Deutsche Bank and the Road

to Basel - III
Case Analysis | Commercial Bank Management | Group 3
Ajit Kumar(004) | Akshat Shah(006) | Biman Kalita(016)
Keyur Prabhu(038) | Shashank Choudhary(047) | Hrishabh Todkar(055)
Introduction
• July 2012, Deutsche Bank reported its 2nd Quarter financial results, first time after
new CEOs Jurgen Fitschen and Anshu Jain took charge.
• The biggest question was whether they would be able to meet the capital
requirements imposed under Basel-III.
• Investors were concerned that Deutsche Bankwould need to raise fresh equity
capital to meet requirements, thereby diluting the equity value of existing shares.
• They were also worried that the global financial crisis effects would further
reduce profitability.
• All of this was reflected in the share price, which was 24.95 Euros, a discount of
40% from its tangible book value per share and roughly 8 times Deutsche Bank’s
trailing 12 month earnings.
Concerns
• Investors wanted to know how the Bank planned to meet the new
regulatory requirements.
• What effect Basel III will have on company’s profitability.
• What lines of business they would focus on going forward in a new
banking environment.
• Investment in Postbank, and was that purchase an indication of a
return to conservative way of doing business and a departure from
investment banking.
Deutsche Bank History and Business overview
• At the forefront of the 1870s economic crisis, Deutsche Bank was established
with the aim of exploiting economic interdependencies between countries and
circumvent the supremacy of British Banks.
• The objective was to transact banking business of all kinds, in particular, facilitate
trade relations between Germany, other European countries, and overseas
markets.
• It was one of the first banks to adapt Universal Banking, which included
diversified banks, established international trade financing, and cross border
commercial investment banking services.
• It handled transactions for German companies, and also gobbled up various
smaller Banks, which increased their international reach.
Deutsche Bank History and Business overview
• Following WWI, Germany went into economic and political chaos, and was in a
frantic need of capital. Inflation was at an all time high and the bank lost many of
its foreign assets.
• By 1929, a series of consolidation efforts saw Deutsche Bank merge with
Disconto-Gesellschaft, to become the largest bank in the country.
• Following WWII, German banks were broken down into smaller regional banks, or
nationalized. Deutsche bank was split into 10 different banks, and the name was
outlawed.
• 10 years later, former Deutsche bank parts in Dusseldorf, Frankfurt, Munich and
Hamburg were merged and allowed to operate under the old name.
Deutsche Bank History and Business overview
• By 1958, the bank started to recover financially. It issued its first foreign currency
bond in 44 years on the German capital market, and hence, reopening to
international firms.
• Deutsche Bank’s global bank history repeated itself as it opened branches and
acquired major banks in Italy, Spain, the United Kingdom, and the United States.
• By the 1990s, the political changes in Eastern Europe helped Deutsche Bank
establish numerous subsidiaries worldwide, and by 2001, it had acquired its way
into 70 countries—it was even listed on the NYSE.
• In addition to becoming a global bank again, Deutsche Bank had shifted its
business focus from traditional retail banking toward global investment banking.
• The goal of adding those services was to make a bank a “one-stop shop” for any
financial need a customer might have.
Deutsche Bank History and Business overview
• By the end of 2002, Deutsche Bank derived a significant portion of its revenues
from investment banking activities, peaking in 2007.
• Revenues from sales and trading increased from 30% to 42% of total revenues
between 2002 and 2007, while revenues from traditional commercial and retail
banking decreased from 22% to 19%.
• Between 2007 and 2011, Deutsche Bank’s revenue composition had varied
significantly.
• By the time Fitschen and Jain took over Deutsche Bank’s leadership in 2012, the
bank was still headquartered in Frankfurt and was one of the largest banks in
Germany—indeed one of the largest financial institutions in Europe and the
world.
Deutsche Bank History and Business overview
Globalization of Banking Industry
• The one-stop shop solution led to the world economy experiencing an
accelerated trend in globalization.
• Reasons included proliferation of Internet, Corporations and Investors
pouring funds into emerging markets in response to staggering projections
for GDP growth in countries including Brazil, India, and China.
• For banks, globalization meant they had to provide a full range of
commercial and investment banking services to clients, and they had to do
so in all the places their customers were doing business.
• To gain new customers and maintain existing ones, Deutsche Bank needed
to provide services on a global level and secure its position in the
investment banking market.
Globalization of Banking Industry
 Global Competition

The effects of globalization and a frenzied stock market from 2002 through
Most of the gains Deutsche Bank’s competitors achieved
2007 increased the volume of financial transactions worldwide and had banks
with little in global revenues were the results were the result of
history of activity in capital markets vying for a piece of the action. That was increased investments in IB activities.
especially the case with other European banks such as Barclays and BNP
Paribas, which had small domestic markets.
Global Competition

