Look at the crazy mess Deutsche Bank CEO John Cryan is expected to fix

Deutsche Bank surprised the markets overnight, revealing a massive €6.2 billion ($US6.96 billion) writedown in the third quarter.

The bank is taking a hit on assets like Postbank in Germany and Hua Xia Bank in China, and also provisioning for more than €1 billion ($US1.1 billion) in legal costs.

To deal with the expected losses, the board will recommend a cut to, and a possible elimination of, the dividend for full-year 2015.

But it’s hardly a shock to those who have followed the German lender closely — Deutsche Bank is a mess.

At the end of June, John Cryan replaced co-CEOs Anshu Jain and Jürgen Fitschen.

The markets clearly loved the news when it was first announced on June 8. The stock price exploded in the early trading session, adding €2.5 billion ($US2.79 billion, £1.82 billion) to Deutsche Bank’s market capitalisation in one morning.

While this is a pretty brutal indictment of the performance of the bank’s former CEOs, numerous analysts across the market warned that Deutsche Bank’s problems were far from over.

The announcement proved them right.

Under Jain and Fitschen, the bank had more than its fair share of scandals and leadership problems.

Fitschen was fighting perjury charges in a non-banking court case, and Jain couldn’t speak German fluently enough to get the support of his staff. The bank paid a big fine in the Libor-rigging scandal. And it still doesn’t have a growth strategy that investors believe in.

In fact, analysts say the German lender needs to address numerous structural issues that are causing a greater problem to its existence than just management. Those issues include the lack of a highly profitable private bank, and a historically poor return on equity (ROE), the amount of net income a bank returns as a percentage of shareholder equity.

In other words, it doesn’t make heaps of money and it doesn’t give shareholders a decent return.

This is what Cryan is expected to clean up.

“Too little, too late”

In May, Fitschen and Jain faced a storm of shareholder criticism over their strategy and acknowledged their performance had fallen short.

They also asked at the time whether shareholders would continue to back them as they cut costs and reshaped their strategy.

Deutsche announced in April that it aimed to cut €3.5 billion (£2.5 billion, $US3.8 billion) in costs by selling Postbank and shrinking its securities business. Many called Deutsche Bank’s restructuring plan “too little, too late.

Deutsche Bank warned at the time that it would cost about €800 million (£585 million, $US891 million) to fulfil its restructuring plans. In turn, it will also cut annual revenues by about €600 million (£438 million, $US668 million).

Meanwhile that month, Deutsche Bank revealed that earnings fell by half in the first quarter this year. This drop was greater than expected as quarterly net profit sank to €559 million (£408 million, $US608 million) versus a year ago.

These were clear warning signs that the bank was facing a huge writedown, and it was at that point that Jain and Fitschen stepped down.

Also under their watch, Deutsche Bank got slammed with a massive fine by US authorities. The bank will pay $US2.5 billion (£1.6 billion) in connection with the manipulation of interbank interest rates including the London Interbank Offered Bank (Libor).

Perjury charges

Meanwhile, Fitschen faces some personal legal battles. Fitschen travels to Munich once a week to defend himself against allegations of perjury. It is in relation to attempted-fraud charges in Germany in a case involving the heirs of the Kirch publishing empire. German prosecutors say Fitschen gave misleading evidence in a civil court case in 2011, brought by heirs of media tycoon Leo Kirch. The trial still continues.

On top of that, Fitschen was personally named in other scandals at the bank. Fitschen and a director, Stefan Krause, were under investigation in relation to an alleged tax-evasion scheme involving the trading of carbon permits.

Meanwhile, Jain has apparently been battling for respect at the bank because he failed to master German. According to The Wall Street Journal, a source said Jain found his lack of German language fluency to be a barrier in communicating within the organisation.

Analysts think management issues are only a small part of Deutsche Bank’s problems

Despite the raft of problems stemming from Deutsche Bank’s management, analysts pointed out that there are more deep-rooted issues.

Take a look at what analysts at Goldman Sachs said in a research note in June (emphasis ours):

All in, we believe this announcement could initially be taken well by the market — however we expect this to be short lived. Deutsche Bank’s central challenges are structural, rather than management related — the basic difficulty is the absence of a high Return on Equity (ROE) platform. DBK does not have a highly profitable private bank (as is the case with UBS/CS), and its retail/commercial bank is low ROE. At DBK, investment banking (and FICC) is the highest ROE business.

Goldman Sachs analysts also provide a whole section in its note saying “Does the new CEO imply a radical strategic change? We doubt it.”

It also provides a chart about how Deutsche Bank is falling behind the average performance of a European bank.

Credit Suisse analysts were also doubtful over how long the positive rally on Deutsche Bank stocks would last.

In a research note the same day, Credit Suisse analysts said (emphasis ours):

Whilst the co-CEOs were under significant pressure following a disappointing strategy update, and challenged by a portion of shareholders at the last AGM, the timing of this announcement is a surprise (only 6 weeks after the strategy update).

With the personality of the new CEO being highly regarded by the market, we think this announcement could re-open the strategic debate. Awaiting clarity on this, we remain Neutral (TP €30.5) but expect share price reaction to be initially positive.

Meanwhile, analysts at Morgan Stanley said Cryan, the new CEO, would focus on “execution as much as strategy.” Judging by its note, it has a little bit more faith that Cryan will be able to fulfil promises of cost cutting (emphasis ours):

We think sharper execution will be critical to achieve value potential. New CEO John Cryan we recall had a tight handle on costs whilst at UBS … Addressing the high exit costs of non-core will be a focus — and Cryan had a good track record on addressing non-core head on at UBS.

In other words, ousting Jain and Fitschen would only have a short-term effect on Deutsche Bank’s stock price and provide some form of hope that Deutsche Bank will improve its performance, but Cryan will need to tightly control costs and bring the bank back into profitability if the lender is going to please its shareholders in the long-run.

And the analysts were proven right.

The stock had a short-lived pop and then rapidly in the months since Cryan took over.

Effectively, investors aren’t stupid. They priced in Deutsche Bank’s crazy mess in a while ago.

Investors are unfazed by Deutsche Bank’s massive impending writedown — shares are down only -1% at the time of writing — because it looks like everyone already knew that it was not an “if” but a “when” the bank would announce huge losses.

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