Jain Fails to Repeat Deutsche Bank Debt Success With Equity
Anshu Jain, the head of Deutsche Bank AG (DBK)’s investment-banking division, earned a promotion to co- chief executive officer of Germany’s biggest bank last month by cementing its status as a debt-trading powerhouse.
He’s had less success in a seven-year effort to turn the equities unit, which sells and trades stocks and equity-linked derivatives, into a global leader, a performance that may haunt the Frankfurt-based company as higher capital requirements threaten to make fixed-income businesses less profitable.
“Jain’s track record is pretty good in terms of bringing businesses he’s managing to a top-three position, though he hasn’t done that with equities so far,” said Dirk Hoffmann- Becking, an analyst at Sanford C. Bernstein Ltd. in London. “The market will clearly shift away from the relative importance of fixed income compared with underwriting, advisory and equities. It’s clear that Deutsche Bank has to move over to these businesses.”
Deutsche Bank fell to seventh in equities in the first half of this year from fourth in 2004, based on its share of revenue generated among the nine biggest investment banks, according to data compiled by Bloomberg from company reports. That compares with a second-place ranking in overall sales and trading revenue, which also includes fixed income, currencies and commodities, up from third in 2004.
The decline occurred as Jain overhauled his equities strategy and management after losses during the credit crunch in 2008, changing his focus from bets with the bank’s own money to trading for customers, a shift mirrored by competitors amid a regulatory crackdown on proprietary trading.
Jain, 48, oversees more than 60 percent of Deutsche Bank’s revenue and 80 percent of its pretax earnings as head of the corporate and investment bank. The unit comprises trading, underwriting, corporate finance, mergers advice and transaction banking, which includes cash management and trade finance.
The India-born Jain will share the CEO role with Juergen Fitschen, 62, who is responsible for Germany, after Josef Ackermann, 63, steps down on May 31. Jain declined to comment for this story.
Deutsche Bank rose 0.4 percent to 27.50 euros in Frankfurt trading, while the 46-company Bloomberg Europe Banks and Financial Services Index gained 1.7 percent. The bank, which fared better than European competitors such as UBS AG and Royal Bank of Scotland Group Plc in the credit crisis of 2008, was up 7.9 percent from the end of that year through yesterday, compared with an 11 percent decline in the banking index.
“If you look at Jain’s performance throughout the financial crisis and earnings over the years, he played a massive role in where Deutsche Bank stands today,” said Michael Rohr, an analyst at Sylvia Quandt Research GmbH in Frankfurt. “It would be desirable for Deutsche Bank to build its strength in equities, but not if that requires exaggerated costs.”
Higher earnings from equities would help the bank counter the effect of stricter capital requirements agreed to by the Basel Committee on Banking Supervision that may cut returns from fixed-income businesses. The profitability of a trading unit often rises with market share, so climbing in the equities rankings may help Jain sustain returns for shareholders.
“Typically at 10 you lose money, at seven you just about cover your cost of capital,” Jain told investors in London on June 1, speaking of industry rankings. “You start to return to shareholders at five; at three, you become hugely profitable.”
“That pressure to be top-three will be the difference between an acceptable ROE and the one that isn’t,” particularly under Basel III rules, he said, referring to return on equity.
While Deutsche Bank has gained market share in U.S. and Asian cash equities, the bank remains “underweight” in these areas, along with equity derivatives trading, Jain said in June, citing data from market-research firms.
The U.S. cash-equities business, or carrying out stock transactions on behalf of corporate and institutional clients, is the hardest to crack. The German bank aims to reach the top five, and is seventh now, according to Jain’s presentation.
“The U.S. market is the 800-pound gorilla and represents about 50 percent of the global commission pool in equities,” said John Colon, a consultant at Greenwich Associates, a Stamford, Connecticut-based market research and advisory company for financial-services firms. “Whoever leads in the U.S. will look like a global leader.”
The Basel committee is changing rules on how much capital banks need to hold for their operations. Regulations on trading assets to be implemented by the end of this year, as well as additional changes that come into effect by 2019, will shave between 13 percentage points and 14 percentage points from pretax return on equity at Deutsche Bank’s investment bank, according to slides Jain presented in June.
An additional 3 percentage points to 4 percentage points may disappear because of regulations such as the Volcker rule, which prohibits proprietary trading, the slides showed.
Deutsche Bank plans to counter that by selling some assets, cutting costs and capturing a greater market share to keep pretax ROE above 20 percent, compared with 28 percent in 2010, Jain said. Equities and advisory businesses can produce higher returns because they are less capital intensive and will be less affected by Basel rules.
Had the stricter requirements been in effect in 2010, the average return on equity in fixed-income businesses on Wall Street would have been 5.7 percentage points lower at 8.3 percent, while ROE in equities would have been reduced 2.6 percentage points to 16.5 percent, Morgan Stanley (MS) analysts led by Huw van Steenis estimated in January.
“Equities-geared banks are best positioned for Basel III,” Morgan Stanley analysts wrote in a paper with New York- based Oliver Wyman Group in March. “Little wonder so many firms are trying to enter or beef up their equities divisions.”
The analysts forecast that the fixed-income revenue pool may shrink this year, while equities may start recovering. Total equities revenue generated by the nine biggest firms in the first half of this year rose 7.9 percent from the same period of 2010, while revenue from fixed income, currencies and commodities fell 18 percent, data compiled by Bloomberg show.
