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Interview with James von Moltke, Chief Financial Officer of Deutsche Bank

"We remain committed to the United States"
Deutsche Bank's Chief Financial Officer on the strategy, stubborn costs, 2019 return target, bonuses and IT write-downsJames von Moltke, Chief Financial Officer of Deutsche Bank

Mr von Moltke, Deutsche Bank's annual general meeting is scheduled for today, Thursday. Are you looking forward to it?

For us, this is an important day for making ourselves available to shareholders and answering questions. The annual general meeting is an important part of shareholder democracy.

The major shareholder advisors are recommending that the actions of the supervisory board and management board not be approved.

This is something that we have been very attentive to. Of course, we are hoping for a favourable result, especially as this year we are approaching our shareholders with a much better feeling than last year. Christian Sewing will be able to explain to shareholders that in 2018, despite a lot of headwind, we delivered exactly what we promised.

In 2018 you achieved a cost target that you revised at the beginning of the year. It is now a question of achieving the targets announced for 2019. The second quarter is almost over: How has it gone?

You know that we essentially do not discuss unfinished quarters. But we are on track to meet our cost target for 2019.

Costs are easier to control than revenues. In order to achieve a tangible equity ratio of 4% in 2019 as planned, analysts say you need to generate earnings at the 2017 level. In 2018, however, the Bank's income was just under 5% lower and 9% lower in the first quarter compared to a year ago.

For us, the path to our target return is comprised of a number of factors. These include cost measures, earnings measures, a lower tax rate and may others, which we can control. The earnings environment in the current year has not yet been as we would have liked it to be. In the first quarter, this was able to be offset by strong cost discipline and a lower tax rate than planned. Should the earnings environment remain weak, however, this will become more and more of a challenge. We're aware of that.

Of all the targets, is the earnings-dependent target return the most difficult to achieve because the bank is more likely to influence its targets in terms of costs, headcount and capital ratio?

In terms of costs, we are on target and our hard capital ratio of 13.7% is already very strong. With regard to the number of employees, you must bear in mind that the bank is pursuing various initiatives to re-internalise outsourced tasks. But, of course: we are less able to control the target return than the other targets, as the market environment plays an important role in the development of earnings.

As Chief Financial Officer, how long can you watch the erosion of earnings in the investment bank before you have to intervene strategically?

We are naturally constantly looking at alternative ways to accelerate and reposition the business, reduce costs and strengthen profitability. However, if you want to manage a company for the long term, you cannot use individual quarters with weaker performance as the basis for strategic decisions. A somewhat longer perspective is required in this case.

Medium-sized investment banks from Europe have recently increasingly withdrawn from the sector. BNP Paribas and Société Générale published profit warnings and announced restructuring measures. Doesn't Deutsche Bank also have to decide whether it is still able to match it at the top?

Some of the French banks' restructuring measures, such as proprietary trading, securitisations and the commodities business, were completed years ago. So I am not sure whether these measures are necessarily also relevant for Deutsche Bank. But of course we feel obliged to achieve better and more sustainable results in the investment bank.

In the US business, it doesn't look like the bank is making any money there. Does the bank subsidise this area because it wants to offer the complete range of investment banking?

Our message is clear and continues to be valid: we remain committed to the USA. Our clients need us there, all of our large and many medium-sized clients have business there, and they are looking for a global investment banking relationship. In addition, the dollar is important for global trade and the US capital market as well as for investors. A global investment bank must therefore be present in the USA. However, this does not apply to every single product category, every business line and every industry segment. That’s why we had previously already decided to withdraw from some fields in the past.

If you shut down the business, you would have the problem of remnant costs: you would have to allocate the bank's costs to fewer business areas and would burden their result.

This is certainly an area that is considered in our planning when we think about additional steps. You cannot always allow costs to remain within the company and increasingly be spread across profitable businesses. Ultimately, this undermines our attempts to improve margins.

The bank's profitability is also influenced by bonus payments. Since 2010, it has paid a good 20 billion euros in bonuses, raised around 30 billion euros in capital and, with dividend payments of just under 5 billion euros, produced a cumulative result of 800 million euros. A lot of people see an imbalance? Do you?

