DEUTSCHE BANK AND THE ROAD

TO BASEL III

Group-3
Abhishek | Raghvendra | Saket | Saurabh | Shubhadeep | Surabhi
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

• Joseph Ackermann stepped down as the CEO of Deutsche Bank on June 1, 2012 after his tenure of 10 years at the office

• Profitability in banking sector was in steady decline since the global financial crisis of 2008 and the uncertainty in Deutsche Bank’s future
prospects was reflected in its share price (at a discount of 40% from its tangible book value per share)

“Would Deutsche Bank be able to meet the capital requirements imposed under a revised global Banking regulatory framework – Basel III ?”

• In response to the global financial crisis, senior representatives Of G20 central banks began formulating this framework to raise:
• Quality
• Consistency
• Transparency of the capital base

• Requirements would be phased-in regularly, beginning in 2013 and becoming fully implemented by January 1, 2019

Major Questions

• How Deutsche planned to meet new regulatory requirements?

• What effect would Basel III have on the company’s profitability?
• What lines of business it would focus on going forward in a new banking environment?
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Basel III

• It is a global, voluntary regulatory framework on bank capital adequacy, stress testing and market liquidity risk

• The third instalment was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007-08

• Basel III is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.

Capital Requirements Leverage Ratio Liquidity Requirements

• The original Basel III rule from
2010 required banks to fund
themselves with 4.5% of common
equity of risk weighted assets (up
from 2% in Basel II)
• Basel III introduced a “minimum
leverage ratio”
• This is a non-risk based leverage
ratio and banks are expected to
maintain a leverage ratio in excess
of 3% under Basel III
• “Liquidity Coverage Ratio”
requires a bank to hold sufficient
high-quality assets to cover its
total net outflows over 30 days
• “Net Stable Funding Ratio”
requires the available amount of
stable funding to exceed the
required amount of stable funding
over a one year period of
extended stress
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Deutsche Bank History

• Founded at forefront of economic crisis of 1870s(HQ at Frankfurt)

• Company objective – “To transact banking business of all kinds, in particular to promote and facilitate trade relations between Germany
and overseas markets”
• Handled international transactions for German companies, which expanded company’s international reach
• It was one of first bank to adopt Universal Banking

After World War I, Deutsche

Bank lost many of its foreign By 2011, Employed 100,654
assets and suffered due to By 1990s, it had acquired its people in 72 countries, with
depression in banking industry ways into 70 countries 3064 branches

Till the end of World War II, it Shifted company focus from
expanded its holdings and opened traditional retail banking to
new branches global investment banking – 42%
revenues from investment
banking in 2007
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

BACKGROUND: DEUTSCHE BANK

Major revenue sources – Investment

Operational in 72 countries
banking, retail banking and asset
with over 3000 branches
management activities

Assets dedicated to investment banking

€1860 billion (June 2012) which was more Tier 1 capital ratio – 10.2%; Tier
than 3 times of assets dedicated to 2 capital ratio – 13.6%
commercial/ retail banking

Acquired Postbank to Deutsche Bank had largest

improve funding base through market share in US fixed
depositors income trading
 Deutsche Bank
Globalization of
Introduction History and
Banking Industry
Business Overview
Business Overview
• By 1929, a series of consolidation efforts
among German bank saw Deutsche Bank
merged with its rival Disconto- Gesellschaft
• Post WWII, Deutsche Bank was split into 10
different banks and its name was outlawed.
• 10 years later former parts of Deutsche Bank
in Frankfurt, Munich and Hamburg were
merged & allowed to operate under old
name.
• By 1958,Deutsche Bank issued its 1st foreign
currency bond on German Market, thereby
opening the market to international firm
The New Banking
Global Deutsche Bank's
Environment and
Competition Valuation
Basel III
• By 1990s, the political changes in Eastern
Europe helped Deutsche Bank establish
numerous subsidiaries.
• By 2001, it had acquired its way into 70
countries and was even listed on NYSE
• Later on Deutsche Bank had shifted its
business focus from traditional retail banking
towards global investment banking
• By 2012, the bank was one of the largest
banks in Germany , indeed one of the largest
financial institutions in Europe and the world.
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

BACKGROUND: DEUTSCHE BANK

Non-domestic revenues as % of total Investment Banking Assets VS Revenue

100% 100%

80% 73% 80%

56% 60% 62%

60% 55% 53% 53% 60%
46% 51%
43%
37%
40% 40%
26% 27% 25%
17% 20% 16%
20% 20% 14% 12% 13%
7% 3% 3%
0% 0%
2002 2007 2011 Investment Bank Asset Growth Investment Bank Revenue Growth
JP Morgan Chase Citigroup Barclays BNP Paribas Deutsche Bank JP Morgan Chase Citigroup Barclays Deutsche Bank

• Deutsche Bank faced competition in international • Focus on globalization after easier cross-border
markets from players like JPMC, Citigroup, Barclays transactions and global communication since late
and BNP Paribas 1990s
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

• By end of 2002,Deutsche Bank derived a significant portion of revenue from investment banking activities.
•
• Revenue from sales & trading increased from 30% to 42% between 2002 and 2007.

• Revenue from traditional retail banking declined from 22% to 19 %.

