When Deutsche Bank announced earlier this month that Anshu Jain and Jürgen Fitschen were stepping down as co-chief executives, shares in the German lender jumped 10 percent on the day as investors welcomed a management overhaul they felt was long overdue. The euphoria was short-lived, however, as attention quickly turned to the challenges facing their successor, John Cryan.
From the moment he takes over as CEO on July 1, Cryan will be under pressure to shrink Deutsche — especially its sprawling investment banking division — in order to adapt to today’s tougher regulatory environment and boost profitability. Deutsche has been buffeted by allegations of improper behavior and agreed in April to pay $2.5 billion in fines to U.S. and U.K. regulators to settle charges of manipulating the London interbank offered rate. The bank has lagged behind European competitors such as Barclays, Credit Suisse Group and UBS in downsizing its investment banking activities.
In April, Jain and Fitschen announced a major restructuring dubbed Strategy 2020, but analysts and investors faulted the plan as being short on detail and criticized the co-CEOs for failing to get a grip on costs. As a member of Deutsche’s management board since 2013 and head of its audit and risk committees, Cryan, 54, had played a big role in drafting Strategy 2020, so he’s not exactly a new broom. But the Briton has a strong reputation as a cost-cutter, earned during a stint as CFO of UBS from 2008 to 2011, when the Swiss bank went through wrenching changes to recover from massive losses racked up during the financial crisis.
“We expect John Cryan to focus in particular on delivery on cost savings, with the previous Deutsche Bank CEOs having missed targets,” Kian Abouhossein, head of bank research at J.P. Morgan, wrote in a note to clients. Although Jain had helped establish Deutsche as a global investment banking powerhouse over the past 20 years, the group today needs an “execution-focused, numbers-oriented CEO,” he added.
A Cambridge University graduate, Cryan began his banking career in 1987 at merchant bank S.G. Warburg & Co. in London, later spending two years as a director in the firm’s German office. When Swiss Bank Corp. acquired Warburg in 1995, Cryan ran the bank’s financial institutions group, which specialized in advising other banks on mergers and acquisitions and capital raisings. He kept that post when SBC merged with UBS in 1998. It was in this role that he advised Paul Achleitner, then COO of Allianz, on the German insurer’s acquisition of Dresdner Bank in 2001. Achleitner, now Deutsche’s chairman, recruited him to the German bank in 2013. Crucially, Cryan speaks fluent German, something that Jain never mastered.
Cryan will need to dig deep into his experience with bank balance sheets if he is to pacify shareholders, who were frustrated at the lack of detail when Deutsche announced Strategy 2020 on April 27. In a note to clients, Kinner Lakhani, head of European bank research at Citigroup, described that strategy as “distinctly underwhelming: a relatively unambitious 10 percent ROE target; a lack of detail on net cost savings targets; and a prolonged time horizon of 2020.”
The discontent burst into the open at the bank’s annual general meetingfine in May, when almost 40 percent of shareholders present voted against the management board. “In our opinion the development of Deutsche’s share price and the total shareholder return since Fitschen and Jain took over three years ago seem to reflect the failure” of management’s previous strategy, said Hans-Christoph Hirt, a director at Hermes EOS, an arm of London-based Hermes Investment Management that represents dissenting shareholders. Jain acknowledged the frustration at the AGM, saying, “Returns to you, our shareholders, have not been what we aimed for.”
Jain also admitted that it was taking longer than expected to resolve the bank’s legal problems, including the Libor allegations. Deutsche incurred litigation costs of €8.2 billion ($9.3 billion) since June 2012, including €1.54 billion in the first quarter of this year.
On June 1 shares in the Frankfurt-based bank were virtually unchanged from three years earlier. Over the same period Morgan Stanley’s shares have almost tripled, Goldman Sachs’ have more than doubled, UBS’s gained more than 80 percent, and Barclays’ were up more than 60 percent.
