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Deutsche Bank CEO said overhaul was 'different this time' – Q3 shows it might be

"It's different this time," said CEO Christian Sewing when he presented Deutsche Bank AG's most recent restructuring plan in July 2019.

It was the group's second overhaul attempt under Sewing, following several strategic reshuffles under former CEO John Cryan in the three years before that, so the market was understandably cautious about his plans. But after a year of consistently lower costs, solid capital and liquidity and the recent increase in revenues, confidence in Deutsche Bank is starting to grow.

Group third-quarter revenues increased 13% year over year to €5.94 billion with costs dropping 10% to €5.18 billion. As a result, Deutsche Bank continued to build positive operating leverage, which it has grown for four consecutive quarters, Sewing told analysts at the earnings presentation Oct. 28.

This is "a major leap forward" from previous restructurings, when Deutsche Bank suffered greater revenue attrition and did not generate any additional operating leverage — a measure of how revenue growth translates into operating income growth, Moody's credit analysts said in a report in November. The swift implementation of the latest restructuring paves the way for its successful completion in 2022 and was a factor for Moody's decision to change its outlook on Deutsche Bank's ratings to stable from negative, they said.

Another key difference this time is the downsizing of the investment bank, which for the first time in Deutsche Bank's history was moved from the core operating business model, Moody's analyst Michael Rohr said in an interview. This helped alleviate the pressure on capital, reduced leverage exposure and potential risk of losses or litigation charges, which were mostly linked to wrongdoing in the investment bank in the past, he said.

High marks

The outlook change also reflects Moody's evaluation that "the shortfalls in corporate governance and in executing on earlier restructuring plans as well as overcoming structural and cultural issues have receded since the new management took over," the analysts said.

Under Sewing, who became CEO in April 2018, Deutsche Bank been more focused on cost discipline and has made progress on corporate governance and compliance, although more needs to be done, DBRS Morningstar credit analyst Sonja Förster said in an interview. "Overall, we view that Deutsche Bank's franchise has benefited from an increase of confidence in the new management team. The strategy and targets have been laid out clearly, and management has been executing," she said.

While cost reduction efforts must continue by 2022, Deutsche Bank has laid the foundations for its core units and can focus on clients, products and delivery, Morgan Stanley equity analyst Magdalena Stoklosa said in a recent note. The latest figures showed what a well-performing group could look like as Deutsche Bank beat global peers in both fixed income, currencies and commodities, and origination and advisory revenues for the first time since the fourth quarter of 2016, Stoklosa said.

I-bank results

With a 43% year-over-year revenue jump, the investment bank was the key driver of third-quarter group revenues and the only one of the four core business units to book a revenue increase in the first nine months of 2020. The unit's year-to-date growth spurt, driven by the pandemic-induced market volatility, brings Deutsche Bank closer to its 2022 group revenue target of €24.5 billion but analysts are wondering how much of the growth will remain after FICC trading normalizes.

Signs of that normalization were seen in the third quarter, with year-over-year growth rate in global FICC revenues nearly halving as compared to the first half, according to data from Coalition, an S&P Global company.

Since the start of the restructuring, there has been a "fairly steady downward progression" of Deutsche Bank's fixed income market share, which accelerated in the second quarter, Credit Suisse equity analyst Jon Peace said in an interview. The bank's explanation has been differences in product mix and geographies but "it's hard not to conclude there has been some market share loss," Peace said.

In the third quarter, however, Deutsche Bank started regaining some ground. It outperformed U.S. peers by 25% in FICC and by 11% in advisory and underwriting revenues, according to Credit Suisse estimates. As things start to move in a better direction, funding costs come down and customers start to return, and there is definitely some optimism that the market share decline can stop, Peace said. "We see Deutsche Bank's market share stabilizing at 7.5% to 8% by 2022 from about 6.5% in the second quarter of 2020," close to the group's average share in 2019, he said.

2022 targets

The investment bank cuts were likely to lead to revenue attrition but that turned out to be lower than the €3 billion that Moody's expected, Rohr said. Giving up prime finance and equity sales and trading did not affect Deutsche Bank's equity capital markets and IPO businesses. "So far, they've grown revenue, which came as a surprise," he said. The group also regained market share with top 100 corporates, which a key driver of the beat because those are the clients that regularly trade and need advice, Rohr said.

Even if group revenues stay at around €23 billion in 2022, profitability would reach a level not seen at Deutsche Bank for some time, Rohr said. Assuming €17 billion in costs, which is Deutsche Bank's target for 2022, and loan loss provisions of some €2 billion in that year, pretax profit should be €4 billion, he said.

Average consensus estimates put Deutsche Bank's adjusted costs at €17.57 billion in 2022, on revenues of €22.44 billion, leading to an adjusted pretax profit of €3.35 billion.

The main reason for the lower revenue forecast is the anticipated decline in the global fixed-income pool, which Credit Suisse expects to shrink by "about a quarter" in 2022 from the 2020 level, Peace said. The higher cost estimate reflects the general market notion that it could be hard to deliver on costs, especially for an investment bank aiming to boost market share, Peace said. A greater proportion of the investment bank's expenses is variable and Deutsche Bank has to pay its people competitively if it wants to win new business, he said.