Deutsche Bank has been having a rough few years. Despite the defenestration of John Cryan, whose miserable demeanour and parsimony in compensation hurt morale, the bank has yet to stop its slide down the rankings in almost all areas of investment banking. New CEO Christian Sewing’s deep cuts to US rates, global equities, and reorientation towards Germany can hardly inspire confidence in investment bankers that, five years ago, might have thought they were joining a global bulge bracket firm. Headhunters are lining up to offer lifeboats to bankers that can only see a future of further shrinkage.
But it’s not all bad news! In leveraged finance, the firm announced, its market share is up more than 100bp in the last year, from 3.9% to 5% — proportionally, a huge rise.
Leveraged finance is traditionally the largest and most profitable part of a DCM franchise, as well as the foundation for a huge range of lucrative dealings with financial sponsors, and the engine that feeds a CLO shop.
Boutiques might be able to wangle advisory mandates without balance sheet, but a bank like Deutsche is expected to reach for its chequebook.
The increase in Deutsche’s market share is particularly surprising because the US is by far the largest market for leveraged lending, and the bank has recently signalled a move away from domestic US business to focus on cross-border corporate finance and situations where there’s a European or German angle. It closed its oil and gas focused Houston office — likely a big originator of leveraged lending to exploration and production operations and shale gas businesses — and sold an associated $3bn loan book to BMO.
Deutsche said very little about how it achieved the increase in market share. Taking a bigger proportion of ‘left lead’ roles in new deals would signal that the bank is on top of its game, with more sponsors and companies entrusting it to take the driving seat of crucial event-driven financings. Conversely, taking a bigger chunk of deals from the right, as rivals pulled back, could signal that Deutsche is increasingly underwriting the risk that nobody else wants to.
Better in the business?
Sewing has said: “I think we are seen as one of the better banks in this business, and therefore, we see increasing volume.”
Perhaps this is true — Deutsche’s franchise has been remarkably resilient given the bank’s troubles — but it rather undersells the competition.
Yes, Deutsche may be one of the better banks, but that’s a peer group including the likes of Goldman Sachs, JP Morgan, Bank of America Merrill Lynch, Citigroup, and Credit Suisse, all of which are in considerably better shape than Deutsche, and unlikely to leave market share going begging. The likes of Barclays, UBS and Morgan Stanley, also have much firmer platforms from which to fight for share, while Nomura and Jefferies, which benefited for years by being regulated as brokers not banks, are unlikely to give up their gains lightly.
The point is, if all things are equal and markets are competitive, ailing banks going through brutal restructurings don’t just pick up huge chunks of market share in one particular business.
But things are not necessarily equal. Leveraged finance is the new hotspot for regulatory worries, and the other banks are pulling back.
Both the Fed and the Bank of England have warned of the risks in the market, pointing to rising leverage multiples and weakening covenants. Recent high profile LBOs like KKR’s buyout of Unilever’s spreads business and Blackstone’s buyout of Thomson Reuters Financial & Risk division have had some of the worst covenant packages ever seen.
JP Morgan’s investor call struck quite a different note, with CFO Marianne Lake saying the bank was being “cautious given where we are in the cycle”, and noting that while the bank hadn’t changed its underwriting standards, it was “cautious at the margin” and unwilling to follow non-banks which are “structure-wise… willing to do things that we are not… for our best clients, we aren’t largely going to lose on price… but we would walk away on structure”.
GlobalCapital is not a levfin doom-monger, exactly — the market has some notable strengths compared to 2006-7 — but about the nicest thing you can say about leveraged finance today is that it’s pretty late-cycle. Everyone thinks we’re near the top, but nobody quite knows when to call it.
Sewing said on the Deutsche investor call that “we certainly are not increasing our risk appetite… we are doing the underwritings in line with our existing risk appetite… with the expertise we have both on the front office, but, in particular, also on the credit side, we feel absolutely confident”.
Magic market share
It’s impossible for Deutsche shareholders or journalists to assess the truth of this statement, but it’s certainly a conundrum — as the whole market gets more and more leveraged, with weaker and weaker covenants, how do you maintain underwriting standards and simultaneously keep, let alone grow, market share? If you’re a leveraged finance banker who has the answer, there’s a long list of investment banks that would love to talk to you about it.
Also concerning is another statement from Sewing on the call, who said: “If I look at the underlying diversification of the portfolio, if I look at our syndication and sell-down successes we have, I’m absolutely confident that we are not taking undue risks.”
Underwriting and moving risk is the core activity of an investment bank, and successful syndications are a cause for celebration — not least in the pages of GlobalCapital — but selling down risk successfully isn’t the same as good credit risk management.
When markets turn, they tend to turn fast. Banks that don’t fundamentally like the exposures they’ve underwritten will be stuck with them, and staring at losses.
Perhaps Deutsche really has picked the best deals to underwrite, and its market share has shot up through good old-fashioned banking expertise. Not all banks can or should think alike, and a healthy market is one where people take different views.
But if you’re surging ahead while others are calling a top, it’s worth looking again, and being absolutely sure that your risk management really is better than everyone else’s.