(Bloomberg) — On the day before one of the biggest margin calls in history, Deutsche Bank AG chief Christian Sewing joined an urgent meeting with a not-unfamiliar message: there was a problem, and billions of dollars were at stake.
But as executives on the late-March call briefed him on the bank’s exposure to Archegos Capital Management, this time it wasn’t all bad news. Risk managers had been concerned by the family office’s rapid growth for some time, and had been collecting additional collateral. And the firm’s traders stood ready to quickly offload the slumping assets.
So as Archegos’s collapse slammed rivals with more than $10 billion of losses, Deutsche Bank walked away without a scratch, reporting its highest profit in seven years. It was enough to stun longtime observers of the firm, which has spent the past decade-and-a-half stumbling from one crisis to the next. The escape added to a growing sense that Sewing may finally be moving Germany’s largest bank past its dysfunction of the last decade.
“What they pulled off is quite impressive in the last couple of years,” said Matthew Fine, a portfolio manager at Third Avenue Management who started investing in Deutsche Bank shares after Sewing was appointed CEO in 2018. “After several failures and years of incredible underperformance and substantial capital raisings, at some point you really have to rip the band aid off, and Sewing seems to have done that.”
Halfway through the CEO’s radical four-year restructuring, the perennial sick man of European finance appears to be on the mend. Its shares have more than doubled from a record low, when the pandemic revived old fears whether Germany’s largest lender was strong enough to survive another crisis. Instead of collapsing under bad loans, Deutsche Bank successfully rode a trading wave that’s buoyed investment banks globally. After years of gloom, some executives inside the Frankfurt headquarters are now even considering deals as they seek to profit from the recent stumbles of rivals.
To be sure, for a bank that lost money in five of the past six years and whose shares remain 87% below their peak, the bar to success is low and blunders remain an ever-present possibility. The stock is still trading at one of the steepest discounts to book value among European lenders. Sewing’s efforts have gotten a boost from factors outside his control, such as the global market rally and extensive government guarantees that kept defaults at bay during the pandemic.
But the CEO, who had initially planned to focus more on corporate banking and cut back trading even more, was quick to adapt when markets moved against him just weeks after he announced his plan. At home, he’s confronted the reality that in order to make money in an overbanked country with negative interest rates, he needs to raise fees and slash jobs, even at the risk of upsetting clients and unions.
Above all, however, the former risk manager has made progress dealing with internal issues that had undermined his predecessors. He ended the divisional infighting that Sewing once called “Deutsche Bank’s disease,” and he addressed risk lapses that had caused the bank, over and over again, to shoot itself in the foot.
Archegos wasn’t the first blowup that Deutsche Bank sidestepped under Sewing. The bank last year avoided taking a potentially damaging financial and reputational hit from the collapse of payments firm Wirecard AG, having cut its exposure as doubts about the company’s business grew. It also hasn’t taken a direct hit from Greensill Capital, the supply-chain finance firm whose demise forced Credit Suisse Group AG to liquidate a $10 billion group of funds.
Read more: Deutsche Bank Cut Wirecard Ties as Its Fund Managers Went All In
Of all those pitfalls, Archegos had by far the biggest potential to do lasting damage to the green shoots of Sewing’s turnaround. Deutsche Bank had joined several other investment banks in dealing with the family office of Bill Hwang, who was barred from the investment advisory industry after pleading guilty to wire fraud on behalf of his shuttered hedge fund in 2012. Many firms had been willing to accept more risk in return for the hefty fees Archegos provided. Credit Suisse, for instance, allowed it to borrow up to ten times the value of its collateral. The Swiss bank ended up with some $5.5 billion in losses, the most of any firm.
Its lost decade stood out even in a post-crisis period that was tough for many European lenders
Deutsche Bank had run up an exposure worth several billions of dollars, according to people familiar with the matter. But it hadn’t lent as aggressively and its arrangement with Archegos allowed it to ask for more collateral to back up what looked like an increasingly imbalanced house of cards.
The German bank had decided two years earlier to exit the business with hedge funds and family offices — known as prime brokerage — and was in the process of transferring its relationships to BNP Paribas SA. That gave Ashley Wilson, the head of the unit, and risk chief Stuart Lewis even more reason to keep things in check. The bank, which was conducting daily analyses of Archegos’s holdings, had noticed already in February that concentration risk was rising. In early March, it started to request more collateral, the people said, asking for anonymity discussing internal information.
