This is our Q4 analysis of Deutsche Bank. When analyzing and valuing entities such as banks and platform-driven tech companies, perception is always key. You see, what one maverick or true contrarian may see, very few others can perceive. The difference, oft times, is sometimes as simple as... They were looking.
While many analysts and investors may be focusing on its solvency and progress with litigation, there's one thing that I think many are missing. Investment banks are not like manufacturing companies or other industrials, where there's a heavy investment in plant and equipment and process. They are dissimilar to biotech or software companies where significant value lay in intellectual property. Investment banks are not even like retailers, who have established distribution channels that may be difficult to replicate. As a matter of fact, even those things that are listed on the typical investment bank's balance sheet don't include the only real, true asset that any investment bank actually has. The only thing that they cannot do without.
Although investment banks may list many of these things on their balance sheet...
What is never carried on the financial statements, whether at book value or economic value, is the investment banks only real asset...
You see, investment banks are nothing but licensed, leveraged capital and people. Licenses can literally be bought, and capital is sloshing around everywhere today - at negative yields to boot. So, the only thing that can differentiate a bank is its people. As industry culture would have it, Wall Street is notoriously highly (over)paid. Thus, when banks get in trouble (and that's exactly what DB has been in), they tend to cut head count. Since the industry pays about 50% of net revenues out in compensation, that amounts to a serious cost savings.
Wait a minute! In business, if you sell your assets to save money, exactly how do you make money? Hmmm...That's the conundrum that DB finds itself in. DB CEO John Cryan has prided himself in cutting costs and headcount, and he has. Look...
... and he's succeeding in shrinking the company's balance sheet. Look...
But... If you remember what I said in the intro, the only truly valuable asset of an investment bank is not even listed on its balance sheet. My Cryan is getting rid of these guys and gals, but he's really not saving any money! As excerpted from our paid subscriber report - pdf DB Earnings Review 4Q 2016 Feb, 2016 (1.07 MB):
- Compensation expense decreased in 4Q2016 and for the full year 2016 due to lower payouts for performance related compensation, but this can be very misleading. Although DB has succeeded in reducing compensation expense in aggregate euros, it's compensation ratio is much less impressive due to the fact that it's not cutting compensation as fast as revenues are decreasing. Long story, short - it's employees are still overpaid relative to what the company can afford. Any further decrease in compensation will likely lead to additional mass exits of the most valuable talent (which is likely already happening), thus closing off the most probable avenues to reverse the downward trend in revenues. This is a very serious development, for the only real operating asset that a bank truly has (from a practical perspective) is it's talent.
Be aware, we can spend a lot of time analyzing this bank, and with the repeal (before it even began) of the Fiduciary Rule which required advisors of qualifies money to actually put their clients interests first (god forbid!) and the general disappearance of the sell side analysts (reference FT.com's Final call for the research analyst?), there are a lot of pitfalls for buyside institutions, institutional investors, and HNW parties to avoid and/or potentially fall into. DB is not easy to analyze correctly, and to be frank, they are loose and wild with their assumptions and reporting. Reference this glaring FIVE BILLION EURO, or so, error (to the upside, of course) in their published financial statements. Of course, not a single sell side analyst or investor has noticed this, because we're the only one's who ever looked at it, and we aren't analysts, we're investors!
Thus, there's likely little surprise that DB's credit rating is dropping faster than Donald Trump's stance in approval polls.
The only surprise may very well be how late to the party the ratings agencies are, yet again, when dealing with these banks.
We have created a 15 page summary analysis of DB's Q4 and full year results for paid subscribers. You can subscribe here. Current subscribers can access the report here - pdf DB Earnings Review 4Q 2016 Feb, 2016 (1.07 MB). As a backgrounder, our risk analysis report from last year can fill in many gaps - pdf Derivative Exposure of Global Banks (11.90 MB)