Litigation costs and restructuring charges grab the headlines from Deutsche Bank's preliminary earnings announcement, but the drop in revenue is the real story.
"Sobering," was new CEO John Cryan's blunt assessment of an expected 6.7 billion-euro ($7.3 billion) full-year net loss.
Investors can often look past one-off items like legal provisions. But at Deutsche Bank, as with some of its peers, the steady stream of such charges means they're no longer exceptional. An extra 1.2 billion euros in the fourth quarter is much higher than most analysts expected but it's hardly a surprise. The bank isn't saying what this has been set aside for -- take your pick from mirror trades in Russia, the foreign exchange scandal and a handful of other possible issues yet to be resolved.
The bigger concern for investors must be the shrinking top line. Fourth-quarter sales of 6.6 billion euros were about 10 percent below what many analysts forecast. The bank cited "challenging market conditions." Big U.S. banks that have already reported earnings noted similar problems, but for the most part managed to avoid a drop in overall revenue.
Deutsche Bank's sales decline underscores the difficult task ahead. Cryan earned plaudits as finance director at UBS in the aftermath of the financial crisis, tilting that bank's focus away from volatile investment banking businesses and toward wealth management. That shift took place against the backdrop of broadly rising markets. Now he must fix Deutsche Bank while markets are in tumult.
One worry is that Deutsche Bank will struggle to hit its targeted capital ratio of 12.5 percent or more by 2018. At the moment, it's headed in the wrong direction. The bank says the ratio is set to drop from 11.5 percent at the end of the third quarter to 11 percent at year end. There are several levers Cryan can pull to turn this around -- cutting leverage, reducing costs, the sale of Postbank or other assets. If revenue continues to slide, though, that's a crucial lever that looks weak so he'd have to work the other options all the harder.
Another risk is highlighted by Cryan's realistic messages on the long slog ahead, communicated in a series of messages to staff. Getting stakeholders to buy in to the much needed turnaround requires them to understand how bad things are and how much pain they need to endure to make things better. Some staff won't be up for it and the bank will probably ease them out of the door to help the cost-cutting effort (Cryan plans to cut about a quarter of its workforce). But how do you stop bleeding good staff once you've started?
The risk, to borrow a phrase from another executive tasked with turning around a troubled global bank, is a "death spiral." Former Barclays CEO Antony Jenkins used the term to describe the danger that cutting too deeply in the investment bank could push out even those people you want to keep.
The same problem probably applies to Deutsche Bank's top line. As the bank cuts back, how can management be sure to stop the shrinkage at the right time, especially in difficult markets? Cryan has to unravel years of built-up problems at Deutsche Bank. Investors -- and staff - must brace for a long and difficult road ahead.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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