Deutsche Bank's options to solve capital dilemma seen to be limited

[October 17, 2016]  By Edward Taylor

FRANKFURT (Reuters) - Deutsche Bank needs to move quickly to boost capital and deliver healthy profits if it is to restore investor confidence, but its room for maneuver appears limited, bankers, analysts and investors say.

When John Cryan took over as chief executive last year, he announced steps to cut staff and overheads and to sell off non-core businesses. But a $14 billion fine sought by the U.S. Department of Justice (DOJ) for the bank's mis-selling of mortgage securities has exposed a potential capital shortfall of between 5 to 10 billion euros, while progress in implementing Cryan's strategy has been slow.

The bank has no solvency or liquidity problems and it says it currently has no plans for a capital increase and that it is meeting all its regulatory requirements. But while the DOJ settlement might finally be significantly lower than $14 billion, the Frankfurt-based lender faces further fines for suspected money laundering that could hike litigation charges to between $8-$9.5 billion. Some analysts say litigation reserves total just 5.5 billion euros ($6.16 billion). That means Germany's flagship lender may have no choice but to raise money, despite limited options in the short term.

The easiest ways to raise cash are via a capital increase and accelerating a job cutting program. But analysts and investors say other options, such as asset sales, bonus forfeitures or even a full-blown merger with a rival should be considered. "Each of the major initiatives is unattractive, in our view. It is simply a question of Deutsche choosing the least bad," Stuart Graham, an analyst at Autonomous Research, said in a note earlier this month. Here are the bank's main options:

CAPITAL INCREASE Shareholders have already authorized Deutsche Bank's management to issue new shares of up to 50 percent of its existing capital. At the bank's current share price it would be able to raise up to 5 billion euros.

To raise any higher amount - some analysts say Deutsche Bank needs about 10 billion euros to lay the capital issue to rest - it would have to call an extraordinary shareholders meeting, a process which takes more time. Investors are loath to subscribe to new shares until the size of the settlement with the DOJ is known.

"Paying for past sins is not an attractive equity story," a Deutsche Bank shareholder said.

Separately, a successful capital hike before a settlement is secured could prompt the DOJ to demand a higher fine, a person familiar with the bank's thinking said, a scenario it would be keen to avoid.

SELLING ASSETS This may be the most lucrative option, but Deutsche's prize assets are either difficult to sell or so deeply integrated into its core business that it would be difficult to achieve at short notice. Global Transaction Banking is one such business. Deutsche put its German retail banking arm Postbank on the block at the end of 2015, but has so far failed to find a buyer. A fire sale is not possible without write-downs since the unit, which was valued at 4.5 billion euros at the end of last year, is now worth between 2-2.5 billion euros, analysts say. Deutsche Bank could also sell or list its asset management, a division that could be worth around 8 billion euros in total, although previous attempts to do a deal failed to attract adequate bids. In September Cryan said in a letter to employees that the bank had no plans to sell the business.

More likely than a complete sale of the whole business is a sale of sub-units like Deutsche Bank's mutual fund brand DWS or its ETF brand DB X-Trackers, or some retail banking operations in Spain and Italy, analysts say.

Most of Deutsche's prized assets are not going to be value accretive in a divestment until bank shares recover, making large-scale transactions unlikely before 2018. COST CUTS Deutsche Bank has already said it will shed 9,000 staff, but the cost savings are taking time to filter through to the bottom line since European labor laws mean staff cuts take between 24 to 30 months to be completed.

Deutsche's finance chief, Marcus Schenck, told staff representatives last month the bank may remove a further 10,000 employees to reduce costs, a person who attended the meeting has told Reuters. Deutsche has declined to comment.

Thanks to a hiring spree to beef up compliance, its headcount rose to more than 101,300 in the middle of this year, above the roughly 98,600 staff levels seen one year earlier. To bring its cost base into line with rivals Credit Suisse and Barclays, Deutsche needs to shed an additional 12,000 to 15,000 jobs, a plan that would likely bring 2 to 3 billion euros in restructuring charges, Autonomous Research said. Another step could be to freeze bonus payments. This could save up to 1 billion euros but would risk seeing the bank's top talent walk out to join a competitor. "Judging from its track record, Deutsche Bank seems to have an inability to cut net costs and generate operating leverage independent of management in charge," JP Morgan analyst Kian Abouhossein said in a note late last month. MERGERS Deutsche Bank has held exploratory merger talks with Commerzbank, but a deal would likely take years to pull off. Again the depressed state of financial stocks limits both banks' room for maneuver.

A merger with a European peer is also an option. Several Deutsche Bank investors have pushed the lender to explore such options. However, no other bank is likely to consider a merger until Deutsche has put its litigation issues behind it. GOVERNMENT INTERVENTION Politicians in Germany are watching developments nervously. Worries that a large fine would cripple Deutsche have prompted German officials to lobby Washington officials to be lenient.

State aid such as the injection of capital will be a tough sell with voters ahead of Germany's national elections in 2017.

If Germany took part in a capital increase, private co-investors would need to be found for it not to be seen as illegal state aid. Any such move would still have to be scrutinized by EU authorities. Earlier this month, German Economy Minister Sigmar Gabriel signaled that sympathy for Deutsche Bank was limited in political circles. "I did not know whether I should laugh or cry that the bank that made speculation a business model is now saying it is a victim of speculators," Gabriel told reporters.

($1 = 0.8928 euros)

(Additional reporting by Arno Schuetze, Simon Jessop, Kathrin Jones, John O'Donnell; Editing by Gareth Jones)

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