By Wednesday, March 24, when Lewis explained the situation to Sewing in that phone call, he told the CEO that the bank’s internal models were pointing to relatively minor potential losses. Still, that didn’t prevent some heightened nerves in the firm’s ranks over the next two days as Archegos was found in default and a standstill agreement that some lenders had tried to broker fell apart.
When it became clear on Friday that rivals were cutting their lifelines and getting out, Lewis got on a 20-minute call with his team, and the bank decided to liquidate. The firm’s traders sold most of the positions that Friday to multiple buyers including Marshall Wace, one of Europe’s largest hedge fund managers. The bank used direct sales, aiming to avoid spooking the markets. Within a few days, it recovered all of its money and even had some collateral left.
Read more: Deutsche Bank Dodged Archegos With $4 Billion Sale
Navigating minefields without a hit is a new experience at a lender that over the prior decades had developed a reputation for putting quick profits and bonuses before the interests of clients, let alone the broader public. When the world stepped up scrutiny of the industry in the wake of the 2008 financial crisis, Deutsche Bank ended up footing the biggest legal bill of any European bank, spending more than $19.4 billion on fines and settlements.
Its lost decade stood out even in a post-crisis period that was tough for many European lenders. Among the 25 biggest banks in the world, it was the only one to have a net loss over the past 10 years, while many rivals racked up more than $100 billion of profits.
“Reputation is something you build slowly but slips away quickly,” said Susanne Homoelle, a professor of banking and finance at the University of Rostock who started her career at Deutsche Bank in the 1980s. Back then, she said, “there was a pride among the staff that the bank was more sophisticated than peers. So much went wrong subsequently in terms of misconduct and compliance issues.”
Inside the bank, many still worry that the next accident is just around the corner. Last month, a lawyer representing Citigroup Inc. in a case related to its mistaken transfer of $900 million revealed that another unnamed bank had recently made a similar mistake. Only three years earlier, Deutsche Bank had erroneously transferred a much bigger sum to an outside account. Now, the first thought for many at the German lender, according to one executive, was: “Was it us?”
Still, the change is palpable in the twin towers in central Frankfurt that represent the beating heart of Deutsche Bank. An annual survey showed staff morale rising to the highest level in eight years. Bonuses for last year rose 29%, and by almost half for investment bankers, at a time when many rivals had to cut. Senior executives say doubts about Deutsche Bank’s strategy have ceased to be an issue during client meetings.
Decision-making has gotten faster as well. Last year, it only took a few weeks in the midst of surging demand for government-subsidized loans during the pandemic to set up a digital solution for corporate clients to file applications. Several similar efforts over many years had failed because no one saw it through, a person familiar with the matter said. Kim Hammonds, who spent more than four years trying to streamline the bank’s dozens of technology systems, once called the firm “the most dysfunctional company” she’d ever worked for. Sewing ousted her in 2018.
The CEO early in his tenure made it a top priority to rein in the conflicts between the various businesses — and their executives — to combat the internecine warfare that had plagued many of his predecessors. After inheriting a bank that had unceremoniously dumped former CEO John Cryan and seen open revolt across the management board, Sewing moved quickly to consolidate power. Out were those of questionable loyalty, often replaced by internal confidantes with whom he’d risen through the ranks.
“The leadership team is committed and aligned to our strategy in a way it wasn’t at some times in the past,” said Fabrizio Campelli, a Deutsche Bank veteran whom Sewing recently appointed to oversee the investment bank and the corporate bank. “The dialog is now all about how units can help one another.”
Avoiding self-inflicted distractions has allowed the bank to ride a broad trading rally that’s now well into its second year. For three quarters in a row, Deutsche Bank’s fixed-income unit has taken back market share from rivals, alleviating concern that the business had been too damaged by years of cutbacks. The investment bank also benefited from a surge in blank-check companies, a business where Deutsche Bank had a top position for years.
Read more: Deutsche Bank Leans on Traders as Corporate Bank Outlook Cut
But the trading boom — and its inevitable slowdown — also raises some awkward questions for Sewing’s restructuring plan and strategy in the future. At its heart, the original plan envisaged cutting thousands of jobs, scaling back the bank’s international ambitions, particularly in investment banking, where the CEO exited equities trading. Instead, Sewing planned to focus on the more stable lending operations, especially the transaction bank servicing big companies.
