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Deutsche Bank Ensnared by Billion-Dollar Malaysian Fund Scandal

A multi-billion-dollar fraud scandal perpetrated by an investment arm of the Malaysian government appears to have ensnared another major global financial institution — Deutsche Bank  (DBGet Report) — which already is reeling from massive restructuring efforts.

The Wall Street Journal reported on Thursday that the Justice Department is investigating whether the German lender violated foreign corruption or anti-money-laundering laws in its work for the 1Malaysia Development Bhd. fund, which included helping the fund raise $1.2 billion in 2014 as concerns about the fund’s management and financials had begun to circulate.

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The investigation comes amid a massive overhaul of the Munich-based bank announced over the weekend, which includes layoffs in the thousands and the creation of a separate entity for bad loans, debt and other problem investments and holdings that have plagued the bank since the 2008 global financial crisis.

Investigators reportedly have been assisted by former Goldman Sachs executive, Tim Leissner, the Journal said, citing people familiar with the matter. Prosecutors have been investigating similar issues at Goldman, where Leissner, a former managing director, pleaded guilty last year to helping re-direct billions of dollars from the 1MDB fund.

A state economic-development fund, 1MDB turned into a major global scandal after billions of dollars were drained from it between 2009 and 2014, leading to multiple government investigations and the downfall of former Malaysian Prime Minister Najib Razak.

The Department of Justice has said the stolen money totals at least $4.5 billion and that it was used to pay bribes to government officials, pad a slush fund controlled by the former prime minister and purchase hundreds of millions of dollars in luxury goods and real estate.

Shares of Deutsche Bank were down 0.54% at $7.36 in early trading in New York on Thursday.

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Source: Deutsche Bank Ensnared by Billion-Dollar Malaysian Fund Scandal – Report

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Deutsche Bank Faces A Smaller, Poorer Future

The London offices of Deutsche Bank. On July 24, 2019, Deutsche Bank reported a headline loss of €3.1bn which it said arose from the radical restructuring plan it commenced this month, in which its operations in the U.K. and U.S. are being drastically cut. (Photo by Alberto Pezzali/NurPhoto via Getty Images)

Deutsche Bank has issued its results for the second quarter of 2019. They make grim reading. The bank reported a headline loss of €3.1bn ($3.44bn), which it said was due to “charges relating to strategic transformation” of €3.4bn ($3.78bn). But both net income of £231m ($256.67m) and underlying profits of €441m ($490m) were significantly down on the same quarter in 2018.

The restructuring announced earlier this month has yet to impact fully. The “capital release unit” into which the bank plans to put €74bn ($82.22bn) of poorly-performing and non-strategic assets and business lines, including its entire equities trading division, is not yet up and running, and although headcount is about 4,500 lower than it was a year ago, the latest round of sackings doesn’t yet show up in the redundancy costs. Restructuring costs themselves therefore only contribute €50m ($55.56m) to the headline loss.

A further €350m ($388.89m) comes from junking software and service contracts that will no longer be needed because of the restructuring. But by far the largest part of the headline loss arises from impairment of goodwill to the tune of €1bn ($1.11bn) and a €2bn ($2.22bn) reduction in the value of the bank’s deferred tax asset.

This may sound like accounting gobbledegook, but it sends a very important message. Deutsche Bank’s management has admitted the bank will never return to the profitability of the past. When the restructuring is complete, it will be a much smaller, poorer bank.

First, the writedown of the deferred tax asset (DTA). A DTA arises when a firm pays taxes in advance and then suffers losses that wipe out that tax liability, resulting in an overpayment. Rather than claiming back the money, firms can “carry forward” the overpayment and use it to offset their tax liability in a subsequent reporting period. This “carried forward” amount is shown as an asset on the balance sheet.

However, a firm can only carry forward overpaid tax into subsequent periods if it is reasonably certain that the firm will eventually make enough profits to be liable for that amount of tax; and there is usually a time limit by which the deferred asset must be used. If the firm can’t generate enough profits to use the DTA, it is lost.

This is how Deutsche Bank explains its decision to write down the DTA (my emphasis):

Each quarter, the Group re-evaluates its estimate related to deferred tax assets, including its assumptions about future profitability. In updating the strategic plan in connection with the transformation the Group adjusted the value of deferred tax assets in affected jurisdictions. This resulted in total valuation adjustments of € 2.0 billion in the second quarter of 2019 that primarily relate to the U.S. and the UK.

Deutsche Bank has admitted that the deep cuts to the investment bank will result in profitability being significantly lower for the foreseeable future.

Now to goodwill. Goodwill can be regarded as another type of overpayment. It is the amount by which the purchase price of an asset or business exceeds the fair value of the tangible and intangible assets acquired and any liabilities taken on. Firms overpay for acquisitions when they expect them to deliver higher returns in future. But if they disappoint, then eventually the value of the “goodwill” must be reduced.

In two divisions – corporate finance, and the wealth management unit within its private & commercial banking division – Deutsche Bank has written off its entire goodwill, amounting to €491m  ($545.56m) in corporate finance and €545m ($605.56m) in wealth management. Importantly, the notes to the accounts show that the write-off is not a restructuring cost; these are business lines that have been under-performing for quite some time. The bank blames “adverse industry trends” and “worsening macroeconomic assumptions, including interest rate curves.” This is code for “we thought interest rates would be much higher by now.” Revenues have persistently disappointed because of very low interest rates, and now that the European Central Bank has indicated that rates will stay low for the foreseeable future – and may even be cut further – there is no real prospect of recovery. These business lines are simply never going to make enough money to cover their acquisition cost. Cue transfer to the “capital release unit” as soon as it is up and running.

The good news is that the €3bn ($3.33bn) writedown of DTA and goodwill didn’t affect the bank’s capital. The all-important CET1 capital ratio stayed firm at 13.4%. But looking ahead, there are clearly more restructuring costs to come. The bank says it currently has provisions for about €1bn ($1.11bn). It expects to use all of this, and it may need more. And Deutsche Bank also faces further litigation charges which it admits could be considerable.

But the biggest problem is Deutsche Bank’s desperate lack of income. Troubled though it is, the investment bank is still Deutsche Bank’s biggest source of revenue. The planned cuts will slash that to the bone, and there is no evidence that any of the other divisions can step up to replace it. All Deutsche Bank’s divisions, apart from its asset manager DWS, have flat or declining revenues and poor profitability. Unless it can turn this around, the future looks very bleak.

Despite the management’s upbeat presentation, the share price fell on these results. Shareholders were clearly unimpressed with the promise of “jam tomorrow” in the form of dividends and share buybacks from 2022. Perhaps they, like me, were looking at the bank’s promise to turn ROTE of negative 11.2% today into positive 8% by 2022, and thinking, “I don’t believe a word of it.”

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I used to work for banks. Now I write about them, and about finance and economics generally. Although I originally trained as a musician and singer, I worked in banking for 17 years and did an MBA at Cass Business School in London, where I specialized in financial risk management. I’m the author of the Coppola Comment finance & economics blog, which is a regular feature on the Financial Times’s Alphaville blog and has been quoted in The Economist, the Wall Street Journal, The New York Times and The Guardian. I am also a frequent commentator on financial matters for the BBC. And I still sing, and teach. After all, there is more to life than finance.

Source: Deutsche Bank Faces A Smaller, Poorer Future

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