Understanding The Impact Of Deutsche Bank’s New Reorganization Plan On Its Long-Term Value

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Meeting over the weekend, Deutsche Bank’s (NYSE:DB) supervisory board has come up with a fresh reorganization plan for the German banking giant – the latest attempt to address the bank’s relatively weak capital position as well as its poor operational performance in recent years. [1] Notably, the new reorganization plan reverses some of the biggest decisions that were being implemented as a part of the older plan (Strategy 2020) announced in April 2015. [2] Deutsche Bank is now looking to reintegrate Postbank to increase its retail banking focus in Germany, and it will sell a minority stake in its asset management unit. Over the next four years, the bank expects its restructuring efforts, coupled with divestments, to reduce its cost base by over €3 billion. The bank will also revert to a reporting structure that is almost identical to the one it used during and after the economic downturn of 2008 – something the bank chose to discontinue in late 2012.

The thing that really caught investors’ attention was Deutsche Bank’s decision to raise fresh equity worth €8 billion in the coming weeks. [3] The news was not completely unexpected, given that the bank trails most of its global banking peers in terms of regulatory capital ratio requirements. But the size of the offering and the steep discount to tangible book value implies that the equity issuance will add 687.5 million new shares to the bank’s outstanding tally of around 1.4 billion shares – considerably diluting the stake of existing shareholders. This led the bank’s stock price lower in trading after the announcement.

We believe that the share issuance is a necessary step, and that the bank’s decision to reintegrate Postbank should  help generate substantial value in the long run. Moreover, the weak outlook for the global asset management industry in the coming years lends support to the bank’s decision to float a part of Deutsche Asset Management. We are currently in the process of updating our price estimate of $21.50 for Deutsche Bank’s stock.

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Changes Targeting Bank-Wide Performance Metrics

  • Capital Ratio Target: Deutsche Bank aims to maintain a CRD 4 fully loaded Basel 3 Common Equity Tier (CET) 1 ratio at “comfortably over 13%”. Notably, the equity raised over coming weeks will push pro-forma CET1 capital ratio figure at the end of 2016 from the reported value of 11.9% to 14.1%.
  • Leverage Ratio Target: Deutsche Bank reduced its leverage ratio target figure from above 5% to 4.5%. The figure was 3.5% at the end of 2016, and will touch 4.1% after the issuance. We expect that the bank should be able to achieve this target by the end of 2018 if it sticks to its divestment plans.
  • Return on Tangible Equity Target: Deutsche Bank retained its 10% target for post-tax return on tangible equitybut meeting this target will now be more difficult given the increased equity base after the issuance.
  • Cost Reduction Target: The bank is looking to cut adjusted annual expenses from €24.1 billion in 2016 to €22 billion by 2018 and further to €21 billion by 2021. Most of the gains are expected to come from better efficiency and integration of services under the new structure. The cost reduction plan will  cost the bank €2 billion in restructuring and severance expenses over 2017-21, with 70% of these costs expected in the next two years. We believe that most of the restructuring costs will be directed towards the reintegration of Postbank.

  • Payout Ratio Target: Deutsche Bank’s relatively weak capital situation has forced the bank to keep dividends low since the downturn, and this is not expected to improve in 2017. The bank’s original plan entailed a payout ratio target of 50% for 2016, which it has revised to a “competitive dividend payout ratio” beginning next year. The chart below represents Deutsche Bank’s adjusted payout ratio (dividends and share repurchases combined) in the past several years as well as our estimate for the payout in the coming years. It should be noted that the figure was 93% in 2014, as the bank’s net income figure was hit by litigation charges. We represent the payout for most years over 2012-16 as 0%, as the figures were not meaningful.

Changes Targeted At Specific Divisions

  • Private & Commercial Bank: Deutsche Bank’s decision to reintegrate Postbank likely stems from the improvement in economic conditions in Europe, and Germany in particular. The retail banking business in the country is highly competitive, and taken together with the prevalent low interest rate environment, this lends support to the bank’s aim of improving profitability by targeting economies of scale. While the combined retail banking division will predominantly focus on Germany, the integrated wealth management unit will continue to grow across key economies in Europe, Middle East, North America and Asia Pacific.

  • Corporate & Investment Bank: Deutsche Bank will reintegrate its Corporate Finance, Global Markets and Global Transaction Banking units to combine all services aimed at corporate clients. The division is expected to gain in particular from the improvement in the securities trading environment globally, and will actively look for growth in the U.S. and Asia-Pacific in the long run. The reintegrated investment bank should see considerable gains to its operating margin.

  • Deutsche Asset Management: Deutsche Bank maintains that its asset management division remains central to its business model, but the plan to float it over coming years will allow it to grow independently while also helping Deutsche Bank raise more cash to shore up its balance sheet. The asset management unit currently has assets under management in excess of €700 billion, and should grow steadily over coming years, although profitability is likely to remain under pressure as investors levitate towards low-cost ETF and indexed funds. Deutsche Bank is expected to retain a majority stake in Deutsche Asset Management over the long run.

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Notes:
  1. Deutsche Bank refines strategy and announces capital increase, Deutsche Bank Press Releases, Mar 5 2017 []
  2. Deutsche Bank announces next phase of strategy, Deutsche Bank Press Releases, Apr 27 2015 []
  3. Deutsche Bank intends to raise capital, plans additional measures and announces new financial targets, Deutsche Bank Press Releases, Mar 5 2017 []