Yet the units at the heart of his growth plans have repeatedly missed their targets after being hit hard by the European Central Bank’s negative interest rates, forcing Sewing to rely more on his traders. German government bonds have some of the lowest yields in Europe, with even long-term yields staying below zero until recently.
“The interest rate environment in Germany is perhaps the most challenging one globally,” said Alexander Hendricks, an analyst at Moody’s Investors Service. “The starting point for German banks is also worse with one of the worst cost-to-income ratios, so it’s imperative that they focus on cost management.”
Germany is one of the most competitive markets in an already fragmented European landscape, with some 1,679 banks battling for business. Many of them don’t face the same pressure to be profitable because they’re backed by municipalities, and so lenders have been slow to cut branches or charge for checking accounts and excess deposits, out of fear that clients could go to rivals.
That restraint, however, appears to be changing, in part because of pressure from international investors. Seven years after the ECB introduced negative rates, both Deutsche Bank and its crosstown rival Commerzbank AG have embarked on aggressive cuts to their branch network and staff. Between the two lenders, some 650 locations and 28,000 jobs are being cut. Clients used to free checking and deposit accounts are increasingly being asked to pay, and take their business online.
“The years since the financial crisis have really been a lost decade for investors in German banks,” said Florian von Hardenberg, a UBS Group AG banker who advises German lenders on acquisitions and other strategic questions. “But the new restructuring plans have more ambition than previous ones, and they’ve worked through their legacy issues. For the first time in a long time, they actually have a chance to achieve a healthy level of profitability.”
Challenges still abound. Analysts remain skeptical that Deutsche Bank can meet its modest profitability target, an 8% return on tangible equity. Legal and regulatory issues continue to crop up. These include an internal probe into alleged misselling of securities in Spain, a penalty from Taiwan’s central bank for currency speculation, an expanded mandate for a BaFin-appointed anti-money laundering monitor, and a lawsuit from Malaysia’s investment fund 1MDB over $1.1 billion.
Read also: Deutsche Bank’s Last-Ditch Plan to Save the Best of Its Business
But at least in the markets, Sewing’s success in avoiding unforced errors has helped restore some degree of confidence. Top investors including Cerberus Capital Management and Doug Braunstein’s Hudson Executive Capital are content with Deutsche Bank’s development, people familiar with their thinking said. Cerberus made a big bet on a rebound in German banking with stakes in Deutsche Bank and Commerzbank almost four years ago. Moody’s is reviewing Deutsche Bank’s credit ratings with a view toward raising them.
In the stock market, Deutsche Bank’s gains have been accentuated by the stumbles of rivals. French investment banks including Societe Generale SA were thrown into turmoil last year when the complex equity derivatives in which they specialize suffered steep losses. Credit Suisse is going through its worst crisis in years after twin hits from Greensill and Archegos.
The diverging fortunes have upended the balance of power in an industry that’s long been ripe for consolidation. Both Credit Suisse and SocGen, whose market value dwarfed that of Deutsche Bank just two years ago, are now worth less than the German lender.
Sewing is a proponent of consolidation, though he has ruled out a transaction in which Deutsche Bank would be the junior partner. But after the bank’s share price recovered, transformational deals are becoming conceivable for top management, people familiar with the matter said. Credit Suisse has recently come up as one option in internal talks, they said.
“We must create the conditions to be able to play an active part in cross-border European consolidation,” Sewing said in a speech prepared for the bank’s annual shareholder meeting this week. “And that will happen sooner or later.”
Deutsche Bank could also revive merger talks with Commerzbank, especially if a bank from outside Germany were to set its sights on Commerzbank, some analysts and bankers say. The two held talks in 2019 at the urging of the government, but decided to focus on their respective restructurings instead.
For Sewing, that decision has worked well so far. Finding a cure for Deutsche Bank’s disease has kept his turnaround plan on track. Ultimately, though, he’ll have to come up with one for the ills plaguing German — and, by extension, European — banking.
“Deutsche Bank has managed a remarkable turnaround in the past quarters,” said Andreas Dombret, a former top official at the German central bank who used to supervise the lender. “Now it’s about making sure that is sustainable.’’
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