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The Last Hurrah for Deutsche Bank CEO Josef Ackermann

Deutsche Bank CEO Josef Ackermann wants to cement the firm’s investment banking status and his own legacy.

For a man who was supposed to be retiring this spring, Josef Ackermann shows little sign of slowing down. Over the past 18 months, the Swiss-born CEO has guided Deutsche Bank through the financial crisis with aplomb, shifting it from a high-risk proprietary trading shop to one geared mainly toward executing customer orders, all while restoring a healthy level of profitability. And he has done so without the help of a government bailout or capital injection — making Deutsche one of only a handful of European banks not to dip into the public purse.

Ackermann’s success, moreover, resonates well beyond Deutsche. The 61-year-old banker has become a standard-bearer for the industry. As the head of Germany’s only healthy and globally powerful bank, Ackermann enjoys a clout at home that enabled him last fall to persuade Chancellor Angela Merkel not to impose a bonus tax on bankers, as the U.K. government had. In January he led an industry push-back against regulatory reform proposals at the World Economic Forum in Davos, Switzerland. Acker­mann warned regulators not to raise capital requirements too sharply, saying such a move would undermine efforts to revive bank lending and stimulate economic growth. He also dismissed as “misguided” a U.S. proposal to bar banks from conducting proprietary trading and running hedge funds and private equity funds — a move that would force Deutsche to curtail some American activities.

Navigating the crisis skillfully has taken Ackermann, and Deutsche, to new heights. Long a German powerhouse with grand but largely unfulfilled global ambitions, Deutsche today stands as one of the few clear winners to emerge from the financial turmoil. While many rivals have suffered massive credit losses and management upheaval, the Frankfurt-based bank has strengthened its position in the global investment banking bulge bracket alongside the likes of Goldman Sachs Group and JPMorgan Chase & Co. of the U.S., Britain’s Barclays and Credit Suisse Group.

“We were never close to needing state funding,” Ackermann tells Institutional Investor in a recent interview. “That was important because it meant we didn’t have to pay fees for state guarantees or take pay curbs for our people. Our business has benefited vastly because clients saw that we were strong and came to us.”

The heart of Deutsche’s investment banking franchise, the Global Markets division run by Anshu Jain, has powered the bank’s ascent. The division stumbled after the collapse of Lehman Brothers Holdings, posting a loss of €4.8 billion ($6.5 billion) in the fourth quarter of 2008 after taking €7 billion worth of credit write-downs, but the unit was able to profit handsomely from a sharp widening of trading margins last year as financial markets rebounded and fewer banks were in a position to compete for the business. The division generated net revenues of €12.5 billion in 2009, or 45 percent of the bank’s total revenues. Sales and trading revenues in fixed income, currencies and commodities amounted to €9.8 billion, or $13.3 billion, ranking Deutsche behind only Goldman ($23.3 billion), Barclays ($20 billion) and JPMorgan ($17.5 billion) in the global industry.

Along with Barclays and JPMorgan, Deutsche benefited from a shift in European fixed-income trading flows away from firms that took significant hits during the crisis to those viewed as reliable liquidity providers and derivatives counterparties, according to a December report by Greenwich Associates. “These three banks have emerged to dominate the postcrisis fixed-income trading business in Europe,” the Stamford, Connecticut–based financial services consulting firm said.

Jain’s trading engine has scored in other areas as well. Deutsche ranked first in foreign exchange trading, with an estimated market share of 22 percent last year, according to Greenwich. The bank also profited from the post-Lehman shakeout to claim the top spot in prime brokerage, according to the consulting firm, after many hedge funds reduced their reliance on Goldman and Morgan Stanley for credit and trading services.

“Deutsche is a clear winner from the crisis because in times of stress, we and others moved balances to them,” says Davide Serra, founding partner of London-based hedge fund Algebris Investments, which is a shareholder in Deutsche. “They were strong and have a management team that understands risk.”

Deutsche’s trading prowess helped the bank’s earnings rebound to €5.0 billion in 2009, compared with a net loss of €3.8 billion a year earlier and not far off the record earnings of €6.5 billion posted in 2007. Those earnings, in turn, helped the bank bolster its core tier-1 capital — regulators’ preferred measure of equity capital — to 8.7 percent at the end of last year from 7.0 percent in 2008.

