In 2016 Deutsche Bank (DB) was the 12th largest bank in the world (8th largest non-Chinese bank) with a market valuation of about €67 billion, which operates in 70 countries. However, its balance sheet was contaminated by a large amount of toxic assets, particularly concentrated in its investment banking unit, which constituted much of its earnings before the financial crisis of 2008-09.
The negative interest rate and financial regulations that were introduced in Europe after the financial crisis—and all the way through till today—have fundamentally overturned its traditional business model. The bank as a balance-sheet lender tended to be heavily reliant on net interest income, but its net interest margins have been severely slashed as a result of ECB’s negative interest rate policies, while at the same time the bank has been under pressure to recapitalize in order to build a larger financial buffer.
In a low growth environment with limited investment opportunities the bank, like other European banks, saw its profit margins squeezed to an unprecedented degree.
More specifically, Deutsche Bank’s $1.75 billion 6 per cent Additional Tier 1 bonds (AT1), known as contingent convertible capital instruments or CoCo bonds came under severe downward pressure when were bid at 69.55% of face value the, and when the US Department of Justice asked Deutsche to pay the aforementioned massive fine to settle an investigation into its selling of toxic mortgage-backed securities. This was lower than the February 2016 sell-off low of 70.2%.
The former chief executive of Deutsche Bank, John Cryan, who in an interview with the German tabloid Bild had stated that a capital increase was “currently not an issue” was forced to issue a statement on September 30th 2016, highlighting the bank’s resilient financial position, emphasizing that it has an “extremely comfortable buffer” when it comes to liquidity. “There are forces now under way in the markets that want to weaken confidence in us,” he wrote. “Our job now is to ensure that this distorted perception does not more strongly influence our day-to-day business,” Cryan added. “At no time in the last two decades has Deutsche Bank been as safe as it is today,” reporting that the bank’s liquidity reserves amounted to more than 215 billion euros. He was putting the blame on hedge fund “speculators” who were shorting Deutsche’s shares and Coco bonds.
The German officials, of course, have denied any attempt on a rescue plan to help Deutsche Bank, as new rules introduced to prevent misguided investments by large financial institutions prohibit taxpayer-financed bailouts. German authorities have been quite vocal in their oppositions to relax these regulations, spurning a recent rescue proposal by the Italian government, allowing them to inject public funds into the Italian banking system. Germans have been steadfast in criticizing southern Europeans for the euro-zone financial crisis and admonishing them for their lack of fiscal discipline. Thus, after so many non-German European banks collapsed or drifted into insolvency because of unavailability of public funds, it would be politically perilous to relax the rules to rescue their own bank. Call it what you may but we have to admire German consistency.
The CoCo bonds eventually recovered, even trading at a premium of 5% to face value by end Q1 2018. But then came news out of DB’s US subsidiary. Deutsche Bank U.S. operations had missed clearing the Fed’s stress tests in 2015 and 2016, and in 2017 was the subject of Fed enforcement actions for perceived lax controls tied to currency trading, money laundering, and Volcker-rule trading restrictions.
But it was when the FDIC had put Deutsche Bank’s US operations on its “Problem Bank List” that we were back to where we had started. The FDIC keeps its “Problem Bank List” secret. It only discloses the number of banks on it and the amount of combined assets of these banks. A week ago, the FDIC reported that in Q1, combined assets on the “Problem Bank List” jumped by $42.5 billion to $56.4 billion. That increase in assets of $42.5 billion on the “Problem Bank List” nearly matches the assets of Deutsche Bank’s principle subsidiary in the US, Deutsche Bank Trust Company Americas (DBTCA).
The price of the CoCos fell from 105 to 91 on face value in two days. And they have continued to fall.
So, here’s my question: which is better? US-style mollycoddling of financial institutions or Teutonic hands-off treatment?