What to do with a problem like Deutsche Bank?

By definition a credit crunch involves what Taylor Swift would call “trouble,trouble,trouble” for the banking sector in general and some banks in particular. A feature of the 2007/08 one is that we find that what we might call the bad smell emanating from the banking sector has never really cleared. This is especially true in Europe as Wolf Street pointed out on Friday.

European bank shares – which have been getting crushed and re-crushed for 12 years – are getting re-crushed again. On Friday, the Stoxx 600 Banks index, which covers major European banks, including our hero Deutsche Bank, dropped to an intraday low of 130.5 and closed at 131.2, thereby revisiting the dismal depth of December 24, 2018 (130.8).

 

European banks did not soar on the first trading day after Christmas, unlike other stocks. Instead they fell further and hit their multi-year low on December 27 (129). The index is down 21.5% from a year ago and 33% from January 2018:

From the point of view of a Martian observing events this would provoke some head scratching, after all there have been reports of recovery for years. He or she would soon note that there is something else going on as the Financial Times points out.

Almost $12tn in bonds trading with sub-zero yield

This poses a problem for banks who essentially live off there being positive interest-rates, as otherwise there is the alternative of cash which suddenly looks rather attractive with its yield of 0%. Anyway our Martian is bright enough to know that it isn’t really necessary to worry too much about the maths as long ago those on Mars learnt that one of the best guides to human behaviour was to head in the opposite direction when we release official denials.

Deutsche Bank

Germany’s premier bank has found itself in the cross hairs of this issue and its travails have become quite a long-running saga. One way of looking at this comes from when we looked at it back on the 29th of August last year.

Back at the peak the share price was more like 94 Euros according to my monthly chart. From a shareholder point of view there has also been the pain of various rights issues to bolster the financial position. These tell their own story as the sale of 359.8 million shares raised 8.5 billion Euros  in 2014 whereas three years later the sale of 687.5 million was required to raise 8 billion Euros. The price was in the former 22.5 Euros and in the latter 11.65 Euros.

As you can see one of the most successful trades of the last decade is selling Deutsche Bank shares, especially if you do so in the face of the periodic rallies. So well done to anyone who has. The main danger is that you get called an “evil (usually foreign) speculator by the establishment. Putting it another way this has been the mother of bear markets, Another perspective is pointed out by the fact that Deutsche Bank had a dividend of 4.5 Euros pre credit crunch whereas this month the share price fall below 6 Euros.

Merger Mania

Regular readers will be aware of the phase where the apparent plan was to merge with Commerzbank. The catch was that really the only benefit from this would be to muddy the accounts for a year or two. Whereas on the other side of the coin a bank to big to fail (TBTF) would hardly be improved by making it even bigger! In spite of that there were several goes at this but eventually the plan folded like a deck chair.

A New Hope?

Last night the Financial Times published this story.

Deutsche Bank is preparing a deep overhaul of its trading operations including the creation of a so-called bad bank to hold tens of billions of euros of assets as chief executive Christian Sewing shifts Germany’s biggest lender away from investment banking.The plan would see the bad bank house or sell assets valued by the German lender in its accounts at up to €50bn after adjusting for risk.

I can see three initial issues with this.

1 Bad banks are so 2010 and it is now 2019

2.In itself a Bad bank does not solve anything as it is just an accounting exercise. What is needed is a behavioural change. Otherwise the shareholder liability does not change one iota.

3. If those “assets” could be sold as ” valued by the German lender in its accounts” then this would have happened many years ago!

Or as Earth,Wind and Fire put it.

Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away

There is something which leaps of the page at me so here it is.

While the derivatives destined for the non-core unit still provide some cash flow, all the profit on the deals — and therefore the associated bonuses for those who arranged them — were booked up-front.

What could go wrong? Well Enron style accountancy results in another Enron. Or in the UK there was the case of Atlantic Computers some years back which booked profits up front and kicked liabilities forwards in time. So the lesson of not taking profits up front had been learnt but there is a catch. as Enron and Atlantic Computers collapsed but this does not happen to TBTF banks. So those managers who took the bonuses up front have done something which I would make subject to the law of fraud. For them it was something of a perfect crime as years later they have got away with it and we are being told the assets are fine.

Or maybe they are not quite so fine.