Now, Ackermann and his team are looking to solidify Deutsche’s position as an investment banking power. The bank unveiled a new expansion plan in December that seeks to double revenues in Asia, the fastest-growing market for investment banking activities. Deutsche is also ramping up its presence in U.S. equities and corporate advisory, areas where the bank’s market share has lagged relative to its European standing. To that end, Michael Cohrs, co-head of investment banking alongside Jain and head of the Global Banking unit, has hired nearly 150 bankers in recent months.

Ackermann isn’t forgetting his domestic base, either. Indeed, mindful of the chief lesson of the crisis — that banks have to rely on their home regulators and central banks in times of trouble — Deutsche has moved to strengthen its German business. In January 2009 the bank struck a deal to acquire a 50.1 percent stake in Deutsche Postbank, a leading retail player in Germany, in a stock-and-bond swap worth €4.9 billion. Deutsche also boosted its wealth management business by buying Sal. Oppenheim jr. & Cie., Germany’s largest private bank, with some €135 billion in assets under management.

Notwithstanding those moves, however, Deutsche’s fortunes are tied up in its London-based investment banking division, which generates about two thirds of the group’s pretax income. Ackermann’s expansion program aims to strengthen the bank’s global position and boost pretax earnings to €10 billion in 2011. That would be nearly double last year’s figure of €5.2 billion and would exceed the record pretax profit of €8.7 billion that Deutsche earned at the end of the last boom, in 2007.

That’s an ambitious target, to be sure. Deutsche’s strategy assumes that trading margins will remain above precrisis levels because of the shakeout in the industry, and that the global economic recovery will stay on track. But there are clear risks to such a benign scenario. Growth is still fragile, especially in Europe, where Deutsche generated nearly two thirds of its investment banking revenues in the first half of 2009. Many rivals that suffered big hits during the crisis are scrambling to rebuild their businesses, with Citigroup, Morgan Stanley and UBS in particular targeting Deutsche’s fixed-income playground. Regulatory reforms also threaten to constrain big investment banks and curtail profits.

Moreover, Deutsche lags its competitors in some key measures. The bank’s performance as a debt and equity underwriter and merger adviser trails well behind its success as a trading shop. Deutsche ranked seventh in investment banking fees last year, with an estimated $2.8 billion, according to data provider Dealogic, far behind industry leader JPMorgan’s $5.5 billion and the roughly $4 billion taken in by runners-up Bank of America Merrill Lynch and Goldman Sachs. Deutsche’s smaller size appears to have cost it a key opportunity. The bank’s attempt to expand its commodities business was frustrated last month when JPMorgan outbid Deutsche and paid $1.7 billion to acquire the oil, metals and European energy operations of RBS Sempra Commodities, a joint venture between Sempra Energy and the U.K.’s Royal Bank of Scotland Group. Kian Abouhossein, an investment banking analyst at JPMorgan in London, regards Deutsche’s profit target as overly ambitious and forecasts pretax profits of €7.4 billion in 2011.

Some analysts regard Deutsche’s reliance on investment banking as more of a liability than an asset. “Deutsche Bank’s management is riding the tiger in OTC trading,” says Richard Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, ­California–based bank rating firm. “The other businesses are stable, but they are not going to provide growth like sales and trading. So the bank’s London traders are betting the ranch every quarter.”

Ackermann, however, has faced plenty of skeptics since he began building the investment bank in the late 1990s, and he is confident the bank can meet its targets. “With conditions attractive again, new players will come in and existing ones will come back strong — absolutely,” he says in an interview in Deutsche’s temporary offices in Frankfurt, where executives are working while the bank’s headquarters undergoes a €200 million renovation to slash its carbon footprint. “This will put margins under pressure. So we will have to find new things, but that has always been the case, and we have always managed it in the past.”

In addition to hitting his profit targets, Ackermann faces a second big challenge: finding a replacement. The CEO, who has held the job since 2002, had long planned to step down this May, when he will turn 62, but a bungled succession effort — supervisory board chairman Clemens Börsig put himself forward for the post, only to be rejected by the board — prompted the bank to extend his tenure last April to 2013.

