DB - Will Credit Suisse Follow The Successful Footsteps Of Deutsche Bank?

Summary

• Secret formula of Deutsche Bank's highly successful turnaround story.
• Credit Suisse's strategic updates (plan) resemble Deutsche's 2019 plan.
• Reiterate Deutsche Bank's Buy rating, and explain why Credit Suisse earns a watchlist spot.

A Tale of Two Banks

Both Deutsche Bank ( DB ) and Credit Suisse ( CS ) are globally systemic banks (G-SIBs), domiciled in Europe, play a financial infrastructure role in their home countries (Germany and Swiss), and had/having troubled pasts.

As a shareholder of Deutsche Bank, I have been closely following its turnaround plan since late 2020 and reported here and here . As I read Credit Suisse's first strategic plan (updates) published in Oct 2022, I noticed they (Deutsche Bank and Credit Suisse) share a lot in common, particularly the crisis they faced and transformation plans.

This article is to revisit Deutsche Bank's 2019 transformation plan, discuss its progress and success, compare it to Credit Suisse's current plan, and highlight areas that I would closely monitor to assess Credit Suisse's turnaround progress.

Deutsche Bank Story

The year was 2017, and Deutsche Bank was at a crossroads.

After a series of scandals and money-losing bets, including as a primary driver behind CDO during GFC, selling bad RE loans before Y08 (~2B settlement with US HFA), then the Libor scandal resulting in $2.5Bn fine in 2015, Deutsche Bank was a banking cowboy who took unhinged risks.

Christian Sewing was appointed CEO in April 2018 and took on a multi-year transformation initiative since 2019. Today, All of Deutsche Bank's core businesses are profitable, have a leaner/less volatile balance sheet, are well-capitalized, and most importantly both investors' and customers' confidence is restored.

Its stock price collaborates with its turnaround success. Since Jan 2019, Deutsche's performance (49%) led the pack among 5 of its peers JPMorgan ( JPM ), Bank of America ( BAC ), Citi ( C ) in the US, and Barclays ( BCS ), and Credit Suisse ( CS ) in Europe.

4Q22 marked the end of its 3-year transformation plan. My focus below is to assess the turnaround efforts by comparing its targets set in the 2019 plan v.s. what it achieved 3 years later in 2022.

2019 Transformation Plan

Its plan boiled down to 3 key areas:

1. Refocus/restructure core business (and exit loss-making ones)
2. Reduce costs
3. Free up capital

Refocus Core Business

The most important part of Deutsche Bank's plan is to refocus on its core business, including Corporate Banking ((CB)), Private Bank/Asset Management (PB|AM), and a part of Investment Banking (units with leading positions globally).

The rationale behind this is 1) Focus on core competency with leading positions. 2) Increase the share of predictable revenue from a strong deposit base, and a well-calibrated low-risk loan portfolio.

Results: Corporate and Private Banks together more than doubled their contribution since 2018 and contributed over 70% of the Group's total profit in 2022. (as discussed in 4Q22 conf call)

In the 2019 plan, it set the goal to be a smaller, simpler, less market-sensitive balance sheet by reducing trading assets/liabilities and replenishing with loans and deposits.

It did just that. From the chart below, trading assets/derivative instrument fair value decreased 1400 bps from 43% of total assets in 2018 to 29% in 2022. Loan and cash increased 600bps from 45% to 51% of total assets.

Trading liabilities decreased 300bps from 34% in 2018 to 31% in 2022, while deposits increased 500bps from 44% to 49% during the same time period.

For a ~$1T balance sheet, each 100bps equates to a $10B movement, and Deutsche bank has made remarkably steady progress over the last 5 years.

Cost Reduction

Plan: Target a cost/income ratio of 70% in Y2022 (from 92.7% in Y2018).

Results: It reduced Its CIR (Cost/Income ratio) by 18%, from 92.7% in 2019 to ~75% in 2022.

At first glance, it falls short. However, it is worth noting that it achieved this while absorbing $8Bn transformation-related effects and a macro environment facing inflation pressure that we haven't seen for decades. It is also worth mentioning that an 1800 bps cost reduction (from 92.7% to 75%) is quite an achievement by any standard in 4 years.

Free Up Capital

Goal: Free up capital for distribution ($5Bn) starting in 2022 while maintaining at least a 12.5% CET1 ratio.

Results: When it initially carved out Capital Release Unit in 2019, it had $74B Risk-weighted assets (RWA), and $288B leverage exposure. By 4Q22, Risk-weighted assets were reduced to $24B, with $22B leverage exposure.

