One of the world’s most important financial institutions faces dwindling investor confidence amid concern it may need more capital or even government help. This story, ripped from the headlines of 2008, is happening today to Deutsche Bank AG. In mid-September, the U.S. Justice Department told Germany’s largest bank it would have to pay $14 billion to settle a case over how it sold and packaged residential mortgage-backed securities a decade ago. Though history suggests that figure is subject to negotiation, it was large enough to spook investors. Now Deutsche Bank may need help -- but what kind, and from whom?
1. Why does this matter outside Deutsche Bank?
Deutsche Bank, with about 1.8 trillion euros ($2 trillion) in assets, is more than half the size of the German economy and operates Europe’s largest investment bank. More importantly, its connections to other lenders may make it the single biggest contributor to systemic risk among global banks, the International Monetary Fund said in June. It has gross notional exposure of 46 trillion euros to derivatives -- contracts with other financial institutions tied to the value of an asset. Some of Deutsche Bank’s most complex deals are “an accident waiting to happen,” Jacques-Henri Gaulard, a Kepler Cheuvreux analyst, wrote to clients on Sept. 29. Stuart Lewis, the bank’s chief risk officer, told Welt am Sonntag that the real net risk of those products is actually much lower than that of several competitors.
2. So is Deutsche Bank the Lehman Brothers of 2016?
News that some hedge fund clients had reduced their exposure to Deutsche Bank carried ominous overtones of 2008, when the collapse of Lehman Brothers deepened the global financial crisis. Yet Deutsche Bank’s situation appears less precarious. It’s better capitalized, has 215 billion euros of liquid assets at hand and has access to cheap funding from the European Central Bank. It could seek to tap investors for fresh capital or sell off assets. What’s more, few observers expect the German government would stand aside and let Deutsche Bank fail, not least because the world is still recovering from the U.S. decision to let Lehman go down.
3. How big a fine is Deutsche Bank likely to pay?
Deutsche Bank insists it has no intention of paying anywhere near the $14 billion requested by the Justice Department, and talks are continuing. In past cases, the DOJ walked back somewhat from its initial requests: Bank of America ended up paying $16.7 billion after an original DOJ demand of $20 billion; Citigroup settled for $7 billion, down from $10 billion. Deutsche Bank’s total litigation reserves stood at 5.5 billion euros at the end of June, and an agreement to pay more than $4 billion “would put questions around capital positions with the need to potentially build additional litigation reserves,” JPMorgan analysts wrote.
4. What can the bank do?
Chief Executive Officer John Cryan, in charge since last year, is already firing thousands of workers, dumping unprofitable clients and exiting businesses. Now he might have to consider additional asset sales to pay for legal bills and bolster capital. While Cryan has ruled out a sale of the bank’s asset management unit, a partial IPO of the business could be an option. The lender has informally spoken to potential anchor investors, including new and existing shareholders, to back a possible capital increase. Qatar’s royal family were said to be considering increasing their stake to as much as 25 percent from about 10 percent. Even some of Germany’s biggest listed companies could be considering a capital injection into the troubled lender, which is considered vital to their interests abroad.
5. What are the markets saying?
The alarm bells over Deutsche Bank that were clanging in the markets have quieted somewhat. The shares touched a record low of 9.90 euros on Sept. 30, before bouncing back on a report that the Justice Department fine will be smaller than feared. The stock then climbed about 25 percent -- though it’s still down by almost half on the year. The cost of insuring Deutsche Bank’s debt from default for five years has declined since last month, when it reached the highest since February, but remains at more than twice the level of a year ago.
6. Would the German government come to the rescue?
The prospect of bailing out Deutsche Bank is politically noxious for German Chancellor Angela Merkel, who’s deciding whether to seek a fourth term next year and has championed European Union rules aimed at keeping taxpayers off the hook in a crisis. Merkel’s spokesman has said the government sees “no grounds” for talk of state funding for the bank. Cryan, for his part, told the Bild newspaper that accepting government support is “out of the question for us.” That hasn’t quelled speculation. Lawmakers from Merkel’s governing coalition said they expect the government to step in if Deutsche Bank were at risk of collapse due to a capital shortfall.
The Reference Shelf
- Bloomberg View’s Mark Whitehouse on the test of post-2008 safeguards.
- The International Monetary Fund said in a June report that Deutsche Bank “appears to be the most important net contributor to systemic risks” among global systemically important banks.
- In Bloomberg Gadfly, Lionel Laurent says that "the market sees Germany and Deutsche as joined at the hip."
- The Bloomberg QuickTake on Angela Merkel notes many of the headaches she’s facing.
— With assistance by Birgit Jennen