Deutsche doesn’t lack for talent, but none of its senior executives as yet appear ready to oversee Deutsche’s investment bankers around the world and its commercial bankers in Germany, while simultaneously managing relations with German regulators and politicians.

As the longtime head of the bank’s biggest unit, the India-born Jain, 46, is an obvious CEO candidate, but he is not German, and people within and outside the bank question whether he could operate effectively in Frankfurt. Cohrs, a 53-year-old American, faces similar doubts, although he boasts stronger German credentials: He oversees the bank’s relations with midsize companies in Germany’s Mittelstand. In Frankfurt, Rainer Neske, the youthful head of Deutsche’s retail banking business, is regarded as an Ackermann protégé, but he is only 45 and has no experience in investment banking, the bulk of Deutsche’s business. Hugo Bänziger, 53, a Swiss, like Ackermann, who serves as the bank’s chief risk officer, played a key role in minimizing Deutsche’s losses during the crisis, but he has never run a client business.

Resolving the succession puzzle will be a big challenge, but for now Ackermann is more than energized, and his lieutenants seem content in their roles. “Jo Ackermann’s staying was the best thing that could have happened,” says one senior executive. “Right now we need a statesman who can stand up for Deutsche Bank and the industry.”

Few would have predicted Deutsche’s rise as an investment banking power when Ackermann was hired by former CEO Rolf Breuer in 1996 to head up the fledgling business. Acker­mann had enjoyed a meteoric rise to president of Credit Suisse before being sidelined by that bank’s former chairman, Rainer Gut, in a power struggle.

When Ackermann arrived at Deutsche, the bank, then a predominantly German retail and corporate lender, was looking to grow beyond its home base by building on the small British merchant bank it had acquired, Morgan Grenfell Group. In 1995, Deutsche hired Cohrs, an equity specialist at S.G. Warburg & Co. and, before that, Goldman, to build up its team of investment bankers. That year the bank also lured Edson Mitchell, a senior executive at Merrill Lynch & Co., to develop a London-based trading operation. Mitchell did just that, bringing a number of Merrill colleagues with him, including Jain, a derivatives expert; hiring aggressively in London; and using Deutsche’s balance sheet to take big trading bets. Deutsche doubled down on investment banking in 1999 by ­paying $10.1 billion for Bankers Trust Corp., a deal that put Deutsche on the map in the U.S. but failed to push the bank into the industry’s top tier.

Following Mitchell’s death in a plane crash in 2000, his protégé, Jain, took over the bank’s debt markets business and gained responsibility for the entire sales and trading division three years later. Jain coined the phrase “flow monster” to describe Deutsche’s approach: providing liquidity to the bank’s clients by executing huge volumes of trades across the credit spectrum. Individually, the margins were thin, but the cumulative result was impressive. Building on the flow business, Jain quickly expanded Deutsche’s derivatives and trading operations, and expanded in the U.S. and Asia. With a global credit boom in full swing, Deutsche, like many other firms, began deploying more of the bank’s own capital and hired star traders, including Boaz Weinstein, to take big proprietary bets. Weinstein developed the credit prop trading unit Saba within Deutsche’s fixed-­income business and built it into the equivalent of a $5 billion hedge fund.

Deutsche also set about catching up with its rivals in corporate finance. Lacking the deep bench of industry specialists of the bank’s bigger U.S. competitors, Cohrs helped Deutsche push its way up the underwriting league tables by targeting private equity houses, then the biggest force in M&A. From 2005 to 2007, Deutsche was one of the biggest advisers to and providers of finance for leveraged buyouts by private equity firms.

When the subprime crisis erupted in August 2007 and financial markets began seizing up, many expected Deutsche to be among the biggest casualties because of its big prop book and LBO exposure. But the bank initially skirted the danger, having shorted subprime mortgages going into the crisis. At a time when Citigroup, Merrill Lynch, Morgan Stanley and UBS began racking up multibillion-dollar credit losses and scrambling for capital, Deutsche succeeded in posting record profits in 2007.

The mayhem that followed the collapse of Lehman Brothers in September 2008 presented a much bigger challenge than the previous year’s events. Deutsche suffered hits on its prop positions, LBO exposures and commercial real estate holdings, pushing it into the red for the year and forcing Ackermann to work quickly with Jain and Cohrs to rein in risk.