The capital increases were necessary for a number of reasons. This includes the reduction of legacy issues and the payment of related fines. We also had restructuring expenses. I therefore do not see a close connection to variable remuneration. Effectively, we have to pay competitively if we want to attract and retain talent. Variable remuneration is one of the costs incurred to generate income. Of course, the performance has to justify the variable payment.

Does this mean that the remuneration structure will remain as it is for the time being?

It is important to note that our remuneration is generally highly regulated with regard to the entitlement to variable remuneration and its maximum ratio to fixed remuneration. A significant part of these payments will also be spread over an extended period of up to five years. Of course, performance-based remuneration will continue to play a role for us.

This is what the institutional remuneration regulation, which applies to all German banks, provides for - all the more astonishing that the disparity between bonus payments and the bank's results can be maintained at this level. Do you sometimes wish you could put the billions in bonuses into digitising the bank? J.P. Morgan invests 10.8 billion dollars in technology annually, which Deutsche Bank does not have.

You cannot compare this investment amount because it relates to a much larger business operated by J.P. Morgan.

But the bank is a competitor of Deutsche Bank.

In principle, with regard to remuneration, we are in very strong competition for talented employees in many areas. When we lose them, it is often because the competition offers a premium on the salary we pay. We must face up to this competition, otherwise we will lose the ability to generate income. But, at the same time, we obviously also have to invest in the future.

What is driving you the most at the moment? The erosion of earnings? The Bank's ratings, which are at the lowest level of investment grade in the case of bail-in-threatened, non-privileged senior unsecured bonds?

As Chief Financial Officer, you face many challenges, so it's difficult to highlight a particular area. Our most important goal is to gain credibility and convince investors. I regard the rating situation as part of the negative public perception. There is no doubt that we are not happy with the "BBB-" and "Baa3" ratings from S&P and Moody's respectively. We are therefore making every effort to steer our ratings in a positive direction. Above all, we are working to ensure that our restructuring measures gain traction and result in a sustainable return that lets us strengthen our resilience as well as build organic equity.

In recent days, credit default derivatives have been traded not only on the bank's non-preferred senior unsecured bonds, but also on the bank's traditional, less bail-in-threatened senior unsecured liabilities. What advantages does this offer the bank?

Quite simply: market players who trade with us and therefore have a counterparty credit risk can now hedge it much more cheaply. The new instruments now reflect the same part of the capital structure in which the investors are invested. No extra costs arise. The second advantage is perception, because the new swaps are currently close to 100 basis points and not 200 basis points as before, and we hope that their price will continue to fall. After all, the market sees credit default derivatives as an indicator of a bank's health.

The latest bond issues have recently seen juicy premiums and the share price is close to an all-time low. Where are the bank's capital costs and where do they have to go?

They're too high, and they must fall.

Can you be a little more specific?

As Chief Financial Officer, you should never discuss exactly where the correct price for your securities is. We believe we are valued at a price/book ratio that does not reflect the strength of our balance sheet at all. For us, the key lies in profitability. If we increase our earnings power, the share price will rise, ratings will improve, and spreads will decrease.

Has the failure of the talks with Commerzbank made this effort more difficult?

People talk about failure, that's not what it is. Two companies have examined a possible merger and have found that it makes more business sense to remain independent. We now have the same challenges and opportunities as before, apart from the fact that we have decided that national consolidation is currently impracticable and is not a top priority.

There had been negative feedback from clients on the talks. Are you getting positive feedback now?

By and large, clients understand that it was the right business decision to consider a merger and ultimately decide against it. We have taken the feedback from our clients on board.

One benefit of a merger would have been that costs could have been reduced and there would have been more financial leeway. Now that the merger isn't happening, the obvious question is: Where do you find the funds to finance the bank's investments in digitisation and sustainability?

Although we could have reduced costs, we would also have had an impact on income and restructuring expenses. The bottom line was that we would not have been better off with a merger than alone. We believe that we have the size to afford many of the investments that are required for digitisation, for instance. However, we believe that, over time, size is an important part of success in the financial services sector. So we have to explore other ways to achieve size.

One way to achieve this size could also be inorganic, just not as part of a merger with Commerzbank.

That could well be the case.

Who'd have to come knocking for you to want to join forces?