To finance the asset growth on their balance sheets, banks had 3 primary options: use profits earned
in previous periods, issue new equity capital thereby diluting existing shareholders, or borrow debt
capital thereby increasing leverage.
 Global Competition

Until 2008, Deutsche Bank achieved remarkable growth in Yet the impressive growth in earnings masked the fact that
per-share earnings, which grew from EUR0.63 to EUR13.05 Deutsche Bank’s increased profits failed to come from
from 2002–07, an 83% annual growth rate. productive assets; they came instead from its increased
leverage as could be seen with a comparison of its return
on assets (ROA) with its return on equity (ROE)
 Global Competition

In contrast, one of Deutsche Bank’s major competitors,

To achieve a higher ROE without a significant increase in
JPMorgan Chase, had a greater ROA over the same time
ROA, Deutsche Bank employed massive leverage,
period—more than twice that of Deutsche Bank in 2006.
increasing its leverage ratio, which resulted in significant
Deutsche Bank’s ROE was almost 800 basis points higher
gainsin both ROE and earnings per share for a while.
than that of JPMorgan Chase.
The new Banking Environment and Basel III
• Even in 2012, Global banks were not expected to return to profitability any time
soon.
• Investment banking business volumes had been in a downward spiral since 2009,
down 25% over a two year period.
• The new requirements of Basel III would effectively increase the minimum Tier 1
equity capital requirement from 4% of risk-weighted assets to between 9.5% and
13.5% of risk-weighted assets.
• By July 31, 2012, Deutsche Bank had a core Tier 1 ratio of 10.2% and a total Tier 1
ratio of 13.6% based on EUR373 billion of risk-weighted assets—with ratios based
on Basel II rules. Beginning in 2013, management projected risk-weighted assets
of EUR488 billion and a core Tier 1 ratio of 7.2% with the new Basel III rules.
While it would meet the minimum requirements for 2013, it was far from the
9.5% core Tier 1 ratio that Deutsche Bank would be required to meet by 2019
under the fully phased in Basel III rules.
The new Banking Environment and Basel III
• In late 2010, Deutsche Bank raised EUR9.8 billion in equity capital to acquire a consolidated
position (50.2%) in Germany-based Postbank to expand the company’s “strong position in our
home market, take a leading position in the European retail banking business, and significantly
enhance Deutsche Bank’s revenue mix.”
• In addition to strengthening its retail banking presence in local European markets, Deutsche Bank
used the downturn in investment banking business to gain market share as many competitors
were being forced to exit the business.
• By July 2012, Deutsche Bank had the largest market share in U.S. fixed income trading, taking the
top spot from JPMorgan Chase.
• According to consultants at Dealogic, based on trailing 12-month figures, Deutsche Bank had a
top-five market share in U.S., EMEA, and Asia-Pacific (except Japan) Debt Capital Markets
transactions and ranked second in European Equity underwriting as well as European M&A.
• These market-leading positions weighed positively on the future prospects of Deutsche Bank’s
investment banking activities, despite the headwinds the industry faced in 2012.
Deutsche Bank’s valuation
• At the start of trading on July 31,
2012, Deutsche Bank’s shares traded
at 8.2× its trailing 12-month earnings
(P/E) and 0.60× its tangible book
value per share (P/TB).
• Since 2006, Deutsche Bank’s average
quarterly P/E and P/TB ratios had
fluctuated widely.
• Someone would likely ask if the
discounted valuation was justified in
the light of the company’s current
financial position and outlook.
Deutsche Bank’s valuation
• At the start of trading on July 31, 2012, Deutsche Bank’s shares traded at 8.2× its
trailing 12-month earnings (P/E) and 0.60× its tangible book value per share (P/TB).
• Since 2006, Deutsche Bank’s average quarterly P/E and P/TB ratios had fluctuated
widely.
• Someone would likely ask if the discounted valuation was justified in the light of
the company’s current financial position and outlook.
Conclusion
• Some analysts predicted that Deutsche Bank would earn 4 Euros per
share in 2012 and 4.92 per share in 2013, on net revenue of 32.8
billion and 34 billion, respectively.
• That represented a sharp increase from its trailing 12-month EPS of
EUR3.04. The global economic outlook, the outlook for the banking
industry, and Deutsche Bank’s future offered little visibility.
• Determining an appropriate multiple or range of multiples to apply to
Deutsche Bank’s shares was going to be a difficult task.
THANK YOU!