There is a clear choice for this month’s “disaster of the month:” Deutsche Bank.
Those of you who follow the markets and read the financial news already know that Deutsche Bank has been under the radar for its shares’ big drop.
On February the 9th the shares of the European bank closed at a fresh low of 13.23 euros per share. This is the type of return that the bank stock has offered its investors:
- -41.80% YTD (year to date)
- -54.64% in the last year
- -1.5% since the lowest week after the 2008 crisis (January 2009)
- -87.16% since the highest point pre-crisis (May 2007)
The following chart paints the ugly picture (On friday 19th of February, the stock was trading right around 16 euros):
Tough times for Deutsche bank investors! (This is why it pays off to diversify, guys and girls – Yes We Can… Diversify!
At a price that travels the medium to low teens, thinking that the shares of this giant bank were once above 100 euros seems like a dream!
To tell you the truth the picture is similar, though not as terrible, for most major European banks. The reasons why European banks are suffering so much and why Deutsche bank is particularly suffering the rage of the markets I am about to explain, so hold on to your hats!
The common causes
Let’s start with the environment that is affecting the old, and new, continent’s financial institutions
Regulatory requirements
Banks have been forced to cut down its businesses due to regulations sprang from the fear that another 2008 might occur. Almost every single business model that banks display is being hit by regulations:
- Retail banking
- Corporate banking
- Investment banking (proprietary trading – completely banned – , market making, hedging activities)
- Private banking
All of them are at this moment negatively affected. If you want to know more about this interesting topic check this research from the EBA (European Banking Authority) published in February of last year – Overview of the potential implications of regulatory measures for banks’ business models
Interest Rates at all time lows
The low interest rates are hammering the banks ability to make money in their lending activities. The Net interest margins have been hitting all time lows for many major banks in the past year.
Slowdown of Chinese growth
Despite of their mild direct exposure to the Chinese economy, western banks are feeling the pain that investor’s fear is bringing. Any talk of a Chinese slowdown translates into lower European and U.S. equity markets, and this includes banks.
Crash of oil prices
We talked about it in a recent article: Past, Present, and Future of Crude Oil. If one thing is certain about the future of the oil market is that we will have a lot of uncertainty. Uncertainty is bad for the markets because the participants don’t know how to position themselves for the future. This translates in lower projects for the near and medium future, which at the same time means lower activity for the financial institutions.
These four developments all relate to one thing: PROFITABILITY. Banks ability to make money is being hindered due to a series of factors that are creating the perfect storm. This is why we are seeing so many restructuring processes around the industry. J.P. Morgan, Goldman Sachs, HSBC, Barclays, UBS, BNP Paribas, Credit Suisse… most major banks have been somehow active in the process to improve their future profitability. They were able to cut the fat and focus on those businesses that can bring money to the bank. Deutsche bank was the last in the pack to start its restructuring process.
Deutsche Bank woes
It is quite crazy, Deutsche Bank is trading below 50% of its book value… Imagine, if Deutsche bank was to be liquidated tomorrow it would be worth more!
How come? Well, at this particular time Deutsche Bank has no problem to pay its debt. Actually, the bank clearly expressed that it has over 1 Billion euros of liquidity to pay the April 2016 coupon of 250 million. Even more, the bank also estimates that it will have 4.3 billion for the April 2017, if they are able to go through with the sale of a Chinese lender. However, there is a little caveat, a higher than expected loss this year (for example a fine or litigation cost, not that far-fetched) could dry the bank’s liquidity… Again, tough times for Deutsche’s investors.
Maybe this is why two weeks ago the credit rating agency Standard & Poor’s downgraded some of the bank obligations to B+ from BB-. Peter Nerby, one of other rating agency analysts for Moody’s said that the interest payments on the bank’s debt appear secure if no major unforeseen event happens. It is not bizarre to get a little nervous of unforeseen events in this uncertain climate of negative interest rates and $30 pb oil price.
Now, we know the problem, but how did the giant German financial institution got to this point!
Lack of response to the aftermaths of the financial crisis
Richad Jenkins, chairman and CEO of Black Creek Investment Management, said it two weeks ago quite well, “Deutsche Bank has been the slowest to change the business model. The others restructured, shrunk, and refocus their business… Deutsche Bank continue with their universal global model, but they might not be able to compete…”
While other financial institutions were doing their homework and shaking their business models to find what really sticks; UBS focusing on its profitable wealth management business and Credit Suisse shutting its European government bond business and leaning more towards Asia are good examples, the German bank has been slacking.
Deutsche Bank has no new (up to our knowledge) strategy. Since John Cryan joined as the new CEO, bonuses have been cut, 6,000 workers have been fired, and communication has improved, however the official strategy is still the same as the one that Anshu Jain, ex-CEO laid out. This is a huge problem.
The bank is less capitalized than its peers
In one easy sentence: Deutsche Bank has less capital than most of its peers. Its leverage ratio (Tier 1 Capital as a % of total assets) at the end of last year sat at 3.5%, far away from competitors. Check the graph:
This should not be a big problem if we were in calm waters, but in turbulent ones it is hard to off-load subpar loans and trades, or sell new shares to boost capital levels. Considering the current state of credit markets it is way more expensive to fix the bank’s lack of capital, and this puts the bank in a difficult position.
Legal Costs
Legal problems, Deutsche has them in all shapes and colors. Some from several years ago that include selling junky mortgages prior to the financial debacle in 2008, and some quite new, like those “mirror trades” involving Moscow and London (allegedly the bank allowed clients to move funds between countries without alerting authorities). Deutsche Bank has already settled major fines in the last years, such as a $1.9 billion settlement for alleged violations of federal and state securities laws, or a $810 million lawsuit from last year concerning residential mortgage-backed securities.
Mr. Cryan made a reference to the lawsuit in an statement a couple of weeks ago “I am personally investing time to resolve successfully and speedily open regulatory case…” Let’s hope he does it without having to open the bank’s wallet again, because he might not like what he sees inside.
The final problem – Lack of alternatives for profitability
In this business is all about the bottom line, How much are you making? Or even better, How much are you going to make? This is what Deutsche Bank doesn’t know.
Why? The bank doesn’t even know where the future earnings are going to come from! We will see how Deutsche Bank’s uncertain future plays out.
At least the moral seems high among top executives. This week Garth Ritchie, Deutsche Bank AG’S trading business’ big boss, talked about the importance of having motivated employees and put a target return for its trading unit of more than 10%. The plan is to target the big clients in the markets business. Most likely this means that they will follow the path set in October when the bank said that it would cut its client list at the global markets, corporate business, and investment bank units by as much as 50%.
It is true that having motivated employees is key in these difficult moments, and if things turn even uglier the FED showed the way with the bail outs of JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, and Bank of America among many others. I am sure that the Bundesbank took good notes then!
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