In the years since the instruments were first arranged, they have become a major drag on the bank’s capital because of their more stringent treatment under new regulations introduced after the financial crisis, said the people briefed on the plan.

There is an obvious contradiction here as if you sell these assets to someone they too will get “more stringent treatment under new regulations ” and thus will reduce the price, but I guess they are hoping we will not spot that.

Seldom does something in the financial press make me laugh out loud but this did.

The German bank believes it can divest the assets without taking large hits to its profit or capital because the long-dated interest rate derivatives are not toxic and have a predefined run-off plan, one of the people said.

If that were true they would have done it many years ago.

Also this feels like they are seeing if they can find a minimum they can get away with rather than really fixing the hole.

The final scale of the non-core unit has not been decided and the number “continues to oscillate”, but executives are discussing at least €30bn of risk-weighted assets with an eventual size of €40bn to €50bn most likely, two of the people said.

Comment

What this how procedure ignores is the rather devastating critique of the credit crunch provided by South Park with an episode based on the three simple words below.

And it’s gone

Whereas Deutsche Bank has been in denial ever since. This has created three main problems.The first is that those who have taken bonuses from the past deals have in my opinion got away with something that would be considered fraudulent in any other industry apart from “The Precious”. Next is that shareholders have stumped up more money for rights issues in return for promises that things could only get better, when they have in fact got worse. So there has been enormous value destruction, or if you prefer a financing of issue one. The third is the impact on the wider economy as Deutsche and the other zombie banks are in no fit state to support it.

The past point is intangible but important. Because in response to that problem we keep getting lower interest-rates and yields which makes the banks weaker and the whole cycle starts again.

This morning’s share price rally has faded a bit and the shares are up 2% at 6.15 Euros, probably because there are as many holes in the new plan as John Lennon sang about.

I read the news today, oh boy
Four thousand holes in Blackburn, Lancashire
And though the holes were rather small
They had to count them all
Now they know how many holes it takes to fill the Albert Hall

On the other side of the coin is the nagging issue that the banking business model has gone too.

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14 thoughts on “What to do with a problem like Deutsche Bank?

  1. shaun

    Have just read your article quickly but also looked at this :

    “The German bank believes it can divest the assets without taking large hits to its profit or capital because the long-dated interest rate derivatives are not toxic and have a predefined run-off plan, one of the people said.”

    Now you have a far better take on the bank than I do but what kind of assets are they talking about?

    Why I say that is property assets have been pumped up all around the globe and its suits the banks.

    But pumped up assets can only go on so long before the balloon bursts. Now readers can say what they want banks would never allow a financial crisis to happen again if it means reducing interest rates further they will do it, but there is only so much banks and governments can do in my humble opinion and sooner of or later the house of cards will collapse.

    On another theme and more at home was BREXIT stockpiling set to hit growth as it all unwinds, this was entirely predictable:

    https://www.theguardian.com/business/2019/jun/17/uk-growth-tipped-to-slow-as-firms-run-down-brexit-stockpiles

    The UK done well with low unemployment thus far but reading Blanchflower take on the situation in the UK he seems to think the employed are underemployed i.e. self employed and part time workers which tend to colour the figures from the ONS.

    • Hi Peter

      This has been a long running issue but the derivatives problem started with all the interest-rate cuts which would mean that even ones which were well “out of the money” would have been reached and frankly passed. Putting it another way events which were priced as been very unlikely not only happened but we cruised past them. Such a scenario is very difficult to hedge and in my experience someone usually comes up with a clever plan that turns out to be anything but. I recall one such effort that turned a 250k loss into one of a million.

      Sometimes there is a chance to get out but as we cover on here the interest-rate cuts have been relentless so over time something which was a bad situation has got even worse. In my opinion these have never been fully valued or what is called marked to market ( or as best you can if the product is very illiquid)

      Danny has done some good research into underemployment but it is also true that he has been consistently downbeat on the UK economy in the period since 2013 when it has improved.

  2. It’ seems pretty outrageous to me that your comment “to head in the opposite direction when we release official denials” is regarded by so many serious and experience market participants as a prudent approach. What a state of affairs we have come to.

