Deutsche Bank: Hunting for Investment Banking Talent

Equity Analyst

Niklas Kammer

Deutsche Bank has successfully halted the detrimental spiral of faster declining revenue. In the process, the bank has shed its global equities sales and trading business, downscaled its fixed income trading business, and materially reduced its workforce. The bank now focuses on its core basics, providing services to its customers globally within its corporate banking, private banking, investment banking, and asset management segments. 

While its strategy had initially been focused on building on its commercial and private banking divisions, a strong performance in investment banking owed to a flurry of activity during the pandemic has rekindled Deutsche’s ambition within the investment banking space. The bank acquired Numis, a U.K. merger and acquisitions advisory as well as equity research, sales, and trading operation, to regain capabilities it had foregone during its restructuring. 

We are skeptical of this strategy. While we had previously questioned the notion that one can be successful within primary markets without a strong footing within secondary markets, we are concerned that ambitions may be greater than just simply rounding out its corporate finance offering to its existing clients. Deutsche seems to have dialed up its hiring efforts to attract talent in order to rebuild a stronger investment banking offering in the hope that declining interest rates will reinvigorate debt and equity issuance as well as spur on deals done globally. We have no qualms with this outlook, but we are concerned that Deutsche’s ambition may laden the bank with high compensation packages for potential income streams which may or may not materialize.

Business Strategy & Outlook

We do not believe Deutsche Bank’s operations earn a moat. Following our moat methodology, we look for structural advantages in DBK’s operations in the form of cost advantages and switching costs. We view cost advantages as the primary source of moats for banks with large retail and commercial banking operations and we divide costs into three categories: credit, operating, and funding. Also, we believe switching costs play a key role in a bank’s ability to maintain low-cost funding. Additionally, we give moats to large scale investment banks which benefit from network effects or intangibles which create structural competitive advantages. Underlying our moat rating is our view of the German banking environment which we rate as fair, although competition in this market is high. Ultimately, the competitive environment in Germany and more importantly low profitability inherent in this market create a significant hurdle which DBK is not able to overcome to a satisfactory degree to warrant a moat. Moreover, we do not think that DBK’s investment banking operation has the necessary scale and set-up to outcompete peers globally or within Europe. 

We rate the competitive landscape of the German banking system as poor. It is best described as a three-pillar system consisting of private commercial banks (Commerzbank, Deutsche Bank, Hypo Vereinsbank) in the first pillar, savings and state-controlled (public) banks in the second pillar, and collaborative (mutual) banks in the third pillar. Within this system, we believe competition between pillars rather than within pillars defines the competitive landscape of the German banking market. Although 1,700 credit institutions indicate a highly fragmented market, we observe little to no competition within the second and third pillar. Public and mutual banks in Germany follow a regional principle ruling out competition among member banks, while back-office infrastructures are shared to reduce costs. As such, private commercial banks compete against few large networks of regionally focused banks as well as other private commercial banks rather than many small, local and independent banks. 

More important than market fragmentation in Germany is the lack of profit maximizing incentives for savings and cooperative banks and their advantaged funding structure. Public and mutual banks control about 41% of banking assets in Germany. Being administered by either municipal governments or owned by clients (mutual bank structure), both bank models prioritize providing access to quality services at the lowest cost possible to as many customers as possible. Additionally, both banks enjoy a large deposit base owing to the perception of government support (savings banks), their long history of involvement in local economies through dense local branch networks and public event sponsoring initiatives, as well as their stable performance through financial crises and willingness to extent credit in bust cycles. This creates a funding advantage for public banks which is mirrored in significantly higher net interest margins relative to private commercial banks.

We do not find evidence of a structural competitive advantage in operating costs for Deutsche Bank. Indeed, we do not think any bank with large retail exposure in Germany enjoys a competitive advantage based on operating efficiency. In our view, this is the result of too many competitors vying for a stifled revenue pool which demands a dense branch network to claim meaningful market share. The German banking system is one of the least efficient systems in Europe with an average cost/income ratio of about 76%. While this is partially the result of relatively low revenue generation, indicated by a cost/asset ratio closer to European averages, banks in Germany do on average operate a large cost base. We think in the German market, where cash transactions are the predominant form of payment, operating a larger branch network offers advantages in attracting, retaining and servicing clients and is therefore a viable strategy to follow. This results in a bloated cost base, which however benefits the largest branch operators (savings banks and cooperative banks) through better deposit gathering and thus lower funding costs.