Strategy 2020 promises to streamline Deutsche but will leave the group even more dependent on investment banking activities, a sharp contrast to the strategic shifts of most of its European rivals. The bank will continue to offer securities underwriting and advisory services, cash management, processing and lending services alongside asset and wealth management; however, it will curb securities trading activities, the traditional heart and soul of the investment bank but an area that requires much more capital in today’s regulatory climate and has underperformed.
In the corporate banking and securities division, which houses the investment bank, Deutsche plans to shrink the balance sheet by €200 billion, to €700 billion, and close some of its low-profit trading units. The cutbacks are expected to reduce the division’s annual revenue by €600 million, or nearly 5 percent. In 2014 the unit posted €4.3 billion in pretax profits on revenue of €13.7 billion. Overall, the bank promised to deliver €3.5 billion of cost savings while maintaining Deutsche as a leading player in global investment banking.
Although investors broadly agree with the strategy, they had lost faith in the ability of Jain and Fitschen to deliver on promised cost savings.
“Deutsche has not succeeded in explaining how it will sustainably create value for investors in a changed regulatory environment,” Hermes EOS’s Hirt said in an e-mailed response to questions. “They need to succeed in doing so when re-launching Strategy 2020 in July, set clear short-, mid- and long-term targets, and then deliver against these.”
Deutsche has pledged to improve its cost-income ratio to less than 65 percent by 2020 from 87 percent for 2014. It also wants to raise its leverage ratio, a simple measure of capital as a percentage of total assets, to at least 5 percent from 3.5 percent last year. The strategy calls as well for maintaining a Basel III risk-weighted common tier-1 ratio of 11 percent; the bank hit 11.1 percent on that measure at the end of the first quarter. To achieve these goals the group is looking to raise capital by spinning off Postbank, its German retail business. Former CEO Josef Ackermann led Deutsche in acquiring Postbank following the 2008–’09 financial crisis, believing it would ensure greater business balance and strengthen the group with its big retail deposit base. But Jain and Fitschen failed to extract the promised cost savings, and regulatory reforms designed to enforce greater separation between retail and investment banking undermined the merger’s rationale.
“The attraction of the Postbank deal was being able to use its deposit base, so the benefits were always more financial than operational,” wrote Citigroup’s Lakhani. “But as soon as deposits were ring fenced by regulators, that benefit was removed.” The new strategy calls for Deutsche to reduce its stake in Postbank to less than 50 percent by the end of 2016.
Under Jain and Fitschen, Deutsche had raised €24 billion in equity over the past three years, bolstering the bank’s long-lagging capital ratios but weighing on its share price. The duo also faced calls to overhaul the bank’s culture as a result of the Libor allegations.
Jain, who will leave Deutsche in six months’ time, and Fitschen, who will stay as co-CEO until May 2016, decided to step down after the rebuke from shareholders at the AGM. Deutsche had tried to avert a shareholder revolt with a hasty management revamp before the meeting. The changes included the departure of Rainer Neske, an executive once viewed as potential CEO material who ran the bank’s private banking and business clients division, including the underperforming retail business. Alan Cloete, co-head of the bank’s Asia-Pacific business and Colin Grassie, CEO of the UK operation, were also sacrificed while Jain took full responsibility for the delivery of the new Strategy.
A fixed-income specialist who spent 20 years at the bank, India-born Jain spearheaded the German lender’s transformation into a global investment banking powerhouse, with a leading fixed-income, currencies and commodities business. At its peak Deutsche would generate €13 billion a year in revenue from fixed income, currencies and commodities, but the financial crisis of 2008 –’09 made trading a less attractive business. The industry has been hit by a blizzard of new regulations that have effectively barred banks from proprietary trading and forced them to set aside much more capital for their trading activities, pressuring returns. Added to that, unprecedented levels of monetary stimulus from central banks reduced volatility in fixed-income markets, further depressing profitability.
The crisis had already forced Deutsche’s main European rivals to scale back their investment banking operations. UBS led the way in 2012 by radically reducing assets and head count in its investment bank and focusing the group around its asset and wealth management business. Credit Suisse halved the balance sheet of its investment banking unit and could be poised for a further retreat when Tidjane Thiam, the former CEO of British insurer Prudential, takes over as chief executive on July 1. Barclays, under pressure from regulators and shareholders, has slashed its investment bank, particularly its big FICC business, since announcing a new strategy in May 2014.
