Deutsche Bank Truth: Behind Huge Derivatives andPoisonous Assets

Wall Street Club 2019-07-13

德银真相：巨额衍生品和有毒资产背后

华尔街俱乐部   2019-07-13

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At 10 o'clock on the morning of July 8th, in front ofthe Deutsche Bank London building, this is the working time. Only the employeeshold the office carton blankly and walk out of the De Yin Building one by one.Deutsche Bank, one of the “Nine Investment Banks”, did not give them anybreathing space. Their passport will expire at 11 am.

The large scale of layoffs of Deutsche Bank can nothelp but make the market that is fragile and fragile.

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This picture is rumored in the WeChat group today, andpeople can't help but think of the financial crisis after Lehman's bankruptcy.

What is the reason for the layoffs of Deutsche Bank?Will Deutsche Bank really go bankrupt?

Rumors begin with information barriers and stop at thetruth.

Is it the tranquility before the tsunami, or is it thecloud of people? Let us find out.

[Deutsche Bank layoffs]

Such massive layoffs are not the first time. In Aprillast year, the new official of Christian Deutsche Bank, Christian Sewing, tookthe fire, and in May, Deutsche Bank announced that it would lay off 7,000people.

After the financial crisis, Deutsche Bank seems tohave been unable to recover and struggle. It spanned 1.5 centuries and has beennegatively entangled in recent years. It has been labeled as “delisted by thenine major investment banks” and “the next Lehman Brothers”.

Deutsche Bank has also reorganized its businessintentions such as the sale of stockbrokers, so it is impossible to reverse thesituation, and even this large-scale layoffs in the shock market. Whathappened, so that Deutsche Bank is so eager to survive?

Heavy costs have to be reduced

Deutsche Bank's first quarter profit and loss

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The high cost of Deutsche Bank's business has becomean unbearable burden.

As Christian Sewing said, “This broken arm survival isour last fight.”

According to the published financial report, in thefirst quarter of 2019, the cost-to-income ratio of corporate and investmentbanking (CIB) was as high as 95%, while that of private banking (PCB) was 88%.As the boss of the German banking industry, the cost/income ratio is high,which makes people stunned.

Is the cost too high or the income too low?

It’s not a cold day. In recent years, the net incomeof Deutsche Bank's corporate and investment banking businesses has graduallynarrowed, and has turned negative since the second half of 2018. The increasingcost has placed a heavy burden on the company's overall profit.

Deutsche Bank's corporate and investment bankingbusiness performance over the years (in millions of euros)

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Therefore, this reduction is mainly for enterprisesand investment banking business. Deutsche Bank's goal is that by 2022 theglobal workforce will drop to around 74,000, a reduction of 6 billion euros inexpenditure, which is more than a quarter of operating costs. Deutsche Bankexpects that the cost/revenue ratio will reach 70% by then, and this level iscurrently as high as 93%.

Deutsche Bank's historical cost/income ratio

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Redundant people say goodbye

In the first quarter of 2019, Deutsche Bank had morethan 91,400 employees, net income of $7.118 billion, and actual employee netprofit per capita was $2210.

Compared with Goldman Sachs, the number of employeesis 35,900, the net income is 8.81 billion US dollars, and the actual employeenet profit per capita is 62,700 US dollars.

Deutsche Bank has a commercial banking business, whichis the reason for the large number of employees; but from another perspective,Deutsche Bank's investment bankruptcy is only half of the total number ofemployees in Goldman Sachs.

Deutsche Bank's number of employees (thousands)

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[DeutscheBank's business]

Excessivepersonnel and heavy costs are the reasons for Deutsche Bank's layoffs, and"open source is unfavorable" is the root cause of businessrestructuring.

Fromthe data of the first quarter of 2019, Deutsche Bank's revenue decreased by 9%year-on-year, and the main business line revenues declined to varying degrees.

DeutscheBank's revenue share of each business line in the first quarter

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Corporateand investment banking business revenue (CIB) accounted for more than half ofDeutsche Bank's total revenue, but net income in the first quarter of this yearfell 13% year-on-year.

Themain reason for the decline was the stock sales and trading business, whichonly achieved 468 million euros in revenue in the first quarter, down 18%year-on-year. This is also the main department of this layoff.

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TheGlobal Transaction Bank (GTB) business, which was originally affiliated withthe corporate and investment banking departments, grew 6% year-on-year to 975million euros. GTB provides payment, cash management and trade finance servicesprimarily to corporate clients. In this reorganization, Deutsche Bank willsplit the GTB to form the corporate banking division, which is expected tobring more profit to the company.

Origination& Advisory's revenue was 455 million euros, down 5%.

Inaddition to the CIB business, net income from private banking (PCB) decreasedby 5% year-on-year; revenue from the asset management department decreased by4%.

Source:Deutsche Bank 2019 Quarterly Report

DeutscheBank, once ambitionous, has developed weakly on every business line that hasbeen rolled out. It really needs to rethink the future direction.