Ackermann prides himself on the fact that his senior team has been together more than a decade — a remarkable period of stability matched by only a handful of banks, such as Goldman and Barclays. He is loyal to his top lieutenants and has given them considerable latitude to run their businesses. “Jo made me feel like I built this place brick by brick, and that’s not a feeling you get at any other firm,” says Jain. Ackermann also listens to Cohrs on broader corporate issues, such as whether the bank should raise more capital. “Jo often treats Michael as his personal adviser; that’s the only way I can describe it,“ says one former Deutsche executive, who spoke on condition of anonymity.

Unsure when or whether markets would recover, Jain took a knife to his securities trading division in the fall of 2008. He fired Weinstein and his team of 100-odd credit traders and closed Saba after it ran up €1 billion in losses. More broadly, he also reduced head count throughout the business by 30 percent from the 2007 peak and unloaded fixed-income assets aggressively to shrink the investment bank’s balance sheet to €674 billion at the end of 2009, down 46 percent from the end of 2007. The resulting credit losses pushed Deutsche into the red in 2008, the bank’s first annual loss since World War II.

Jain also shook up Deutsche’s equities business in December 2008 after equity derivatives and prop trading took a hit that generated a loss of €635 million for the year. He promoted Robert Karofsky and Garth Ritchie as co-heads of global equities, replacing Yassine Bouhara, who became global head of structuring and head of global markets for Europe before taking a sabbatical in June 2009. As in fixed income, Karofsky and Ritchie emphasized flow trading on behalf of clients rather than proprietary position-taking.

Notwithstanding its losses, Deutsche fared better than many of its rivals, and the bank was well placed to profit from the recovery of financial markets and the sharp widening of trading spreads last year. In addition to the surge in trading profits on fixed income, currencies and commodities, Deutsche’s equity trading operations generated pretax profits of €2.7 billion in 2009, compared with a loss of €631 million in 2008. The big question is, what level of trading profits can Jain’s operation sustain going forward?

Stefan Krause, Deutsche’s CFO, told reporters in November that trading margins had been running 10 to 60 percent above precrisis levels and were likely to remain high. But margins and client activity fell significantly at the end of last year, causing Deutsche’s sales and trading profits to decline by 39 percent in the fourth quarter from the third. Jain recently told investors that revenues in Global Markets could rise or fall by 10 percent this year.

In lowering his risk profile, Jain runs the risk of losing top talent. The trader who established Deutsche’s short position on subprime mortgages, Greg Lippmann, is leaving to join an investment firm being set up by Fred Brettschneider, Deutsche’s about-to-depart head of markets in the Americas.

To keep profits growing, Jain is counting on a big contribution from Asia. Deutsche is seeking to double its profits from the region, to €2 billion, by 2013, and achieve a top-three ranking in debt, equities and M&A. Of course, Asia’s boom hasn’t escaped the notice of Deutsche’s competitors. ­JPMorgan’s James Dimon, Citigroup’s Vikram Pandit and Barclays’ Robert Diamond Jr., among others, have all identified Asian expansion as a top priority. But Jain believes Deutsche’s strength throughout the region places the bank in prime position to succeed. Indeed, a February survey by Greenwich Associates identified Deutsche and HSBC Holdings as the leading fixed-income franchises in Asia.

“The Asian markets are local markets. They are not about exporting capital to the West,” Jain says. “Our strong local fixed-income presence means we have the platform and investor intelligence to grow further our equities business.”

Cohrs’s banking division is also looking to grow after emerging from the crisis relatively unscathed. The unit had a large leveraged-loan exposure when Lehman collapsed, a legacy of its push into financing buyouts, but Cohrs, after conferring with Deutsche treasurer Chris Whitman, decided to maintain those holdings during the worst of the crisis rather than unload them at fire-sale prices. “We avoided bigger losses by not selling during the fourth quarter of 2008, as others did, waiting instead until early 2009, when there was a better window,” Cohrs says.

By selling some assets and taking advantage of international financial reporting standards to reclassify others as long-term loans rather than trading assets, Deutsche reduced its exposure to leveraged loans and commercial real estate to €12 billion at the end of 2009 from €35 billion two years earlier.

