This week, we look at the rather precarious position in which the mighty German Deutsche Bank presently finds itself. For global asset allocation specialists like ourselves, the big question is whether Deutsche Bank is a systemic risk, a solvency issue or simply in a vicious liquidity spiral that it needs to pull out of?
Systemic risk: There are plenty of indicators to cause us to worry about this possibility. Back in July 2016, the IMF pointed to Deutsche Bank as the world’s most systemically risky bank. Whilst its share price has subsequently fallen significantly, shares of most other big European banks, whilst still relatively weak, have largely been unaffected. There have been vague reports that other big banks were considering their credit lines with Deutsche Bank and some hedge funds were already removing funds, but many bastions of German Industrialism have all stood solidly behind their bank. Regulatory frameworks are much tighter than in 2008, and we are talking about an iconic German brand which both could and would rally the politicians into action if required. The systemic risk option at this stage does not stack up.
The solvency issue: This is less clear-cut. According to the Financial Times, Deutsche Bank has a €35bn “creditability gap”, i.e. the difference between what the bank records as it tangible assets and the market’s value of the company on the stock exchange. Not surprising, for a bank that has a €1.8trn (yes, that’s trillion!) balance sheet, which can swing in rising volatility.
Chart: Overlay of Deutsche Bank recent share price relative to Lehman’s during the 2008 Crisis
An interesting point is that, within most European bank balance sheets, the big concern is about bad commercial loans and provisioning for such bad debts. Not so at Deutsche Bank, where loans only make up 25% of assets and are generally acknowledged as mainly high quality borrowers in Germany. The big issue is the derivatives book of €985bn (yes, nearly a trillion), or over half of its assets. From a regulatory perspective, the net exposure of the derivatives books are termed Level 3 assets on the balance sheet, which are deemed illiquid or have no observable prices (this is a lower ratio than, for example, Credit Suisse or Barclays, but much higher than the other big global banks). Without going into details of how European banks are forced to value certain assets differently to those in the U.S. and the level of disclosure on what makes up these Level 3 net assets of €28.8bn, it is safe to say that these numbers place Deutsche Bank at the high risk end of the spectrum.
Liquidity spiral: The market noise around the $14bn fine, imposed by the U.S. Department of Justice (DoJ) for U.S. mortgage mis-selling in the financial crisis, whilst undoubtedly important to resolve, it is not going to bring down Deutsche Bank. They have already provided for $5bn and I am not sure the DoJ wants to cause the next global financial crisis. This too shall pass.
Deutsche Bank equity has already lost most of its value, while its debt is trading at around €0.85, which for the brave may be a much better entry into a high-risk company, which, despite the chart above, in my eyes does not, at this stage, look like being the next Lehman Brothers.
Deutsche Bank
