Early this week, Deutsche Bank announced sweeping organization-wide changes aimed at cutting costs, improving profitability and ensuring a sustainable business model – putting an end to months of speculation about the future of the German bank. The bank has been under pressure from investors over recent years for its notably poor performance compared to peers in terms of profitability and returns, even as it remains embroiled in a long list of high-profile lawsuits and regulatory probes. The newly announced plan, dubbed Strategy 2020, replaces the ambitious Strategy 2015+ which was announced by Deutsche Bank in September 2012 and sought to largely retain the business model with focus on cutting costs (see Deutsche Bank Set For Complete Shake-up As Part Of ‘Strategy 2015+’). Strategy 2020 includes a plan to shrink the investment banking operations, to deconsolidate Postbank and to increase the bank’s focus on asset management and transaction banking. The bank will also improve operating efficiency by investing in technology and by exiting several countries where low operating profits do not justify the bank’s presence.
Investors have anticipated an announcement of a major shake-up in Deutsche Bank’s business model for over three months now – something that helped the bank’s shares jump 30% from late January to earlier this month. With the bank finally detailing the plan on Monday, April 27, investors booked profits to send the shares 5% lower over trading that day. We maintain a $36 price estimate for Deutsche Bank’s stock, which is roughly 10% ahead of the current market price.
Changes Targeting Bank-Wide Performance Metrics
- Return on Tangible Equity Target TGT +1.21%: Deutsche Bank wants to raise its post-tax return on tangible equity figure to at least 10% in the medium term. This is a notable reduction compared to the bank’s original target of raising post-tax return on equity to 12% by the end of 2015. The bank generated a return on equity of 2.7% and a return on tangible equity of 3.5% in 2014.
- Leverage Ratio Target: Deutsche Bank wants to raise its leverage ratio figure to at least 5%. The figure was 3.5% in 2014.
- Capital Ratio Target: Deutsche Bank aims to maintain a CRD 4 fully loaded Basel 3 Common Equity Tier 1 ratio at around 11%. This figure was 11.1% at the end of Q1 2015.
- Cost Reduction Target: The bank intends to improve its cost-income ratio to less than 65% over coming years. This will require considerable effort, given that the figure was 87% for 2014. The target is to be achieved through annual cost savings of ?3.5 billion ($3.8 billion) by ”reducing complexity, increasing controls and boosting efficiency.” Notably, these savings are over and above the ?4.5 billion reduction laid out under Strategy 2015+, which will be realized by the end of this year. The newly proposed cost-reduction plan would itself come at a one-time cost of about ?3.7 billion ($4 billion).
- Payout Ratio Target: The bank intends to increase its payout ratio to shareholders to at least 50% over coming years. In the last couple of years, the bank has diluted its equity considerably by raising fresh capital to meet stringent capital requirements and has been forced to keep dividends at a minimum. The chart below represents Deutsche Bank’s adjusted payout ratio (dividends and share repurchases combined) over the past and also includes our estimate of the payout over coming years. Do note that the figure was 93% in 2014 as the bank’s net income figure was hit by litigation charges. We represent the payout for 2012 and 2013 as 0% as the figure was not meaningful.
- Changes Targeted At Specific Divisions
- Corporate Banking & Securities: The investment banking arm will see a total reduction in its balance sheet of ?200 billion, with about ?50-70 billion worth of existing assets being redeployed towards client-focused operations. Deutsche Bank will do away with its offerings to hedge funds, and will also shutter some of its low-profit trading units – incurring a cost of ?800 million in these disposals. The refocused investment bank will forego roughly ?600 million in annual revenues, but will gain significantly in terms of operating margins.
- Private & Business Clients division: This division includes Deutsche Bank’s retail business, and will see the biggest changes under Strategy 2020. While the bank will retain its retail banking operations in Germany and the five European nations of Italy,Spain, Belgium, Portugal and Poland, it will spin-off Postbank through an IPO. Deutsche Bank is likely to reduce its stake in Postbank to under 50% by the end of 2016. The deconsolidation of Postbank, an investment of up to half a billion euros in digital technology and the reduction in branch network from the current figure of 700 to around 500 should help the division’s operating margin improve from the dismal level of 6.3% seen in 2014.
- Asset & Wealth Management division: Deutsche Bank created this division as a part of Strategy 2015+, and has put in considerable effort over the years to grow it in size. The bank will continue to target a 5-10% growth in assets for this business in the future by growing its workforce by roughly 15% and investing in product specialists. The bank will also launch more products across asset classes to boost the growth rate.
- Global Transaction Banking division: This division, which offers commercial banking products and services for corporations and financial institutions, will see investments to the tune of a billion euros over coming years to improve operational efficiency as well as to develop new client propositions. Deutsche Bank enjoys a strong position in this sector, and it will leverage the cross-selling opportunities that exist with the investment banking arm to grow its transaction banking operations steadily in the years to come.