When Deutsche Bank announced plans to carve out €380bn of loss-making assets into a dedicated unit tasked with winding down the portfolio in mid-2019, chief executive Christian Sewing framed the move as critical to his vision of creating a simpler, more resilient and less leveraged bank.
The capital release unit was Deutsche's third big clean up in seven years and included its equities trading business as well as hundreds of old rates trades. Sewing pledged to slash the leverage exposure of the portfolio by 90% by the end of 2020 and free up capital to use elsewhere.
“Winding down these assets will substantially improve our leverage ratio and free up resources to allow for shareholder returns,” he told analysts at the time. “These decisions will make our bank more competitive, more resilient and simpler to understand, but also simpler to operate.”
In its full-year results announcement on Thursday, Deutsche updated investors on its efforts relating to the CRU, with Sewing hailing progress as “faster than planned”. But in reality, progress has fallen short of the lofty aims he set for the unit in 2019 and Deutsche now looks set to be saddled with the portfolio for many years to come. (See People & Markets section for more on the results.)
While the CRU has offloaded almost half the assets and beaten its risk-weighted asset targets, the promised “capital release” has not really happened. The €4bn of capital freed up by selling assets and winding down trades has essentially been wiped out by the more than €4bn of losses racked up by the unit since mid-2019.
It is also a long way behind its initial leverage targets. When the portfolio was first carved out, Sewing committed to bringing its €250bn leverage exposure down to just €17bn by the end of 2020. Five months after that, the bank rowed back on the pledge, moving its target to €50bn.
In December, just days before the deadline to meet the target, Deutsche once again revised the target upwards – to €80bn. Handily, that allowed the bank to “beat” the target. The CRU portfolio actually had a leverage exposure of €72bn at the end of 2020, four times higher than initial plans.
James von Moltke, Deutsche's chief financial officer, insisted that the bank had made considerable headway with the CRU when asked by IFR. “Since the end of 2018, we have reduced leverage exposure in the capital release unit by a little over €200bn – so I would call that pretty significant progress,” he said.
The bank has indeed made substantial progress in some parts of the CRU. It sold its cash equities business to BNP Paribas and an unwanted emerging markets debt portfolio to Goldman Sachs. It has also offloaded around 400 derivatives transactions with minimal impact on its financials.
“What we talked about with investors in December were some changes – you are correct – in our planning,” said von Moltke, who said the bank took a decision last year to focus more on the risk-weighted assets rather than leverage targets it had initially set.
“[We took] a decision if you like not to over-accelerate leverage exposure reductions and incur losses that would otherwise never crystallise,” he explained. “We decided the right economic choice for our investors was to allow leverage exposures to run off more gently on their own maturity schedule.”
But the decision to wait for trades to roll off will delay the clean-up and leave Deutsche saddled with trades for years. Deutsche expects the leverage exposure to remain above €50bn into 2023, and even then about half the portfolio will be “structurally challenging” or “inefficient to exit”.
What has changed in the market to make them inefficient to exit is unclear, although tougher regulatory treatment makes such assets less attractive for any bank to hold. In mid-2019, Sewing expected to offload more than 90% of the portfolio. It is possible that the bank was simply too optimistic about its abilities to offload these assets and is slowly rowing back.
One analyst who declined to be identified said the bank might have taken the decision to run down assets slower to help boost overall revenue and avoid missing its group targets. “Outside the investment bank, all the divisions are underperforming, so if you can save a few hundred million that is very valuable,” he said.
The bank has for many years been struggling to cleanse its balance sheet of old trades. Some were structured in the heady 2000s, with bankers booking big bonuses on trades that are now expensive to carry or simply loss-making.
A senior banker familiar with past clean-ups told IFR that Deutsche had some "unpleasant" assets, including some with long tenors. “That requires a lot of structuring and complexity of the deals. Clearly they would have wanted to get rid of the assets, but if they are too complex or the price offered is too low you don’t get rid of them,” he said.
Some recent activity at the CRU indicates the high cost of offloading some of these legacy positions. The bank has taken “material negative” hits on eight positions, von Moltke told analysts at an investor day. Losses on those positions appear to account for a large chunk of the €400m of so-called de-risking costs booked by the CRU, since the bank says that 98% of trades had minimal impact on P&L.
The bank is reported to have asked some former board members including ex-chief executive Anshu Jain, ex-chief financial officer Stefan Krause and even its current chief risk officer Stuart Lewis to pay back a portion of their bonuses. The bank declined to comment.
It now looks like the unit, which employs nearly 500 people, is here to stay for some time.
“A decision as to whether at some point in time we would reintegrate it into the rest of the bank hasn’t been made and we don’t expect a decision of that nature for a considerable time given the focus we have on completing the mission,” said von Moltke.