 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Investment Banking Activities

Sales and Trading

Sales & Trading activities engaged in the purchase and sale of corporate/ government securities, currencies and derivatives on exchange or
in OTC market

Corporate Finance, Origination & Advisory

A broad range of services was covered under the category of Corporate finance. One of the largest was origination and advisory services
which ranged from helping companies raise equity and debt to advising companies in M&A and restructuring activities

Asset Management
It provided investors with investment advice and portfolio construction that was tailored to meet the individual needs of each client. This
division was sometimes referred as Private wealth management or private banking
 Deutsche Bank
Globalization of
Introduction History and
Banking Industry
Business Overview
• With commercial bank already focused on providing
investment banking activities and being a one step shop
for financial service needs, the world economy
experienced an accelerated trend in globalisation.
• One major reason for this was the proliferation of the
internet in the late 1990s, which made global
communication and cross border transaction easier to
facilitate.
• Moreover, Many corporations and investors were
pouring funds into emerging markets in response to
staggering projections for GDP Growth in countries
including Brazil, India, and China.
The New Banking
Global Deutsche Bank's
Environment and
Competition Valuation
Basel III
• For Banks, It not only meant that they had to provide
all the commercial and investment banking services to
the clients, but they also had to do so in all the places
their client was doing business in.
• Moreover, most investment banking activities benefited
from Economies of Scale, meaning they became more
profitable as they grew in size.
• To gain new customers, and retain existing ones,
Deutsche Bank needed to provide services on a global
level and secure its position in the investment baning
market.
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Industry Trends

• As DB started internationalising its

operations, other banks followed suit as we
can see from this graph. Since European
banks like Barclays and BNP catered to
smaller markets, their presence was wider

• The increase in revenues of global

competitors were a result of increased
investments by competitors as well. This led
to increased rivalry among the IB firms
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

DB’s Performance

• Banks have three primary options to finance

asset growth on balance sheet: Past period
profits, issue equity or borrow debt capital.

Until 2008 DB achieved remarkable growth in

EPS at an annual growth rate of 83% from 2002-
07.
However comparison of ROE with ROA shows
that growth came from increased leverage and
not from use of its productive assets. This was
not a good sign for its earnings sustainability.
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Industry Trends

• JPMC on the other hand had more than

double the ROA of DB in 2006.
• DB had an ROE 800 basis points higher than
JPMC

• DB employed massive leverage and increased

its leverage ratio which allowed them to
receive significant gains in both ROE and EPS
but in 2008, the simplified returns due to
leverage caused a -0.18% ROA and
subsequently loss to shareholders.
• Post 2007, DB significantly de-levered its
balance sheet by decreasing trading book
assets and liabilities by approximately
€700billion in 2008-09
• To continue this process, assets needed to be
shed or increase equity base through
Retained Earnings or Raising Capital
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Basel Norms : Details

1998 2004
⸙ Set out the minimum capital requirement of ⸙ Upgrade Over Basel I
financial institutions to reduce credit risk ⸙ Included 3 pillars
⸙ Bank assets classified into 5 categories on the ⸙ Minimum capital requirement
basis of risk ⸙ Supervisory review of banks
⸙ Banks required to maintain a capital which is ⸙ Effective disclosure of bank activities
8% of its risk weighted assets to improve market discipline
⸙ Only considered credit risk, operational and ⸙ Better classification of asset risk
market risk not covered categories

2013
⸙ Enhanced Capital Requirement Common equity raised
to 4.5% from 2%
⸙ Tier 1 Capital requirements raised to 6%
⸙ Additional Capital Conservation Buffer of 2.5% to
bringing the total Tier 1 Capital reserves required to 7%
⸙ Leverage Ratio should be at least 3%
⸙ Liquidity coverage ratio >=100%
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Challenges faced by Deutsche Bank

Raising fresh equity capital
would dilute the equity value
02
Additional Capital
Need to increase regulatory
capital to comply with
increased ratios and risk
weights
01
Expectations
Doubt on Deutsche Bank’s
ability to meet new regulatory
framework as per Basel III
norms.
03
EV Dilution
04
Low profitability
of existing shares. European debt crisis and
slow economic recovery
made it difficult to achieve
pre-crisis profitability.
05
High Leverage
Profits came from increased
leverage and not productive
assets. Competitors had a better
ROA.
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

• On July 31, 2012: DB’s shares were trading in the range of 8.2x its trailing LTM P/E & 0.6x its tangible BV
• Wide fluctuations in its valuation since 2006
• At 0.6x P/TB, DB was trading in the same range that it did during the depths of global financial crisis

P/E P/TB ROA ROE Dividend Leverage

LTM EPS 2012E EPS 2013E EPS MRDQ LTM LTM Yield Ratio
JPMC 8.3x 7.8x 6.9x 1.04x 0.72% 11.20% 3.00% 15.4x
CitiGroup 7.9x 6.8x 6.1x 0.54x 0.54% 7.30% 0.10% 13.5x
Barclays 13.1x 10.0x 4.9x 0.46x 0.10% 3.10% 3.50% 31.4x
BNP Paribas 6.5x 5.5x 5.6x 0.54x 0.29% 9.10% 3.80% 31.2x

Average 9.0x 7.5x 5.9x 0.65x 0.41% 7.70% 2.60% 22.9x

Median 8.1x 7.3x 5.8x 0.54x 0.42% 8.20% 3.30% 23.3x

DB 8.2x 6.2x 5.0x 0.6x 0.13% 5.70% 3.00% 44.3x

• Two reasons can be: Reduced leverage, Increased capital requirements (BASEL III)
 Deutsche Bank The New Banking
Globalization of Global Deutsche Bank's
Introduction History and Environment and
Banking Industry Competition Valuation
Business Overview Basel III

Compared to its peers, DB needs to have a

It needs to reduce risk &
DB had higher leverage balanced outlook based
increase earnings
and average profitability on RoA & RoE

DB can issue hybrid

Acquisition of Postbank securities in order to
can give stability to finance asset growth and
earnings also comply with BASEL
III capital requirements
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