I don't want to speculate about that. There is much talk of consolidation at a European level. We have said that we want to be part of it. But we still have work to do to increase our profitability as an independent bank. If we can do that, hopefully our market value will also rise and put us in a good position.

In any case, Deutsche Bank sees itself as a senior partner rather than a junior partner.

I don't really see mergers as win/lose situations. Rather, companies merge in the hope of combining the best of both organisations. Each merger is unique in the way it brings together the different companies and their employees.

Deutsche Bank wants to reduce its liquidity surplus. How’s it going?

We are expanding our investments in assets that are considered highly liquid for regulatory purposes. We are also putting more money into a very high-quality portfolio of assets, typically in credit format, from our own client business. And we recently decided to reduce our new bond issues by around 5 billion euros. Because, instead of making more money work on the assets side, you can achieve the same effect on profitability by reducing your liabilities. We currently have around 260 billion euros in liquidity reserves. We could reduce this by 20 billion to 30 billion euros. Our liquidity coverage ratio is currently 141%. We could reduce this by 10 percentage points, which would still make us conservative and very cautious in the management of our liquidity. We also feel very comfortable with our liquidity because our results in the ECB's latest liquidity stress test were very strong.

Do you also invest excess liquidity in Italian government bonds?

Yes, but only a very, very small part with a short maturity.

Are the bank's interest rate offers for six-month deposits, which were recently advertised in the retail market, part of the efforts to optimise the refinancing structure?

They’re part of it, yes. But it also reflects our growth in the lending business. We want to have a good balance of deposits and loans on our balance sheet.

The ECB has reviewed the banks' internal models and initiated improvements where it considers these to be necessary. To what extent will this reduce Deutsche Bank's capital ratio?

Based on our discussions with the European Central Bank, we expect an effect of around 20 basis points over the coming quarters. We announced this in our latest investor call.

Are you facing any threats to earnings, for instance in view of the money laundering scandal at Danske Bank, for which no provisions have been established so far?

At the end of March, we did not have any corresponding provisions or contingent liabilities.

What about the judicial investigation into the Panama Papers?

Exactly the same.

What is your take on the debate about tax offences in connection with phantom stock?

We have been working very closely with the authorities on this matter for some time.

Is there still a risk of write-downs in the course of the IT restructuring at the bank?

This is something that we are constantly monitoring. Every quarter, we remeasure the software capitalized as an asset as well as the corresponding applications and record smaller write-downs where necessary, sometimes we also accelerate them. However, we expect the burden on our core capital ratio to be reduced in the long term, especially in the area of IT.

By how much?

The EU Capital Accord CRR II will end the deduction of capitalized software from hard core capital. For us, this means that we have around 100 basis points more core capital at our disposal - just like many of our competitors in Switzerland and the USA, for example, where IT investments are not deducted from equity in line with the local rules. Conversely, this also means that our capital calculation today is 100 basis points more conservative than that of our competitors in the USA or Switzerland.

Deutsche Bank's capital ratio will therefore increase by 100 basis points?

The exact value depends on the assessment of the extent to which the valuation of our IT would survive a liquidation. So we probably won't get the complete 100 basis points, but we will get a part of it, starting from 1 January 2021. And that's not all. In July, restrictions on payments on additional core capital, the so-called FDI, will cease to apply. The new credit derivatives on preferred senior unsecured bonds is another step. All these are indications of the progress we are making. In the perception of the bank, however, this is unfortunately overshadowed by the discussions about the accusations in connection with Danske Bank and all the other things, so that the market does not take sufficient notice of it. When, for example, we recently announced that we were going to reach an area of global systemic relevance that only provides for a premium of 1.5 percentage points, there was far less coverage of this issue than at the time when we were at 2 points and were considered one of the three most systemically relevant banks in the world.

In the ECB liquidity stress test, you say, the bank did well. In the US stress test, the US subsidiary of Deutsche Bank was the only institution to fail in 2018; the Fed regards it as a "troubled institution". Will it do better next time?

In recent months, we have worked extremely hard to improve our processes and remedy the shortcomings we have been notified of. You never know the results in advance, but we believe that we have improved significantly.

The interview was conducted by Bernd Neubacher and Anna Sleegers.

Börsen-Zeitung, 27th of May 2019

James von Moltke is Chief Financial Officer of Deutsche Bank.