On capital distribution, In Y2022, Deutsche Bank repurchased 26.5Mn shares, at an average price of EUR11.31, a total of EUR300Mn. It also resumed dividends (EUR0.21/share) in Y2022, distributed EUR 420Mn.

It returned a total of EUR720Mn back to shareholders in Y2022, a first and important step towards its initial $5Bn capital distribution goal by 2025.

Still a Deep Value

While Deutsche Bank's transformation has been remarkably successful since 2019, and its price chart (in the 'Deutsche Bank Story' section) underscores its success, I would argue the market is far from fully recognizing this true turnaround story and its future potential.

From a different perspective, the chart below shows that Deutsche Bank's relative P/TBV (Price to Tangible Book Value) has been consistently behind all its peers with the exception of Credit Suisse. Its valuation gap from its peers hasn't been materially narrowed since 2019.

Now let us turn to the 2nd part of this article.

Credit Suisse Story

Today, Credit Suisse is at crossroads.

It endured a $10B loss in Greensill Capital in 2021, and another $5.5B loss in Archegos in 2022 - and it was an epicenter of both unmitigated disasters. Client outflows led to a liquidity drop, followed by credit downgrades at Fitch and S&P, then 4 consecutive quarterly losses (~$1.6Bn in 4Q22), and clients and investors' confidence eroded quickly.

Ulrich Korner was appointed the new CEO in July 2022 and published its first strategic review in Oct 2022.

It Follows Deutsche Bank's Playbook

Its plan boiled down to 3 same key aspects:

• Refocus core business and restructure money-losing, non-core assets
• Accelerate Cost reduction
• Strengthen Capital Base.

Refocus Core Business

It intends to allocate more capital from Investment Bank to Wealth Management, Swiss Bank, and Asset management. It also planned to carve out CS First Boston as an independent unit*.

* On Feb 9, 2023, it announced the acquisition of M. Klein & Company and marked another milestone in the carve out of CS First Boston as an independent investment banking business.

Cost Reduction

Its 2025 target is to Reduce costs by 2.5Bn (appropriately 15% compared to 2022).

Strengthen Capital Base

It targets a Group CET1 ratio greater than 13.5% in 2025 (12.6% in 3Q22)

As a part of the capital strengthening plan, it intends to wind down non-core units, carve out CS First Boston, and reduce exposure to non-core securitized products. It even borrowed a page from Deutsche Bank and named it 'Capital Release Unit' to host non-core units and securitized products.

It also concluded a $4.3Bn capital raise in Dec 2022.

KPI to monitor its progress

From my vantage point, Credit Suisse takes Deutsche Bank's transformation framework, and intend to follow in its footstep. It is still in the early stage, and Credit Suisse already took some instrumental steps in each of these areas, such as capital raise, acquisition of M. Klein, etc.

I don't have a crystal ball about Credit Suisse's future.

What I learned from Deutsche Bank's successful transformation is, in addition to topline profit numbers, and CET1 ratio that everyone pays close attention to, the following KPIs also inform us of its turnaround progress.

• CIR (Cost / Income Ratio)
• Business segment revenue as % of total revenue
• Balance Sheet: Trading assets (liabilities) vs Loan (deposit) as a percentage of assets (liabilities)

As transformation progresses, the Cost/Income ratio shall continue to trend lower (Deutsche Bank reduced 1800 bps over a 4-year time period).

On the balance sheet, trading assets/liabilities shall be reduced and replenished by Loan/deposit as Credit Suisse refocuses its core business on wealth management and private banking.

Conclusion

Deutsche Bank comes out of its transformation plan as a more robust, healthier, and highly disciplined bank. Valued at 0.45x P/TBV, I continue to rate Deutsche Bank a buy today.

Credit Suisse is on a battleground-tested turnaround plan (tested successfully on Deutsche Bank) and already took some encouraging initial steps.

However, we must recognize turnaround is hard, not to mention it is a large-scale global bank. Turnaround takes time, and restoring clients' and investors' confidence takes even more time (and sometimes even luck).

Therefore, I will closely monitor Credit Suisse's progress and its KPIs, anticipating market is often attracted to the headlines, and pricing actions might deviate from reality (i.e. the actual turnaround progress) quite drastically sometimes. I will be prepared to step in when perception differs from reality to a degree that offers a sufficient amount of margin of safety.

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