We also do not find Deutsche Bank to be advantaged based on its funding structure. We typically assign moat ratings for retail and commercial operations based on access to a large pool of deposit funding, particularly non-interest-bearing checking accounts, which form one of the cheapest types of funding a bank can obtain. The strength of the moat based on this potential funding advantage is enhanced if we find switching costs which prevent clients from moving this inexpensive source of funding to competitors in search for higher rates. Preferably, the deposit base consists mostly of retail rather than wholesale deposits, as the former tend to be stickier and lower cost compared with the latter. Although 42% of DBK’s assets are funded by deposits, only about 39% of these deposits come in the form of non-interest-bearing accounts. Additionally, DBK does not have the scale in retail deposits compared with competitors such that we would be inclined to warrant a moat rating. In DBK’s largest market, Germany, savings banks and cooperative banks control 37% and 27% of total retail deposits in the market, respectively. Private commercial banks collectively only attract about 12% of retail deposits. 

In its private banking segment, Deutsche Bank groups together its retail business including Postbank as well as its wealth manager servicing high net worth individuals. We do not see any competitive advantages in this segment. The retail business is subject to the highly competitive forces in the German market, keeping profitability in this segment low, and despite relatively low capital requirements and access to cheap deposit funding, we do not think this segment is moat supportive. Wealth management on the other hand is typically a moaty business with sticky customer relationships, opaque pricing structures and low capital requirements which tends to yield healthy returns. However, with about EUR 213 billion in assets under management, which puts Deutsche well outside the top 10 of global wealth managers, we think it lacks a sufficient scale to earn a moat in this business. Meanwhile, its competitors in Europe (UBS and BNP) rank in the top 10 in assets under management globally, with the smallest competitor BNP boasting about double of Deutsche’s AUM. 

Deutsche’s corporate banking segment brings together its global transaction bank with its corporate and commercial clients. In this segment, Deutsche serves large corporates, multinational companies, and SMEs with cash management and trade finance solutions. We believe Deutsche enjoys good client relationships in this segment and can offer a wide product portfolio tailored for corporate Treasuries, although we do not think this constitutes a defensible, structural competitive advantage. Below cost of equity returns in this segment and multiple banks rediscovering the SME business (including Deutsche Bank) in search for growth indicates to us the highly competitive nature of large corporate banking in Europe. 

Deutsche’s investment banking division does not earn a moat. Typically, we award moat ratings to large scale investment banks which offer a full-service product lineup and through network effects repetitively secure a top rank globally for debt and equity placements and advisory revenue. In this regard, Deutsche has lost its footing. In global rankings, Deutsche has fallen well behind American peers in most investment banking segments and even within Europe, European and global peers eat Deutsche’s lunch. 

Its asset management unit, DWS, is Deutsche’s strongest assets. DWS is the 20th largest asset manager ranked globally based on assets under management, with above 60% of assets invested in active funds. Light capital requirements in this business make it one of the more attractive spaces in banking today. We think this segment positively contributes to a potential moat for Deutsche, although the segment by itself does not move the needle for the group, in our view.

None

Economic Moat

Deutsche Bank

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Deutsche Bank AG is a stock corporation company, which engages in the provision of corporate banking, investment services, private banking, and asset management. The company is classified in the Commercial Banks and Capital Markets, as per ISS ESG’s sector classification. It operates through the following segments: Corporate Bank, Investment Bank, Private Bank, Asset Management, and Corporate and Other. The Corporate Bank segment offers cash management, trade finance and lending, foreign exchange, optimization of working capital and liquidity, securing global supply chains, and distribution channels to corporate and commercial clients; correspondent banking, trust and agency, and securities services to financial institutions; and business banking services to small corporate and entrepreneur clients. The Investment Bank segment is involved in origination and advisory businesses as well as fixed-income, currency, sales, and trading, which serves corporate and institutional clients. The Private Bank segment focuses on private bank Germany, private and commercial business international, and wealth management business units, as well as the International private bank, which also caters to commercial clients. The Asset Management segment refers to the investment solutions for individual investors and institutions through the DWS Group GmbH & Co. KGaA brand. The company was founded by Adelbert Delbrück on March 10, 1870 and is headquartered in Frankfurt, Germany.