2bn.
In capital markets, Deutsche is the world’s largest underwriter (ex self-led deals) of international bonds (January 1 to November 19). Perhaps more importantly, in 2003, it attained top five status in worldwide long-term debt underwriting, which includes the US and all other domestic markets.
The bank’s US build-out was particularly impressive in 2003. For the first time, Deutsche can lay claim to a credible US franchise with leading positions in businesses previously reserved exclusively for home-grown incumbents.
Asset repackaging
Away from mainstream debt and equity trading, Deutsche developed a leading distressed franchise in 2003, working for clients and on a proprietary basis. By the middle of the year, its revenues had exceeded the whole of 2002. “Our modus operandi is to go in, position the assets [on our own balance sheet] and develop a secondary market for the paper,” said Michael Cohrs. “It’s been a phenomenally successful year for us.”
The bank was a big repackager of loan portfolios in 2003. “We’re usually at the top of people’s lists as somebody they will call to get prices and/or work with us to package them up and on-sell them to investors,” said Cohrs. The bank was active in Europe, the US, Japan and Asia.
The bank’s loan trading desk covers par to distressed assets. The desk created liquidity using its own balance sheet and built out the user base of institutional investors. In 2003, the bank created a full-service loan sales force in London. Its Investment Recovery Unit actively bid for loan portfolios. The most notable was the €511m block of loans it purchased from Dresdner Bank. Deutsche fully distributed the portfolio – consisting of investment-grade, leveraged, stressed and distressed loans – into the secondary market.
Client solutions
Trading prowess only tells part of the Deutsche Bank story. Bulking up is one thing; using that bulk to create and execute solutions for clients is the point. In 2003, Deutsche showed time and time again that it was able to bring to the table integrated cross-product solutions.
The bank scored an amazing hit rate of the big strategic multi-product recapitalisations for companies in dire need of liquidity. For France Telecom, Deutsche was involved in the €15bn rights issue, funded the State’s take-up through the €9.5bn ERAP bond, and underwrote FT’s €5.9bn senior unsecured bond.
Other DB cross-product successes included Allianz (rights issue, hybrid capital, senior debt); Munich Re (rights issue and hybrid capital); HeidelbergCement (bond, rights issue and bank loan restructuring); and ABB (high-yield bond, renegotiation of bank lines, rights issue). It was also involved in Xerox (common stock, mandatory convertible preferred, senior unsecured notes, bank refinancing).
Rights issues formed a large key component of many of the recaps. In 2003, Deutsche hit the high spots in the rights business. As well as the deals for Allianz (€4.45bn), FT (€15bn) and HeidelbergCement (€400m), Deutsche executed the £928m Xstrata rights issue via an innovative convertible unsecured loan stock structure (CULS) as part of the takeover financing of MIM.
“We won business in 2003 because of our willingness to take risk, our superior distribution and the strength of our corporate relationships,” said Cohrs. Other highlights in its ECM year were the US$490m IPO for Telkom South Africa (the largest EMEA telecom IPO for two years) and the groundbreaking £389m deal for Northumbrian Water (IFR’s IPO of the Year). It was also one of four leads on the US$3bn-plus IPO for China Life, due to price on December 11.
The bank won accolades in the equity-linked market (see European Equity-linked House of the Year). The €5bn KfW/Deutsche Telekom exchangeable it executed was the largest ever equity-linked transaction. The SFr1bn ABB convertible, and the US$1.22bn Vivendi Universal exchangeable into shares of USA Interactive (USAI) were also key pieces of financing for the clients.
Derivatives DNA
A multi-faceted institution, the core of the success of Deutsche’s CIB – in both fixed-income and equities – is derivatives. The DNA of Deutsche Bank’s investment bank is most definitely derivatives, preferably of the structured kind. This is not surprising, given that Ackermann, Jain and Parker all have derivatives backgrounds. But 2003 finally saw the wholesale application of derivatives technology to the bank’s core businesses.
What set the bank apart in 2003 was its ability to capitalise on the advantages of its global reach, skills and client relationships in derivatives to drive a host of other businesses, from cash trading, equity and debt capital markets, to corporate advisory.
As well as improving returns on low margin businesses, derivatives drove the overall profitability of Deutsche Bank. Between 75% and 80% of bottom-line income for the global markets division in 2003 will come from derivatives.
Steadily falling credit spreads in 2003 slowed the rate of growth for many credit derivatives businesses, but Deutsche increased revenue by over 50% and is likely to hit €1.5bn. A key to maintaining credit derivatives momentum was channelling risk from non-traditional credit markets, such as real estate, leasing and project finance. “Sourcing illiquid risk is the new paradigm,” said Rajeev Misra, head of the integrated credit trading group at Deutsche Bank.
Trading of correlation risk between credit, interest rates and equity was supplemented with new forms of risk, including mortality risk from insurance contracts. The Winchester Capital principal finance unit was set up at the end of 2002 to use credit derivatives valuation techniques to source and repackage asset-backed securities. In 2003 it had over €16bn under management by the fourth quarter.
