Sagging German economy hits Deutsche Bank’s revamp

Bloomberg

One month into Deutsche Bank AG’s boldest restructuring effort yet, the world has turned against Chief Executive Officer Christian Sewing. Or at least, Germany has.
Fears of an economic recession and the specter of even lower interest rates have taken a toll on banks across Europe. But for Sewing, who just pinned his bank’s future on closer ties with Germany’s export-oriented firms in a pivot away from Wall Street investment banking, the rapid deterioration comes at a particularly bad time.
Shares of the Frankfurt-based lender fell to a record low this week as reports showed Germany is teetering on the edge of recession. Manufacturers are reeling from the trade war between the US and China, with big exporters such as Daimler AG, BASF SE, Continental AG and Henkel AG cutting forecasts. Should their woes get worse, they could complicate a revamp that has little room for error after a series of costly and unsuccessful turnaround efforts under Sewing’s predecessors.
“Deutsche Bank’s restructuring plan has been ambitious from the start and Germany’s economic slowdown will make it that much harder to achieve,” said Philipp Haessler, an analyst with Pareto Securities who has a hold recommendation on the bank.
Sewing is cutting 18,000 jobs and exiting equities trading in a further retreat from Wall Street, while focusing on the transaction bank that serves corporate clients. Despite the recent decline, Deutsche Bank’s shares have outperformed peers since Sewing flagged “tough cutbacks” to the investment bank at the shareholders’ meeting in May.
Anticipating an economic slowdown, the Finance Ministry had encouraged merger talks earlier this year between Deutsche Bank and crosstown rival Commerzbank AG, in which Berlin still holds a roughly 15% stake. But after more than five weeks of meetings, Sewing in April walked away from a deal, saying it would be too difficult to execute and wouldn’t justify the restructuring costs and additional capital requirements.
Both Commerzbank and Deutsche Bank had based their respective turnaround plans on the assumption that interest rates would eventually start to rise, boosting income from lending. But after half a decade of negative rates that punished banks, the European Central Bank now looks poised to lower them even further.
Falling interest rates may keep losses from bad loans low, and they may make it easier for Deutsche Bank to sell assets as its exits some businesses, because the returns those assets offer become more appealing when yields on other investments decline. But in the long run, lower rates mean less income from lending, hurting a key source of earnings at Deutsche Bank and Commerzbank.
Even more than Deutsche Bank, Commerzbank has refocused its business on serving corporations and retail clients in its home market, after a bruising excursion into investment banking that ended with a bailout in 2009. But while CEO Martin Zielke has steadily increased the number of clients, low interest rates and competition in the business with corporations have eroded earnings. The bank conceded this month that its goal of lifting profit this year is looking “ambitious” after it set aside more money for soured loans.
Shares of Germany’s second-largest listed lender also slumped to a record low this week, capping a roller coaster ride that saw the stock more than double after Zielke announced his strategy three years ago, only to give up those gains when expectations for higher interest rates reversed. The German government is now seeking to hire a consultant to advise it on its stake in Commerzbank.
While the Finance Ministry’s backing of the merger talks was met with skepticism in other parts of the government, it highlighted the concern in Berlin about the state of the country’s top lenders, a decade after the financial crisis. Unlike the US, where companies can tap deep capital markets for funding, Europe remains more dependent on bank loans. When more borrowers run into trouble and banks tighten lending standards, that can reinforce an economic crisis — particularly if the lenders are weak to begin with.
Both banks are currently well capitalized, with a key regulatory metric placing them broadly in the middle of their European peers. But Sewing has had to draw up his restructuring plan without fresh capital from investors, who coughed up 30 billion euros ($33 billion) in four capital increases over the past decade.