Deutsche Bank’s Decision To Exit Russia The First Of Many Moves To Boost Profitability

Deutsche Bank (NYSE:DB) is shuttering its investment banking operations in Russia in what comes as the first concrete step taken by the German banking giant towards fulfilling the goals laid out as a part of its long-term reorganization plan, Strategy 2020. ^[1] While the bank will no longer offer onshore corporate finance, markets or custody banking services to clients in Russia, it will retain its transaction services business in the country. The exit will largely be completed by the end of this year, and could see Deutsche Bank reduce its total headcount by around 200. ^[2]

Despite being one of the largest foreign banks in Russia, Deutsche Bank’s operations in the country are a small part of its global footprint. According to the bank’s last annual report, its total credit exposure in the country was less than €5 billion ($5.8 billion) at the end of 2014. However, the move to discontinue these operations makes sense on multiple fronts in terms of long-term value, and will likely be followed by a series of exits from as many as 10 countries over coming months.

We maintain a $38 price estimate for Deutsche Bank’s stock, which is roughly 25% ahead of the current market price. A bulk of the price difference stems from the sell-off seen across sectors over recent weeks.

See our full analysis for Deutsche Bank

Deutsche Bank has been under considerable pressure from investors over recent years for its notably poor performance compared to peers in terms of profitability and returns. At the same time, the bank’s image continues to take a hit as it remains embroiled in a long list of high-profile lawsuits and regulatory probes. In a bid to address concerns about long-term profitability which were not adequately met under its older reorganization plan (Strategy 2015+) Deutsche Bank announced an updated plan (Strategy 2020) this April. ^[3] The new plan is primarily aimed at shrinking the investment banking operations while increasing focus on asset management and transaction banking. As a part of the plan, Deutsche Bank also sought to improve operating efficiency by exiting several countries where low operating profits did not justify its presence.

The recently announced plan to discontinue investment banking operations in Russia meets several of the criteria set out by Deutsche Bank under Strategy 2020. Firstly, the recession in Russia has shrunk revenues in the country – putting pressure on margins. Combined operations in Russia generated €161 million ($185 million) in total revenues in 2014 for a total pre-tax income figure of just €71 million ($81 million) – a figure that is expected to fall further in 2015. Secondly, the bank’s Russian unit has taken considerable heat over recent months for allegedly aiding money laundering activities, and is currently under investigation by several global financial regulators. ^[4] The decision to shutter these operations should help Deutsche Bank salvage its reputation to an extent.

Now this particular move in itself is not going to make a large difference to Deutsche Bank’s balance sheet or operating margins. However, with the bank looking to reduce its global footprint by 10-15% over coming years, the overall impact on figures will be sizable in the long run. Deutsche Bank had a presence in 71 countries at the end of 2014, and a 10-15% reduction in this figure points to an exit from between 7-10 countries in the near future. The cumulative effect on the bank’s stock price will be evident in the form of sharp improvements in investment banking over coming years, as we capture in the chart below.

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Notes:

1. Deutsche Bank to streamline operations in Russia, Deutsche Bank Press Releases, Sep 18 2015 [↩]
2. Deutsche Bank eyes Russian pullback amid money-laundering probe, Financial Times, Sep 11 2015 [↩]
3. Deutsche Bank announces next phase of strategy, Deutsche Bank Press Releases, Apr 27 2015 [↩]
4. DOJ Said to Probe Deutsche Bank on Russia Mirror Trades, Bloomberg, Aug 3 2015 [↩]