What lessons do Deutsche Bank’s job cuts have for Australian financial firms?
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Last week, Deutsche Bank cut 18,000 jobs. The retreat suggests Deutsche is struggling in its push to rival the US giants.
But within its move are fascinating insights about the investment banking industry.
Deutsche Bank is completely exiting equities sales, trading and research. It will remain in asset management, forex and private banking. Deutsche will reduce costs to 17 billion euros in 2022 ($27 billion).
While Deutsche Bank is saying these cuts will lead to “sustainable profitability”, analysts at rivals are less convinced. JP Morgan analyst Kian Abouhossein projected the return on tangible equity to rise from 2 per cent to 6 per cent by 2022 and argued that – for an investment bank – that is not enough.
While there were no job cuts for now, its European competitors are also struggling on Wall Street including Barclays, UBS & Credit Suisse. Collectively, they have only half the share of the US majors including Goldman Sachs & JP Morgan.
At first glance Deutsche Bank may seem an odd firm out among financial firms in Australia or at least irrelevant to the small cap market.
Our small cap rainmaker and investing market seems to be in business as usual – judging by recent activity. Sigma Funds Management has shut up shop, and WA broker DJ Carmichael got bought by Shaw and Partners. Underperformers closing and top performers getting acquired seems normal, right?
Most investment banks and brokers in Australia are not listed and if so usually only overseas. Australian performance is rarely singled out.
Since listing on the ASX in 2017, Moelis is an exemption. Its most recent annual result was a $39 million profit – 39 per cent higher than in 2017 (calendar year).
Within its results is a fascinating insight, especially considering their success, being born right in the middle of the GFC and expanding fast in Australia.
There are three attributes that have contributed to its profitability and performance and hence lessons for other money managers & investment banks.
First, asset management will continue to be profitable, particularly for Chinese high net worth clients. The company recently opened an office in China and helps it to serve Chinese-based clients.
Australia is the largest beneficiary of net migration from Chinese high net worth immigrants; in fact 20 per cent more than the USA.
Of course poor performance can mean asset management declines fast – just ask Sigma.
Second, property may provide better returns than many give the sector credit for. Moelis has substantial assets in real estate acquiring $300 million in properties in late 2018 right amidst a major equities downturn.
It also IPO’d the Redcape Hotel Group which owns over two dozen hotels and gaming venues.
CEO Andrew Pridham told investors at its recent AGM: “Investment into the retail property sector today is considered counter-cyclical.”
“However we believe that the assets were acquired on attractive terms and represent sound investments relative to many other asset classes and in particular given the expectation of lower interest rates in Australia for a significant time period.”
Since he said those words, the RBA has cut interest rates twice to a record low. But circumstances can quickly change and Pridham is aware of this.
“We are mindful of the economic cycle and remain cautious in deploying client and balance sheet capital,” he said.
Corporate advisory was another strong profitable division for Moelis. Among its clients were the South Australian government on a reinsurance transaction with Berkshire Hathaway.
While Moelis is profitable, it is not complacent. It has approximately $90 million in cash which is over a third of its net assets ($240 million). Pridham has told shareholders such holdings are strategic and will facilitate long term growth.
One non-mention was equity research. Deutsche Bank has completely closed down its equities desk in Australia and its global function into a broad ‘Company Research and Advisory Group’.
Under MiFID II laws, asset managers have to specifically pay for equity research rather than as an inclusion.
Initially Deutsche tried to absorb the cost itself rather than pass it on.
Equity analyst and Pitt Street Research co-founder Marc Kennis last week said this was part of a decade long margin compression in the industry and these laws were the last straw. His firm’s model is to have the companies pay for research rather than investors.
“I think Deutsche is at that point where it can’t justify having all those people on payroll for a business that is basically going bankrupt,” he said.
Walking away from acquisitions is another money-loser. DJ Carmichael’s acquisition stands in stark contrast to Deutsche Bank which spent months trying to merge with Commerzbank before abandoning talks.
It would not have tried the move if it would not have made a difference. Aware of this, Barclays is facing pressure from an activist investor to downsize. While ignoring the investor’s calls for now, CEO Jes Staley has said cuts may eventuate if performance does not improve.
Finance is notorious for its bonus system which can be several times an employee’s salary – especially for executives. The GFC showed this isn’t always linked to performance.
In its last eight years, Lehman Brothers paid CEO Dick Fuld US$484 million ($825 million in 2019 AUD at current exchange rates). Of this only US$6 million was in salary; the rest in exercised options, bonuses and shares.
His response to Congressman Henry Waxman’s question ‘Is this fair?’ was… ropey:
The EU set a cap on bonuses after deciding in 2013 enough was enough. Deutsche Bank responded by hiking salaries well above other banks. Average salaries were over 40 per cent more than UBS.
The rot in the share price set in around this time. Hence any advocates of a similar plan here might want to think again.
Deutsche Bank’s CEO Christian Sewing said: “We are creating a bank that will be more profitable, leaner, more innovative and more resilient.”
His actions are based on perceptions of what is profitable and what is not.
Regardless of whether this plan works for Deutsche Bank, the industry in Australia and observers should take note.