We have some sympathy for John Cryan, but only to the extent that he has the near impossible task of putting the biggest German bank back on a sound footing regaining market share and generating some elusive revenue growth: a virtually impossible task as long as Europe is choked by NIRP. As we noted two weeks ago, Deutsche’s 3Q 2017 results confirmed that the situation is still getting worse:
Deutsche Bank’s Q3 2017 revenues were €6.78 billion, below market expectations of €6.88 billion. The share price fell 2.7% shortly after the European market open. The problem – like the previous quarter - was a bigger-than-expected drop in trading revenues. Trading revenue was down 30% year-on-year to €1.512 billion versus €2.162 billion in Q2 2017. The challenge for the embattled CEO, John Cryan, is that the trend is still deteriorating. Trading revenues in Q2 2017 fell 18% year-on-year to 1.666 billion euros versus 2.027 billion euros. Earlier this year, Cryan pledged to turnaround the performance of the investment bank as soon as this year.
At the time, we wondered if Cryan’s time wasn't running out: "The countdown to Cryan's replacement is ticking ever louder."
So if you were Deutsche CEO Cryan and you needed revenue growth and you needed it fast, what would you do? One thing is to identify a “hot” sector in capital markets with high margins and go all out for growth, never mind the risk. Which is exactly what Deutsche Bank is doing in the leveraged loan market as Bloomberg implies.
While investors are attracted to the high yields from leveraged loans, investment banks are lured by the fees. “Leveraged finance is juicy, juicy stuff,” said Tim Hall, global head of debt capital markets at Credit Agricole SA until last year. “In corporate banking, it probably hast the best margins.” Yet the fees are lucrative for a reason: banks take the risk that investor appetite for leveraged loans may suddenly disappear before they can sell on the debts. Deutsche Bank lost about 2.5 billion euros on “leveraged loans and loan commitments” in 2007 and 2008 combined, annual reports show. “Anyone getting into this sector today should have a good understanding of where we’re at in the cycle of leveraged loans,” said Knutson. “Are we closer to midnight in terms of the exhaustion of it or are we halfway through?”
So…what is Deutsche doing to generate more revenue in leveraged loans? Here's Bloomberg:
As John Cryan mulls steps to restore growth at Deutsche Bank AG, he’s counting on U.S. companies’ appetite for ever more debt to help lead the charge. The Frankfurt-based lender added 24 managing directors and directors at its U.S. corporate finance business this year, a record hiring pace, according to Mark Fedorcik, co-head of Deutsche Bank’s global capital markets unit. Among the goals: to become a top arranger of leveraged loans again, the risky debt that has surged amid low interest rates and the prospect of a rollback of post-crisis regulations. “Next year will be a robust one for U.S. leveraged finance and we’re going to capitalize on this,” Fedorcik said in an interview. “It’s an area that we’re going to continue to invest in and regain a top-five position.”
As a result, next year might be a “robust one for leveraged finance”, then again it might not. Still, we know three things about banks’ behaviour:
- They are spectacularly “good” at pro-cyclical investment and the leveraged loan market is very “hot”, especially in the US;
- Deregulation, which loosens credit standards, always makes banks take more risk, rather than less; and
- They never learn from one crisis to the next.
As Bloomberg explains, Deutsche might be able to tick all three of these “boxes”:
Investment banks have arranged $1.2 trillion of U.S. leveraged loans for clients so far this year, more than any other year since at least 2006 and already 18 percent more than all of 2016, data compiled by Bloomberg show. Adding to the frenzy is the U.S. Treasury Department, which has proposed loosening restrictions imposed on Wall Street banks after the 2008 financial crisis. Some analysts fear this could mean a return to the kinds of high-risk loan deals that saddled lenders -- including Deutsche Bank -- with billions of dollars of debts they couldn’t sell during the crash.
In Deutsche’s defence, it does have “form” in the leveraged loan market, having been a top 5 player before slipping down the rankings as the bank stumbled from one crisis to another. In 2017, Deutsche tumbled to ninth place in arranging US leveraged loans, it’s worst showing since 2012.
Then again, the market is already dominated by JP Morgan and Bank of America who, we suspect, are unlikely to roll over to accommodate more market share for their German rival. Consequently, a critical question is how much risk might Deutsche need to take as it seeks to regain its former market position? None according to Deutsche’s co-head speaking to Bloomberg.
The decline was caused by “a little bit of bad luck,” said Fedorcik. The firm has also been “more selective” on taking risks “in some cases,” further reducing the amount of completed deals, he said. Deutsche Bank has arranged more than 300 U.S. leveraged loans so far this year, helping clients including software giant Dell Technologies Inc. and hotel chain Hilton Worldwide Holdings Inc. borrow about $61 billion, according to data compiled by Bloomberg. The hires in the U.S. corporate finance business bring staffing level back to where they were at the beginning in 2016, before speculation about its financial strength rattled the bank and management introduced the steepest bonus cuts in the bank’s recent history. Hires this year include Philip Pucciarelli and Robert Verdier, two health-care investment bankers who joined from BMO Capital Markets. Deutsche Bank also added professionals in its trading operations, bringing in Alexandra Cannon from Barclays Plc as a director in leveraged-loan sales in July. Paul Huchro, who retired from Goldman Sachs in 2015, is joining to oversee investment-grade trading globally as well as high yield in the U.S. and Europe, the bank said last month.
Okay, but we always get nervous when we sense over-confidence on the part of investment bankers. This was the other co-head speaking to Bloomberg.
Deutsche Bank can revise its stance on how much risk it wants to take on leveraged loans at any time, said Alexander von zur Muehlen, Fedorcik’s co-head. “We have the capital and the ability for the business,” said von zur Muehlen. “U.S. leveraged finance is a core business for us.”
Dial up the risk and dial down the risk. If only it was so easy. Our sense is that Cryan is under so much pressure to deliver growth, his strategy is to close his eyes, hope for the best and go for it. After all, this was the man who last month said that “we are now seeing signs of bubbles in more and more parts of the capital market where we wouldn’t have expected them."
Clearly, he was not referring to leveraged loans. Last month, S&P Global Ratings begged to differ, noting that "the risks of this debt binge are significant, given that excessive leverage can bring down a company as fast as prudent borrowing built it up.”