ChristianSewing, CEO of Deutsche Bank, said in May that it would focus on “profit andgrowth areas”. This means that Deutsche Bank will focus on the most competitivebusiness.

TheUS "New York Times" pointed out: "Deutsche Bank has notrecovered from the 2008 financial crisis, deviating from its corecompetitiveness, pursuing a glamorous investment banking business or even ahigh-risk credit business, is destined to fall into today's dilemma."

DeutscheBank hopes to divest its unneeded assets by 2022 by business restructuring andincrease its core revenue by 10% to 25 billion euros ($28 billion).Restructuring may be the only chance for it to achieve its goals.

[Giantderivatives or erosive capital? 】

Backto the beginning, the market rumors that Deutsche Bank's derivatives exposurereached 43.5 trillion euros, and the change in net worth will erode capital.There are even the following pictures:

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Source:Network, from left to right, Earth, central bank balance sheet, Deutsche Bankderivatives position

So,is the rumor true?

Fromthe 2018 annual report, we can see that the nominal value (deionalamount) ofDeutsche Bank's derivatives products is 43.5 trillion euros, and the marketvalue is only a fraction of its value.

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DeutscheBank end of 2018 assets (million euros)

Source:Deutsche Bank 2018 Annual Report, Yunfeng Finance

Inaddition, as can be seen from Deutsche Bank's June Client & CreditorPresentation material, because the annual report's total derivatives positionincludes the Master netting agreement*, if this part of the hedge position isdeducted in accordance with US GAAP accounting standards, And minus thecollateral, the net exposure will be significantly reduced to 21 billion euros.

DeutscheBank derivatives position

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Source:Deutsche Bank "Client & Creditor Presentation" June 2019, YunfengFinance

Inaddition to derivatives, is there a “toxic asset” on the Deutsche Bank account?Of the relatively high loan assets, about two-thirds are retail mortgages andasset management, and one-third are corporate and investment bank-relatedloans, half of which are loans to investment-grade counterparties. These loanassets are not high in risk from the category, indicating that the businesssector of Deutsche Bank is relatively stable.

DeutscheBank loan assets distribution

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Source:Deutsche Bank 2018 Annual Report, the largest of which are mortgages, wealthmanagement, commercial loans, consumer finance, etc.

Ofcourse, the financial institution's balance sheet is extremely complicated.During the global financial crisis, even bank CEOs said that they could notunderstand the balance sheet of their own banks. In addition, the disclosureinformation of derivatives is relatively limited. What we can do is to look atthe public data and make a Common sense judgment.

Whenit comes to capital, Deutsche Bank’s capital adequacy ratio is not bad. At theend of 2018, Deutsche Bank's ordinary tier 1 equity capital adequacy ratio was13.6%, which met regulatory requirements and reached its own long-term goal.

DeutscheBank's long-term performance goals

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Source:Deutsche Bank 2018 Annual Report

BaselIII stipulates that the lower limit of the tier 1 capital adequacy ratio ofglobal banks is 6%. The European Central Bank has higher requirements forDeutsche Bank's Tier 1 capital adequacy ratio. On February 28 this year, theEuropean Central Bank raised the minimum capital adequacy ratio of DeutscheBank from 10.69% to 11.82%.

Althoughthe rising asset adequacy requirements limit the strength of Deutsche Bank'sdividend payouts for ordinary primary equity, these assets have a strongercushioning effect on risk.

[Conclusion]

Thelarge-scale layoffs of Deutsche Bank are for throttling, not"bankruptcy." The gossip about the scale of its derivatives is alsofull of false and exaggerated elements.

Peopleremember the fear of the financial tsunami after the collapse of Lehman, butthey forgot that Citibank, which was also in crisis, was too big to be rescuedby the government.

DeutscheBank is Germany's largest bank, and its assets account for nearly half ofGermany's GDP. Its commercial banking business is solid and systematicallyimportant and will not be the next Lehman.

Asfor the "Goldman in Europe", Deutsche Bank has indeed had a moment ofhigh light in history. At the time, Anshu Jain, who was in danger of being outof the plane's plane crash, became the only Indian CEO of the European bank. Heled the radical development of Deutsche Bank's investment banking business.Deutsche Bank once became the No. 1 in the pricing of credit derivatives in themarket.

Thisis not the same as before. High cost and reduced income, Deutsche Bank'sability to make money. Needless to say, it can't be compared with thedouble-digit ROE of US banks such as Goldman Sachs and JP Morgan Chase, andeven worse than the BNP, which is also a European bank.

Returnon net assets of each bank (%)

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Source:Bloomberg, Yunfeng financial consolidation, blue dotted line for German silver,dark orange for Goldman Sachs and JP Morgan Chase, light blue for Faba

Thistime, I abandoned some of the investment banking business and survived. Perhapsas Deutsche Bank said in the annual report, "To achieve the performancegoal, only become a simpler and safer bank."

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Returningto the source, it must be always.