Disenchanted At Deutsche Bank

Its investment banking unit, DMG, will get reined in

Surveying the gleaming surroundings at Deutsche Morgan Grenfell's London headquarters, a key executive sighed at the thought of the hefty cost of keeping the enterprise going. "It's a lot better to work at one of these places than to own one," he remarked.

Much to its chagrin, DMG's parent, Deutsche Bank, is discovering that there is considerable truth to that. The Frankfurt-based colossus has lavishly endowed DMG to buy itself a place in the global big leagues of investment banking. But this much-trumpeted foray has been divisive, costly, and, in many respects, disappointing. At the same time, mergers--including the recent marriage of Swiss Bank Corp. and Union Bank of Switzerland--threaten to put Deutsche at a further disadvantage.

Now, Deutsche seems close to launching a reorganization that would rein in its pampered progeny. Deutsche will try to put a happy face on the changes, but they will be tantamount to an admission by CEO Rolf E. Breuer that the bank's expansion-at-any-cost strategy hasn't worked. That puts Breuer and his board in a bind. Unless Deutsche pulls off a major investment-banking acquisition, it may be doomed to also-ran status as a dealmaker. "They face serious questions on what to do next," says Matthew Czepliewicz, an analyst at Salomon Smith Barney.

EVOLUTIONARY? In the proposed shakeup, Deutsche Bank would merge DMG with the parent's corporate banking arm to create a giant wholesale bank. A retail bank and an asset management group are also likely to be created. DMG's CEO, Michael Dobson, may step aside to become head of global asset management. The Morgan Grenfell name, a London fixture since 1854, may be dropped.

Breuer and others portray the proposed changes as evolutionary. He says that combining corporate and investment banking would present "one face to the customer" and "optimize the bottom line." The revamping is designed to encourage corporate and investment bankers to share clients. But it's debatable whether the proposed changes will work. Deutsche's empire is already plagued by culture clashes. Trying to blend the Anglo-American-tinged DMG with the staid German corporate bank may add a whole new set of problems.

Yet Deutsche needs to shift its investment-banking strategy. When it began pumping money into DMG in 1994, Deutsche hoped to become a major global player without additional acquisitions. So far, the results haven't been encouraging. Czepliewicz estimates that DMG's $492 million in earnings in 1996 amount to only about a 12% return on equity. Since U.S. investment banks make 15% to 30%, it is difficult to justify putting roughly one-fourth of Deutsche Bank's capital on the line for DMG, he says. Moreover, with markets turning rocky lately, these relatively slim returns may have aroused fears in Frankfurt that in a bad year they might drop to single digits or worse.

THREE AMIGOS. Deutsche Bank's board has long been split on the wisdom of the DMG experiment, industry sources say. Worsening conditions may be strengthening the hand of skeptics such as Jurgen Krumnow, Deutsche's accounting and risk-control chief. The Frankfurt crowd is unhappy with the size of investment bankers' pay packages. DMG's costs ate up 84% of its 1996 income, sky-high for an investment bank. The norm is around 60%. "They have a very aggressive, high-cost U.S.-investment-banking culture," says a rival. "That has been hard for Deutsche to control."

The lightning rods for such complaints are global fixed-income chief Edson Mitchell, equities boss Michael Philipp, and North American head Carter McClelland. Known inside the bank as the three amigos, they are viewed as a cocksure group bent on enlarging their turf. The three are said to be frustrated with the degree of control Frankfurt maintains over key areas such as accounting and information technology, which cost DMG hundreds of millions of dollars each year. But the German side is likely to exert more discipline in the future. It isn't clear who will succeed Dobson, and DMG may end up being run by a group of Frankfurt board members. Such possibilities have some insiders wondering how long the American top guns will stay. "We call them the three stooges now," says a DMG executive.

Considering how fast DMG built up its staff of 6,500, culture clashes were probably inevitable. The best and brightest investment bankers were lured from rivals with offers of big pay packages. In 1996, DMG wooed technology ace Frank Quattrone and eight associates with an equity stake in DMG's tech group, 50% of the profits, and a share of a $50 million venture-capital pool. Such lucrative deals created internal dissension. It didn't help DMG morale when newly arrived American honchos shoved aside veteran bankers.

The suave, Cambridge-educated Dobson has never seemed cut out to handle brash New World investment bankers or run DMG's core trading and merger businesses. He came up through Morgan Grenfell's investment-banking arm--not the brass-knuckles environment of trading and dealmaking. "His friends have always been amazed at how fast he has risen," says an acquaintance. Dobson declined to comment on the record.

Too bad the ranks of DMG's clients haven't risen as fast. The bank has made good progress in fixed income. And Quattrone's group has made an impact in U.S. tech deals. Still, DMG trails in the key advisory area. It was 13th in European mergers and acquisitions and 11th in its British home market in 1997, according to Securities Data Co. Most galling, DMG ranked only eighth in German M&A, with just $1.37 billion in announced deals, compared with $9.4 billion for the leader, Morgan Stanley, Dean Witter, Discover & Co. "We haven't got the motor running at full horsepower yet," Breuer says.

INTERIM MOVE? DMG insiders say it's too early to expect top speed. Deutsche has just finished two years of an expansion program of five years or more. Still, one of the most confident DMG execs worries the bank is being left behind. It is now unlikely that Deutsche Bank can fulfill its ambitions without a major deal. The reorganization may even be an interim move in preparation for a major merger. But Deutsche has few prospects. The most attractive might be French insurance giant AXA Assurance. Such a marriage could provide Deutsche with long-coveted access to the U.S. market through AXA's Donaldson, Lufkin & Jenrette Inc. subsidiary. Another possibility mentioned is Lehman Brothers. What is sure is that the German bank would have to pay an enormous price for a quality partner.

Not long ago, plunging into investment banking looked like the road to riches. But Deutsche is finding it a lot harder to build a money machine than it looks. Will reining in DMG's freewheeling investment bankers make them work harder? Or will many abandon ship for a rival with a keener appetite for high-stakes dealmaking?

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