“Deutsche Bank’s strategy a few years back was to prioritize fixed income versus equities,” said Jeremy Sigee, an analyst at Barclays Capital in London. “They took a more negative view on equities and tried to approach the business differently. More recently they’ve come back a bit and said we do need a more prominent equities business, partially because of the capital rules.”
Jain, who started his career as a derivatives strategist at Merrill Lynch & Co. and was brought to Deutsche Bank in 1995 by Edson Mitchell, was charged with revamping the bank’s equities business in 2004 as analysts including Stuart Graham, then at Merrill Lynch, criticized the firm’s reliance on bonds. While the criticism died down as the fixed-income revenue pool grew 67 percent from 2004 to 2010, that dependence increased.
Fixed income, currencies and commodities contributed 61 percent of the securities unit’s revenue in the first half of this year, up from 55 percent in 2004, company reports show. The share produced by equities trading fell to about 15 percent from 22 percent during the period, data compiled by Bloomberg show.
“Deutsche Bank remains first and foremost a fixed-income house,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London.
The bank rose in the rankings for revenue from stock and bond underwriting and advising clients on mergers, the data show, benefiting from an expansion under Michael Cohrs, who retired in 2010. The company hired 141 managing directors and directors in corporate finance between 2008 and 2010, according to Jain’s presentation.
Deutsche Bank captured the sixth-biggest portion of revenue from underwriting and advisory work among the nine largest banks in the first half of 2011, up from eighth in 2009. Since the financial crisis, Jain also boosted the bank’s portion of revenue from fixed income, currencies and commodities, ranking second behind JPMorgan Chase & Co. (JPM) in the first half of this year, the data show.
The gain is partly the result of the bank’s expansion in commodities, a division Jain began bolstering in 2006 with the hiring of David Silbert from Merrill Lynch as global head of the business. By 2009, revenue from commodities more than doubled, and the bank is now one of the top five firms with an 11 percent market share, according to Jain’s June presentation.
When Jain took charge of the equities business in 2004, he combined the unit with fixed income to cut costs in research and technology and replaced senior managers. At that time, about half of equities revenue came from proprietary trading and retail structured products.
Jain kept the proprietary business to avoid losing top traders to hedge funds and tried to boost Deutsche Bank’s revenue by focusing on more complex products, rather than on plain-vanilla trading of stocks for clients.
The equities business suffered during the crisis, posting losses of 1.7 billion euros ($2.5 billion) in stock derivatives and 413 million euros in proprietary trading in the fourth quarter of 2008.
After the losses, Jain decided to reengineer the business to gain more market share from providing services to clients and less from taking positions in the market. The firm appointed Michele Gissi and Roger Naylor to run global equity derivatives in November 2008 and a month later named Garth Ritchie and Robert Karofsky co-heads of equities to replace Yassine Bouhara. Karofsky left in June 2010.
‘Work in Progress’
The contribution to total equities revenue from proprietary trading fell to about 10 percent in 2009 from 21 percent in 2005, and the business was shut in the third quarter of last year. Pablo Calderini, head of equity proprietary trading, left to join a hedge fund.
“Jain inherited a business that was over-dependent on proprietary trading, structured equity derivatives and arbitrage strategies,” said Kinner Lakhani, a London-based analyst at Citigroup Inc. (C) “Equities remains a work in progress, but Jain deserves some credit for reshaping the business.”
Since early 2009, Deutsche Bank has hired 150 people in equities across research, sales and trading, with a focus on North America and Asia. The bank climbed to the seventh and third rankings in U.S. and Asian cash equities, respectively, from the ninth and 10th spots in 2007, according to Jain’s June presentation. It ranks first in Europe.
Deutsche Bank has also been trying to win more business from hedge funds and was ranked the fourth-biggest prime broker by hedge-fund assets and voted the best by respondents in a survey by Global Custodian, a securities-industry magazine.
The gains in market share haven’t yet translated into higher revenue. Deutsche Bank’s portion of the total equities revenue pool shrank to 8.6 percent in the first half of the year from 11 percent in all of 2004, data compiled by Bloomberg show.
Some competitors fared better in equities after the credit crisis. Credit Suisse Group AG (CSGN), which had about the same revenue from equities as Deutsche Bank in 2007, also suffered losses from proprietary trading and equity derivatives in the fourth quarter of 2008. The Zurich-based bank said in February 2009 it would shut some businesses, reduce risk-taking and focus on client business. By the end of that year, Credit Suisse had the second-largest share of equities revenue after Goldman Sachs Group Inc. (GS), data compiled by Bloomberg show. Credit Suisse ranked third in the first half of this year behind New York- based Goldman Sachs and Morgan Stanley.
Gaining market share in equities requires significant investments in research and advisory, as well as infrastructure and technology, said Greenwich Associates’ Colon.
“Deutsche Bank has made real strides,” he said. “But the mountain only gets steeper and air only thinner as you move up.”
Jain said in June he is “committed and determined” to make it into the top five in U.S. cash equities. A revamp of the bank’s electronic trading platform to improve order-management systems is scheduled to be completed by the end of the year.
The bank’s performance eliminated any doubts that it would become a “significant equities firm,” Jain said at the time.
“It’s execution, execution, execution,” he said. “Gone are the days when investment banking was such a good game that just by showing up and becoming the seventh- through ninth- ranked player you were still giving your shareholders an adequate return.”
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