Deutsche Bank: A Lehman Moment?
By IP Banking Research
Feb 10 2016, 11:38
About: DB • Includes: GS
European banks are mostly trading at a huge discount to book – much more so than their peers across the Atlantic.
Deutsche Bank has been identified by the markets as the weakest link and is down year-to-date ~40%.
Its senior and subordinated debt are trading at a 20%-30% discount to par.
Mr. Market is smelling blood.
Is this Europe’s banking Lehman moment?
Market valuation of Deutsche Bank (NYSE:DB) capital structure are clearly stressed. The share price is at ~0.3x book and its Contingent Convertibles (CoCos) are at ~30% discount to par value.
Such stressed valuations suggest this bank is about to implode.
If you listen to Bloomberg’s Tom King coverage of DB over last couple of days – you would probably conclude an imminent diluting capital call is coming.
On the other hand, DB’s CEO Mr. Cryan describes the bank as in an internal memo as “rock-solid, given our strong capital and risk position”.
So what is really going on?
Capital and liquidity are not a real concern
The facts are the facts. DB is comfortably above its current minimum capital requirements and with a reasonably conservative funding profile. The below extracts from the 2015 full year earnings illustrate the above:
(click to enlarge)
(click to enlarge)
As can be seen from above, DB has a buffer of 177 basis points above minimum capital requirements that apply in 2016. Similarly, the more ‘flighty’ unsecured wholesale funding comprises of ~6% of its liabilities. In any case, the ECB has multiple liquidity facilities that can be utilized by DB should a real need arise – liquidity or solvency issues are simply non-existent.
So why is the market freaking out?
It is really a confluence of several factors. In fact almost a perfect macroeconomic storm and DB is perceived as the weakest link in the global banking chain.
The issues facing the uncertain global economy include:
Fears of a hard landing in china
Oil and commodity prices collapse
Global recession and/or deflation
Negative interest rates
Equity market declines
Signs of a slowing U.S. economy
A divergent monetary policy drive by the Fed’s desire to begin the normalization
It is important to note that against this background, Mr. Cryan has been attempting a massive restructure of the bank.
So why is the market panicking about DB?
Much of it is completely divorced from fundamentals and the market is simply misreading the situation.
The market sees a reported 2015 FY loss of EUR6.8 billion but does not necessarily see through the full details of that loss – which includes a substantial goodwill write-off (accounting adjustment that does not impact capital), accelerated litigation costs and non-recurring restructuring costs in 2015 and 2016.
Mr. Cryan, as one would expect from a new CEO, is accelerating the clean-up of legacy issues – in other words, the proverbial kitchen sinks quarters.
It is important to note though, that DB’s management is clearly focused on ensuring that it carefully manages its capital position and paces the restructure accordingly.
Can we completely rule out a capital call?
No, a dilutive capital raise cannot be completely ruled out – but I believe that the probability is low. The main risk is that if current market fears around DB persist – the regulator and/or markets will force it to re-capitalize inorganically.
Hence, this explains DB’s management efforts to reassure markets by confirming its intention and capacity to continue payments on its CoCos and intention to potentially buyback senior debt securities.
Mr. Cryan will certainly do all that he can to avoid tapping the market for additional capital.
Perspectives from a counterparty
In the investment banking world, most would probably acknowledge that Goldman Sachs (NYSE:GS) are generally the smartest guys on Wall Street.
In yesterday’s presentation during the Credit Suisse Financial Services Forum, GS CEO noted that he had no concerns trading with any of the large European counterparties (in response to a question on DB).
I would certainly listen to Mr. Lloyd Blankfein when he speaks (and perhaps less so to the talking heads on Bloomberg or CNBC) – clearly, Mr. Blankfein understands that the challenges DB is facing are performance related but certainly not existential in nature.
This is clearly not Europe’s Lehman moment.
DB has significant challenges with its business model and there are substantial execution risks in the implementation of its strategy – but this is not an existential issue for the bank and thus it will not implode and bring down the financial system with it.
Mr. market grasp of the issues is misguided and certain commentators are simply irresponsibly wrong.
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Disclosure: I am/we are long DB, GS.
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