In the years after the financial crisis, many of the world's biggest lenders set up vast "bad banks" to cleanse trillions of dollars in toxic assets from their balance sheets. Until now, very few of them have needed a second bite at the cherry.
However, six years after creating its first non-core unit, Deutsche Bank is repeating the trick. The Financial Times reported on Monday that Deutsche is seeking to divest a further €50 billion ($86.4b) of assets adjusted for riskiness on its balance sheet.
This comes alongside a deep overhaul of its investment bank that may see swaths of its non-European equity and rates trading businesses shut down, combined with a sharper focus on transaction banking and private wealth management.
Chief executive Christian Sewing has five weeks to put the finishing touches to his "Plan B" after the collapse of merger talks with German rival Commerzbank in April. Investors are impatient. The shares recently dipped below €6, the lowest in Deutsche's 149-year history, and its return on equity is mired in the low single digits.
But will Sewing's plan be enough to halt the slide at Germany's biggest lender? Or is this just another round of too little, too late cuts that further erode Deutsche's competitive position?
"I think it's a very good step in the right direction," said Davide Serra, head of asset manager Algebris that owns Deutsche debt.
"It de facto kills the misplaced mantra of the 'Goldman Sachs of Europe' and makes it more the 'BNP Paribas of Germany', refocused on its core corporate customers." Deutsche shares rose 1.4 per cent on Monday.
However, some observers caution that unless the plan is combined with revitalised earnings from other businesses and an overhaul of the bank's inefficient IT systems, it may not be enough to restore profits to an acceptable level.
"These proposals would be a good start, but it requires further cost cuts — if they are the only thing announced next month, the market will be disappointed because it would be the bare minimum expected," said Kian Abouhossein, analyst at JPMorgan.
At the upper end of the range, Deutsche's bad bank corresponds to 14 per cent of the €347b of risk-weighted assets. However, it will be far smaller than the German lender's first effort.
From 2012 to 2016, Deutsche ran down a non-core unit with more than €125b in risk-weighted assets — including a US$4.3b ($6.6b) Las Vegas casino — resulting in a cumulative pre-tax loss of €14.6b over that period.
Despite those efforts, Deutsche still has €7b of so-called "non-strategic legacy assets" left in a special unit and a €25b pile of illiquid, hard-to-value "level 3" assets on its books.
However, executives argue that its new bad bank will be different to the first one, because it will comprise long-dated derivatives such as interest rate swaps deemed "non-strategic" rather than "toxic" assets of questionable value.
"No one doubts our asset quality today; we have a profitability issue, not a toxic-asset issue," said one Deutsche insider.
While the assets in question generate little income, because all profits were taken up front, managers hope they should be able to be unwound or sold without taking large hits to its earnings or capital, according to people familiar with the project.
The assets have also become increasingly burdensome as Deutsche's funding costs skyrocketed in the past two years.
"Equity derivatives are short-term, usually three years or less, so should roll off quite quickly if they are properly marked to market . . . it is the longer-dated rates derivatives, sometimes 20-year-long trades, that can be tricky to unwind," said a person involved in the lender's first non-core rundown.
Executives hope some of the derivatives can be sold to other banks with lower funding costs and fewer capital pressures or to private equity investors, one of the people said.
After Barclays created its £118bn bad bank in 2014, it struck a deal with JPMorgan to offload tens of billions of long-dated interest rate swaps, similar to those Deutsche is struggling with. However, this comes at a cost.
"The other banks aren't charities; if I'm at JPMorgan my job is to help clients, not Deutsche," said a US hedge fund manager who used to run a bank's derivatives book.
The other major concern about Sewing's plans is that closing down significant chunks of its non-European equity and rates operations could cause big clients to desert other parts of the investment bank.
"There is a substantial difference between downsizing and outright closure of Deutsche's non-European equity capacity," said Goldman Sachs analyst Jernej Omahen. "An outright closure would raise questions about its capacity to act as a global investment bank to its European corporate client base."
Its global equities trading business has about €2bn of annual revenues, against €5.4bn of bond trading revenues. Analysts say the US equities business is heavily lossmaking. One of the lender's biggest investors said: "Their US equity business is no good, they are not a major player and it doesn't do anything for core clients — the Daimler treasurer doesn't care if Deutsche is on the Uber IPO. German clients just want transaction services and lending."
There is also the issue of how Deutsche pays for the retrenchment, hemmed in as it is by its shrunken market capitalisation and the more stringent capital rules coming over the next few years. Analysts warn restructuring costs are often 150 per cent of initial savings. Abouhossein has pencilled in a conservative €4b of charges.
"Sewing looks like he really means what he said at the AGM about 'tough cutbacks'. He knows he doesn't have many chances, there isn't much room for error," said Daniele Brupbacher, analyst at UBS. "But until we see the [profit-and-loss] cost and capital implications of exiting these assets, we do not know the full story."
- Additional reporting by Patrick Jenkins, Robin Wigglesworth and Laura Noonan.
Written by: Stephen Morris
© Financial Times