Ackermann and Cohrs admit that, going forward, the bank needs to broaden its industry coverage to grow its underwriting and advisory revenues and reduce the group’s reliance on securities trading. Deutsche ranked ninth last year in global M&A revenues, with an estimated $546 million, and ninth in equity underwriting, with revenues of $1 billion, according to Dealogic. By contrast, the bank ranked fourth in debt underwriting, with revenues of $1.1 billion.

Cohrs believes the crisis-related woes at rivals such as Bank of America Merrill Lynch, Citi and UBS present an opening. He has been hiring actively over the past year, focusing in particular on the U.S., and has succeeded in poaching some top names from competitors. Immediately after Lehman’s collapse he hired the firm’s former head of mortgage advisory, William Curley, and its head of nonbank financial institutions, Anthony Viscardi. The two bankers made a quick impact, helping Deutsche land a mandate in December 2008 to advise the Federal Deposit Insurance Corp. on the $13.9 billion sale of assets of failed mortgage lender ­IndyMac Bank to a consortium of private equity and hedge fund firms.

Deutsche also recruited four top financial institutions bankers from Bank of America Merrill Lynch: the brothers David, Eric and Seth Heaton, and Venkat Badinehal. In Europe, Cohrs raided Bank of America Merrill Lynch to lure a highly rated French team led by Marc Pandraud, who had worked for Deutsche in the past. The new hires helped Deutsche rise to third place in M&A advisory in France last year, from 13th in 2008.

In addition to the new hires, Cohrs revamped his banking division in October to give his top rainmakers greater authority and accountability for winning and executing deals. He named Brett Olsher, the London-based co-head of global M&A, to head up a 12-person global clients committee responsible for handling the bank’s biggest customers and transactions. He also appointed Stephan Leithner, Deutsche’s co-head of client coverage, to oversee a new corporate finance committee looking after management of the Global Banking unit.

With his team and strategy in place and business humming, Ackermann’s biggest risk, assuming markets don’t go into another swoon, appears to be tighter regulation.

The week before Ackermann, Jain and Cohrs presented the bank’s new strategy to investors in London in early December, the industry was gripped by the U.K. government’s decision to impose a windfall tax on banks. Such banker bashing is usually more common in continental Europe than in the City of London, but in this instance, Germany’s Merkel made it clear she had no intention of following suit, dismissing the British initiative as merely a “charming idea.” Many in Germany attributed that stance to effective lobbying by Ackermann. “The fact that Merkel is not jumping on this bandwagon and calling for bankers to be taxed — that’s down to Jo,” says one senior Deutsche executive.

Deutsche raised compensation and benefits by 18 percent last year, to €11.3 billion. That amounted to 40 percent of the bank’s revenues, a higher level than Goldman’s 36 percent and JPMorgan’s 33 percent. The bank also set aside €225 million to pay the U.K. bonus tax, spreading the cost among its worldwide workforce rather than letting U.K. employees take the hit.

The risk of tighter regulation continues to hang over Deutsche and its rivals and explains Ackermann’s repeated interventions, both in public forums and in private meetings with regulators. The Basel Committee on Banking Supervision is seeking to finalize rules by the end of this year to require banks to hold more capital to guard against excessive risk-taking. “The fixed-income environment is clearly going to be more difficult,” says Andrew Awad, a principal at Greenwich Associates. “Banks will have to hold more capital against derivatives that are not centrally cleared, making them more expensive. In areas such as cash credit and high yield, where banks act as intermediaries and holding inventory is important, new rules on capital could hurt liquidity.”

Deutsche’s enhanced capital ratio should provide a sufficient buffer, Ackermann believes, but he worries that regulators could raise the capital bar higher, which could restrain bank lending — and Deutsche’s profits. “The two biggest problems are, on the one hand, the absolute uncertainty about further regulatory changes being introduced in one country or another,” he says. “On the other, the proposed trading book treatment of securitization, requiring banks to hold high levels of capital, will choke off a badly needed revival of the securitization market.” His other big fear is that regulators will try to impose new limits on bankers’ compensation, something he is adamant that the industry must resist. “There are no limits on the quantum of compensation yet, and we want to avoid that.”

For Ackermann, the next three years will be a fight to the finish.

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