With both credit spreads and equity volatility low, and relatively steady for much of the year, debt against equity trade opportunities were less obvious than in 2002. The capital structure arbitrage desk run by Boaz Weinstein in New York is thought to have again produced returns of over US$100m, and Deutsche improved relations with hedge funds and sophisticated asset managers by cutting them in on trades.
The merged interest-rate cash and derivatives business run by Michele Faissola also performed strongly. Among structured product innovations it developed Target Redemption Notes (TARNS). Combining a high early coupon with downside rate and principal protection, the bank sold over US$3bn of paper. It also engineered equity and rate hybrid range accrual notes.
On the flow side, Deutsche maintained its lead in the euro swap market and boosted client relations in the US by providing liquidity during the rate, spread and volatility hike of the summer. The bank traded US$25bn of interest-rate options in the first week of August, when many dealers were pulling back from the market. In one 20-hour trading space, the bank handled US$20bn of swaps.
Balance
Although the bulk of global markets revenues continued to come from derivatives, Jain strove to create a better balance between derivatives, cash and capital markets. He doesn’t want the bank to be seen as a derivatives powerhouse only. “Capital markets are a main event at Deutsche Bank,” he said.
The focus in the global markets division in 2003 was getting in front of clients as strategic advisors, developing a dialogue on a variety of fronts – commodities, DCM, derivatives, FX, liability management and advisory. A key goal was to take what was already built in Europe to a greater level, and impose the same level of discipline in the US.
With the integration of the markets division in place, the bank now views capital markets and OTC derivatives as inextricably linked.
“Our ability to leverage a capital markets transaction into an OTC transaction is very, very high,” said Hope Pascucci, global head of syndicate and head of European debt capital markets. The bank aggressively pursues other banks’ lead managed transactions to win OTC business, but its hit ratio is significantly lower than it is with lead managed trades it executes itself. “We’re very focused on the bottom line. But we’re also focused on the profile of the business.”
Allowing other businesses to feed off the derivatives platform and relationships was key in 2003. In the US in particular, the derivatives dialogue was behind the advances Deutsche made with corporates, but more specifically with the US agencies, particularly Freddie Mac and Fannie Mae.
“The business we’re doing with the US agencies as an underwriter of their syndicated deals is being awarded to us because we are one of their largest and most sophisticated derivatives counterparties,” said Jorge Calderon, global head of debt capital markets.
“If you’re having a strategic dialogue with the agencies about the optionality in their mortgage portfolios, that feeds right into what we can do in the capital markets through callable transactions. You can’t really occupy our place in the spectrum unless you also provide underwriting services,” he added.
The callable franchise Deutsche developed with the US agencies directly led to other business: the dollar deal for Italy was a classic example. Italy took on board the fact that Deutsche was a major underwriter for the US agencies and awarded the firm its dollar mandate. “We would not have had the access to the clients Italy wanted had it not been for the progress we’d made with the agencies in dollars,” said Pascucci.
Import-Export
In debt capital markets, the bank’s major theme of 2003 was what it termed import-export business (see Bond House of the Year). At the same time as successfully defending its European franchise, the bank finally made a breakthrough in the US. Combining the two elements enabled it to execute a number of transactions for US companies in euros, and for non-US companies in dollars. The bank claims more of these trades than any other firm.
In 2002, Deutsche executed deals for more than 30 clients new to the franchise in dollars. In 2003, the bank had racked up another 25 by mid-November.
ANZ Bank’s complex Tier 1 dollar deal was a coup for the bank. This was an acquisition-related trade where Deutsche was not the M&A advisor. But it wrested a bookrunning slot as well as the structuring agent role. Calderon points to the deal as a good example of the marriage of derivatives and origination. As well as the underwriting, Deutsche executed a reasonable part of the derivative associated with the trade, which brought in significant fees.
Elsewhere, Deutsche’s position in the landmark and heavily oversubscribed US$3bn Eurodollar bond for the United Kingdom also offered a prime validation of its capabilities.
The cash/derivatives linkage doesn’t work so well in the corporate space, but Deutsche won a series of marquee mandates in dollars, both for US domestic and international borrowers. The bank also had a record year in its dollar private placements business.
M&A developing
M&A is not yet a franchise business, but Deutsche had an acceptable 2003 as M&A fee income held steady in a year when others struggled. The bank won roles in Insurance Corp of Japan/ Resona, ANZ/Lloyds TSB New Zealand, Xstrata/MIM, topping the M&A tables in Japan and Australia, and making a good showing in the UK.
“I’m pretty proud of the fact that for three years in a row, our M&A fees have been flat, in a market where volume of activity is down quite considerably. On the fee side, where three years ago, we were quite a long way from the leaders, in the last year, we’ve gotten in the same neighbourhood as them,” said Cohrs.
“People are starting to call us on M&A. There was a time when we were frustrated at our inability to convince our clients that we were an interesting M&A advisor. In the last year, we’ve cracked that and now we get the calls. That’s quite an important breakthrough for us.”