Deutsche was slower to react both because of its long-standing dependence on securities trading and because Jain believed that, with rivals retrenching, the bank would be able to gain market share and reap benefits when fixed-income markets recovered. In the wake of Barclays’ retreat, Jain last year said Deutsche would be Europe’s “last man standing” in global investment banking.
Jain defended his record when he stepped down, pointing to the fact that under his management Deutsche had boosted capital and created a new division, called asset and wealth management, to provide a fourth pillar of its business alongside investment banking, retail banking and global transaction banking. “The Bank has rarely been as well balanced as it is now, with all four of our business divisions contributing over a billion euros each for the first time ever in 2014,” he wrote in a memo to staff on June 9. “We have also resolved some of our toughest legacy issues. Though expensive and difficult, we have made significant progress.”
Analysts expect Cryan, who won plaudits at UBS for scaling back the investment bank, to stick with Strategy 2020 rather than junking it and starting fresh. Not only did he help design the strategy, but Deutsche doesn’t have the flexibility to scale back its investment bank as radically as UBS has. The corporate banking and securities division produced 44 percent of the group’s revenue last year. The AWM division has $1.3 trillion in assets under management, trailing well behind UBS’s $2 trillion. And unlike Barclays, which has a profitable credit card and retail banking business to fall back on, Deutsche will slash its retail presence by spinning off Postbank.
“Under Cryan, we believe, the overall contours of the bank will remain unchanged,” said Lakhani. “Deutsche’s core strategic strength lies in global transaction banking and corporate banking and securities.”
Notwithstanding the strides made by Jain and Fitschen, investors expect Cryan to further boost Deutsche’s capital base. “Cryan has had a strong view on the need for balance sheet strength,” says Lakhani. “At UBS he anticipated the capital levels UBS would need even ahead of Basel III.” Deutsche will free up capital with the planned spin-off of Postbank, but Cryan could also sell the bank’s 20 percent stake in China’s Hua Xia Bank, which is valued at about $4.8 billion.
Analysts also expect Cryan to sell Deutsche’s international retail networks, which are mainly in Italy and Spain, potentially fetching between €2.6 billion and €2.8 billion. He may seek as well to dispose of RREEF, the group’s real estate and infrastructure funds business, which is valued at between €1 billion and €1.5 billion, according to Citigroup.
Investors believe Cryan will be a more ruthless cost-cutter than Jain, who they felt hesitated to rein in a business he had built and staffed with key allies. “The new CEO will bring a more impartial view,” said Lakhani.
Cryan’s challenge will be to make reductions without undermining the bank’s strong market positions in foreign exchange, rates and credit. He is also likely to invest in Deutsche’s securities underwriting and M&A advisory businesses, which have become more attractive to banks because they consume less capital. “Cryan is a banker, not a trader, so that will be a positive for the M&A business,” says Stéphane Rambosson, a London-based managing director at financial services recruitment firm DHR International.
Deutsche generated $4.3 billion in revenue in equity and debt underwriting and M&A advisory last year, according to Dealogic, ranking fifth globally with a 5.4 percent market share. That was up from $3.9 billion in 2013, with a 5.2 percent market share and sixth-place ranking.
Cryan will be looking for an early boost following a recovery in fixed-income markets brought about by an increase in volatility. “The FICC revenue pool was exceptionally low last year because of central bank stimulus, and with a potential liftoff in Fed rates, the cycle is starting to improve,” said Lakhani.
Jain will cast a long shadow, and his departure could lead to the loss of some of his loyal lieutenants, whom he nurtured during his two decades at the bank. On June 29, Henrik Aslaksen, one of the bank’s most senior deal makers and a close ally of Jain, resigned as head of global M&A after 13 years at the firm. Other Jain protégés, such as Colin Fan, a fixed-income specialist who is co-head of the CB&S division, and Michele Faissola, whom Jain picked to build up the AWM platform, could follow, posing yet another challenge for Cryan.