    • Hi ladydog

      I use the theme on social media regularly and now people contact me after some statements if I have not used it. But the real credit goes to the television series Yes Minister from as far back as the early 1980s when Jim Hacker said this.

      “First rule of politics: Never believe anything until it’s officially denied.”

      There is always doubt as to who said what in the past but many attribute the origins of this to Chancellor Bismarck of Prussia/Germany.

  3. Shaun,
    It doesn’t get much more depressing than:
    1. Bonuses taken up front
    2. Massive rights issues which effectively pour billions down the drain
    3. Ludicrous financial engineering to try to fool people for even longer
    4. Bankers continuing to make entirely false claims about the “assets” of the bank.
    The fact is that these bankers:
    1. Haven’t a clue what they are doing, as demonstrated by the Deutsche fiasco
    2. Have had absurd rewards
    3. Have almost bankrupted the banks and the rest of us
    4. Expect and get government bail-outs
    5. Still feel entitled to tell the rest of us how to run an economy.
    I have a radical idea – why not set up a bank that:
    1. Takes in capital;
    2. Lends money to businesses to try to help them grow
    3. Pays its staff reasonable salaries and no bonuses
    4. Never ever ever indulges in trading, derivatives, swaps etc.
    Just a thought…

    • James, what I always wonder is who are the idiots who bought into the rights issues? The first one, perhaps, if you place too much trust in management promises, but the second one?!

      My worry is that I will find out is was my pension fund managers but it won’t be their bonuses that are affected by these poor investment decisions.

      • A great point! I suspect that it boils down to:
        1. Fund managers don’t seem to care whether or not you make money;
        2. For them, the only measure is whether they do better than some index;
        3. It therefore seems dangerous to them not to invest in a big company in case it does well and they lose against the index.
        The same thing happened in the UK, I think, when the banks were calling for cash.

        You only have to look at the Woodford fiasco to see how fund managers reward themselves for failure. I wish that I could give myself £63 million to lose money for other people!
        As I say, though, your question is an excellent one and no doubt others have a better idea than I do as to why good money is poured after bad.

    • As that famous bank manager Capt. Mainwaring said to his chief clerk-
      “I think you’re in the realms of fantasy now, Wilson “

      The bankers have come too far to turn back now, James.
      It’s now death or glory

      Doomed! We’re all doomed.

  4. So the final plan is to divest the toxic crap into another company, but how can that survive if it was causing the company that spawned it to die? Am I just being too cynical in thinking there will be a whole new set of financial tricks and smoke and mirrors to define the new company as a going concern that will at some time in the future require the German government to bail it out?
    Thus deflecting blame away from the current directors?

    Nothing has changed has it? The same culture exists of excessive risk taking and fraud to cover it up, a few years ago I was told most investment banks were getting out of FICC i.e gambling – sorry – their investment arms were trading on Fixed Interest(bonds) Commodities and Currencies as they couldn’t make money on them any more, but DB was gearing up to become the leader, doesn’t that sound like the gambler going into the casino for one last try with the money from re-mortgaging the house?

    Also, am I the only one who finds it amusing that the current policies of the ECB and the Bank of England are actually destroying the balance sheets of the banks they are trying to save, as every time they cut rates to help the housing market they also cut the banks margins, trapped or what?

    • Hi Kevin

      One of the best replies I saw to the current plan was that what was requited was a plan for the “good” bit. In essence that mines the theme that banking is not that profitable in the current environment. As to the bad bank that would need to be taken over by the German taxpayer who may well be understandably unenthusiastic about another example of privatisation of profits and socialisation of losses.

      As to the junkie culture trap around interest-rates it will be a subject at Sintra tonight as the ECB summer events starts up. I doubt they will be laughing though…

  5. Shaun, I was put forward for a job with DB this week, that would be quite a laugh, if I could give an insiders view… in due course. Paul C

  6. We didn’t have this trouble when “DB” stood for German Railways.

    Geez Shaun. How many billions?

    To paraphrase the Texan oil baron- a billion here a billion there; pretty soon we’re talking real money.

    Whoever is holding this parcel when the music stops is in a lot of trouble.

    Will we ever be able to put a total, final figure on the credit crunch damage?

    At least Danny has realised there’s a difference between efficiency, utilisation and productivity, and under-utilised resources have a direct adverse impact on productivity.

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