Why we’ve said ‘auf Wiedersehen’ to Deutsche Bank
Insights

Why we’ve said ‘auf Wiedersehen’ to Deutsche Bank

At a Glance

  • Our Investment Grade team is always looking to invest in credible turnaround stories
  • The German bank had a culture problem, but when it appointed a new CEO and began to embark on a period of restructuring, we were interested
  • Things are now looking brighter for the bank, but is further progress likely to be achieved?

A great German thinker once said: “We rarely find people who achieve great things without first going astray1.”

Back in 2018 the analyst team at Columbia Threadneedle Investments considered Deutsche Bank2 to be an example of a culture problem. The old joke was that it was better to be an employee of the bank than a shareholder. From 1995, when it began building the investment bank, to 2018 total shareholder returns were negative €13 billion, while staff bonuses over the period were €79 billion3!

That year, under new leadership, the bank embarked on a period of restructuring. We were initially skeptical – Deutsche Bank’s previous track record of change was poor – but we took note when CEO Christian Sewing began hitting his targets. On Columbia Threadneedle’s Investment Grade Credit team we invest in credible turnaround stories. As a company improves, borrowing costs fall, bond prices rise and our clients reap the benefits. In this instance we talked to management, reviewed the numbers and decided it represented an investment opportunity.

Slowly, things started to change at Deutsche Bank. Over a six-year period the cost-to-income ratio (a measure of efficiency) fell by more than 15 percentage points and the return on equity (measure of profitability) improved from zero to around 6%4. What’s more, the culture around risk management and governance and the approach to society and the environment was overhauled.

Things are now looking brighter in Frankfurt, and credit markets have taken note. Deutsche Bank’s cost of borrowing is currently around the same level as Barclays or Société Générale – companies which have demonstrated greater stability and predictability of cashflows over the years.

So, what now for the new Deutsche Bank? We felt further progress would be harder to come by. Let’s look at why:

The investment bank

Deutsche’s investment bank performed well from 2000-06, but only because it was leveraged around 50x! In fact, when we look back and apply recent leverage levels of 18-20x, the investment bank didn’t meet its cost of capital at any point until Sewing arrived in the CEO role. By focussing on efficiencies and exiting underperforming businesses, Deutsche has since been punching its weight relative to peers such as Citi and Bank of America. While that is impressive, we thought further gains would require increased market share – which we thought unlikely. Deutsche Bank didn’t have a particular edge in this business relative to the big US players.

Asset quality

The new management team improved transparency and tightened lending standards. The CFO and CRO led “investor deep dives” into the darker corners of the balance sheet and the company avoided some of the embarrassing mistakes that caught out its peers (for example, Archegos and Signa). Credit risk had been well managed to-date and bad debt numbers had come through on expectations.

Nonetheless, Deutsche has been heavily exposed to US office commercial real estate, equivalent to about a sixth of capital, and we felt loan-to-value levels were high5.The longer the US Federal Reserve kept base rates at existing levels, the more pressure this portfolio would be under. If Deutsche Bank had to adjust provisioning levels to match those of large US banks it would put a serious dent in profitability, leaving 2025 targets at risk.

Domestic competition

Germany is a tough banking market. It consists of the private banks (mainly Deutsche and Commerzbank), the public sector banks (the Landesbanken and Sparkassen) and the credit cooperatives (the Volksbanken and Raiffeisenbanken). The public and cooperative sectors have a combined market share of about 50% and are not-for-profit institutions. They don’t have shareholders or profitability targets so can lend at lower margins. Put simply: the competition can offer the same product at a better price.

However, a couple of years into Deutsche’s turnaround, the European Central Bank (ECB) started to hike rates and profitability became easier to achieve. The German system is awash with deposits. “Deposit beta” – the percentage of an ECB rate hike which gets passed through to depositors – is around 30%. This rising rate effect helped to add more than 20% to net interest income between 2021 and 20236.We felt the timing was fortuitous. Interest rates have been the tide that has lifted all ships in banking. As rates fall over the next couple of years, our view was that profitability growth would be much harder to come by.

Conclusion

Deutsche is no longer astray. Sewing and his team have steered things on to a better path. The credit market has adjusted its perceptions. Valuations are close to those of peer companies, which didn’t stray as far. However, we felt it would be a tall order for the bank to continue this trajectory of improvement. As such, it was time for us to say “auf Wiedersehen” and move on to the next turnaround opportunity.

8 Juli 2024
Paul Smillie
Paul Smillie
Senior Credit Analyst
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Why we’ve said ‘auf Wiedersehen’ to Deutsche Bank

1Meister Eckhart, see Cyprian Smith: Meister Eckhart, The Way of Paradox, 1987

2Mention of specific stocks is not a recommendation to buy or sell

3Columbia Threadneedle Investments’ analysis of company statements, May 2024

4Columbia Threadneedle Investments’ analysis of company statements, May 2024

5Average loan-to-value on US Office commercial real estate at FY23 of 81%. Columbia Threadneedle Investments’ analysis of company reports, April 2024

6Columbia Threadneedle Investments’ analysis of bank reports, May 2024

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial
advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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