Who's in the most trouble? Barclays, or Deutsche Bank?
Barclays and Deutsche have several similarities. Both have embattled chief executives. Both have been doing some big hiring. Both need to up their games. And both have just reported very disappointing third quarter results for their investment banks compared to U.S. rivals.
Although you'd never know it from the comparatively upbeat statements coming out of Deutsche and Barclays today, the performance of the two banks in the three months to October 2017 is bound to raise eyebrows. Both banks have already seen their share prices decline as a result.
Jes Staley and Tim Throsby have staked their futures on growing the investment bank at Barclays, and John Cryan has been criticized for his lack of a strategy for the investment bank at Deutsche. If senior management at Barclays and Deutsche were weak already, they're therefore a lot weaker now.
With results like these, the danger is that both banks will soon have new chief executives (again) and that the replacements will be a lot less inclined to maintain large and poorly performing investment banks. Both Barclays and Deutsche look a toxic. But one is more so than the other.
1. The return on equity (RoE) collapsed at both Barclays and Deutsche Bank's investment banks in the third quarter
So much for improving returns for shareholders. As the chart below shows, both Barclays and Deutsche's investment banks generate much lower returns for shareholders than U.S. rivals. Worse, those returns are getting worse.
Barclays has a "double digit" target for returns at its investment bank, but the RoE fell from 9.2% in the third quarter of 2016 to 5.9% in the third quarter of 2017. Deutsche Bank is targeting a return of around 10% across the bank, but the return on equity in the corporate and investment bank fell to just 2.1% in the third quarter.
Something at both banks needs to change. Barclays insists that it's at a "different stage in the cycle" to U.S. banks because it's only just finished restructuring and that returns will increase as leverage and risk weighted assets are redirected to high returning trading businesses. Deutsche has yet to comment.
2. Something terrible happened to profits at Deutsche's corporate and investment bank in the third quarter
Deutsche and Barclays' third quarter RoE problems were rooted in declining profits.
Barclays and Deutsche each saw big declines in both their top and bottom lines. The biggest reduction was in the profitability of Deutsche's corporate and investment bank, where profits were down 63% year-on-year in the third quarter. Deutsche has yet to explain why this happened, but notes that its fixed income sales and trading business suffered (along with other banks) from low volatility in the third quarter.
3. Both banks now look like need to cut costs in their investment banks. Deutsche Bank needs to cut costs most of all
Jes Staley says restructuring is over at Barclays. He also says, "You cannot cut yourself to glory and those that try will ultimately fail."
Even so, Barclays could surely benefit from some trimming in its investment bank. Costs ate 74% of revenues in Barclays' corporate and investment bank in the third quarter and Barclays' aim for its group cost income ratio is just 60%.
Barclays' cost issues are nothing compared to Deutsche's though. In the third quarter, costs consumed nearly 90% of revenues at Deutsche Bank's CIB. Cuts are surely (surely?) coming soon.
4. Barclays is already cutting bonuses. Deutsche Bank can't
While Barclays is still investing in its investment bank, it's alert to the need to cut costs in the unit. During today's call with investors, finance director Tushar Morzaria said the bank has made "significant cuts" to its "performance pay accrual." CEO Jes Staley later clarified by saying bonuses accruals were cut 25% in the third quarter. Staley added that this is unlikely to be repeated in three months to December.
Deutsche Bank, however, is backed into a corner when it comes to pay. After cutting performance bonuses to almost nothing last year, it's promised to make things up to its bankers in 2017. Unfortunately, today's results suggest it can't afford that. Year-to-date, average pay per head at Deutsche's corporate and investment bank is down 7.5% to €126k. So much for the compensatory pay rise.
5. The danger is that Deutsche Bank will need to cut headcount. Barclays, meanwhile, is trying to swap out contractors
As we noted a few weeks ago, it looks increasingly like Deutsche needs to cut some more heads in its investment bank. Instead, the opposite is happening: Deutsche has added 39 managing director level credit sales and trading staff in Europe since the start of 2016 and increased headcount in its investment bank by 632 people between October 2016 and October 2017. As ever, however, Deutsche's rising headcount is down to increasing numbers of non-revenue generating staff in the middle and back office: while Deutsche's front office headcount fell by 452 people between October 2016 and October 2017, middle and back office headcount rose by 1,084.
At Barclays, attempts are also being made to cut costs by trimming expenditure on technology contractors. Today, only around 50% of Barclays' technologist are full time employees. In future, Staley says he wants this to rise to 75%.
6. Both Barclays and Deutsche can trace their problems to their trading business
Barclays and Deutsche Bank both under-performed U.S. banks in terms of trading. Deutsche under-performed by most in fixed income. Barclays under-performed by most in equities.
Barclays blamed its poor equities performance on its over-reliance on flow equity derivatives (it's trying to grow in cash electronic trading to remedy this) and to the earlier departure of key members of staff. Barclays blamed its poor performance in fixed income to its exit of the "energy related commodities" business and the integration of its non-core unit. The worst hit came to Barclays' macro business, where revenues were down 40% year-on-year, partly as a result of the integration of non-core. Nonetheless, Barclays is doubling down on the macro business and giving it additional leverage and additional risk weighted assets in the belief that it can rebound in future as volatility normalizes and new electronic trading systems take effect.
Deutsche Bank attributed its miserable performance in fixed income sales and trading (where it's supposed to be regaining lost market share) to lower FX revenues and "significantly lower" emerging markets revenues. It also noted that part of the decline came from a change in the businesses it includes in the fixed income trading reporting line (some revenues have been shifted into 'financing') and that without this revenues would only have been down 26% year-on-year. Right.
7. Deutsche Bank under-performed rivals in investment banking businesses too
Within the investment banking division, Barclays doesn't break out revenues for M&A, equity capital markets and debt capital markets separately. However, Staley said the bank's equity and debt capital markets business had a "record" quarter. Across the combined "banking" business, revenues at Barclays were up 15% for the first nine months of 2017 vs. the same period of 2016, although they were down 5% in the third quarter.
Deutsche Bank does break out revenues by investment banking business and as the chart below shows, they were not at all pretty. Compared to U.S. investment banks, Deutsche was the worst performer in M&A and DCM in the third quarter, and the second worst performer in ECM. - And this was despite the fact that Deutsche has made growing M&A and ECM revenues a priority this year.
Across the investment banking business as a whole, revenues at Deutsche Bank were down 24% year-on-year in the third quarter and down 3% year-on-year for the first nine months.
It's hard not to conclude, therefore, that if Barclays is in a tight corner, Deutsche is in a deep hole. Both need to do something to improve, but Deutsche Bank' dangers are the most acute. Although John Cryan has promised to stick around for three more years at Deutsche Bank, shareholders may have other ideas unless the performance of the investment bank improves.
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