Smart money flees Deutsche Bank – share price tanks again, halved in 2016

Banking is all about confidence. These institutions generate profit through borrowing by taking in deposits with that money lent on to those seeking credit. Banking reserves are only a fraction (around a tenth) of the money lent out to clients who cannot quickly repay these borrowings. So at a basic level, banks have two priorities: ensure depositors trust the institution is a safe place to keep their money; and holding delinquent loans down to a fraction of what is lent out. Failing to hold the line on either area raises the prospect of bankruptcy. And the bigger the bank, the greater the vulnerability of the wider economy to it going bust. Such “systemic risk” was so great during the Global Financial Crisis that Governments were forced to step in to avoid a domino effect that would very likely have triggered a repeat of the 1930s Depression. The sharp increase in regulation since then was done to ensure no banks was ever again “too big to fail”. Whether the new regulations will meet the coming stress is being tested in Germany where once impregnable Deutsche Bank is teetering. Investors have been rushing for the exit for the past 18 months, driving the share price down two thirds. Last night the stock took another big hit as professionals started bailing again, dropping the price almost 10% in New York. They are now concerned that Deutsche Bank will be unable to withstand a fresh flotilla of legal penalties stemming from past sins. There are eerie similarities to the way the Global Financial Crisis of 2008 began. Be prepared. – Alec Hogg

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By William Canny

(Bloomberg) — Amid mounting concern about Deutsche Bank AG’s ability to withstand pending legal penalties, about 10 hedge funds that do business with the German lender have moved to reduce their financial exposure. The shares slumped.

The funds, a small subset of the more than 800 clients in the bank’s hedge fund business, have moved part of their listed derivatives holdings to other firms this week, according to an internal bank document seen by Bloomberg News. Among them are Izzy Englander’s $34 billion Millennium Partners, Chris Rokos’s $4 billion Rokos Capital Management, and the $14 billion Capula Investment Management, said a person familiar with the situation who declined to be identified talking about confidential client matters.

“In any given week, we experience ebbs and inflows,” said Barry Bausano, the bank’s chairman of hedge funds. “And this week is no different; it goes on all the time.” He declined to comment on net flows.

The shares dropped as much as 8 percent and were down 7.1 percent at 10.10 euros at 9:04 a.m. in Frankfurt, a record low.

While the vast majority of Deutsche Bank’s more than 200 derivatives-clearing clients have made no changes, the hedge funds’ move highlights concern among some counterparties about doing business with Europe’s largest investment bank. Deutsche Bank’s stock and debt have been under pressure after the U.S. Justice Department this month requested $14 billion to settle an investigation into residential mortgage-backed securities. The bank has said it expects to negotiate that lower, as other Wall Street banks have.

How Deutsche Bank Key Metrics Stack Up as Risk Premiums Rise

“Our trading clients are among the world’s most sophisticated investors,” Michael Golden, a spokesman for Deutsche Bank, said in an e-mailed statement. “We are confident that the vast majority of them have a full understanding of our stable financial position, the current macroeconomic environment, the litigation process in the U.S. and the progress we are making with our strategy.”

Millennium, Capula and Rokos declined to comment when contacted by phone or e-mail. The hedge funds use Deutsche Bank to clear their listed derivatives transactions because they are not members of clearinghouses.

A man walks past Deutsche Bank offices in London in this December 5, 2013 file photo. REUTERS/Luke MacGregor/Files
A man walks past Deutsche Bank offices in London in this December 5, 2013 file photo. REUTERS/Luke MacGregor/Files

The amount sought by the U.S. is not far from the Frankfurt-based company’s current market value of 15 billion euros ($16.8 billion). Credit-default swaps protecting Deutsche Bank bonds surged to a six-month high earlier this week, according to data compiled by CMA, while the stock hit a record intraday low of 10.18 euros.

The financial pressure on the lender is spilling over into German politics, stirring speculation Chancellor Angela Merkel’s government might be forced to offer support. Chief Executive Officer John Cryan told Bild newspaper this week that government aid was “out of the question.” Any taxpayer-funded solution for the bank’s troubles would be Merkel’s downfall, according to the leader of Germany’s biggest opposition party.

Confidence ‘Issue’

The International Monetary Fund in June said Deutsche Bank may be the biggest contributor to risk among so-called global systemically important banks. The bank has gross notional derivatives exposure of 46 trillion euros, according to an Investor Relations presentation published this month. After netting and collateral, reported derivative trading assets fall to 41 billion euros, the bank said.

“The issue here is now one of confidence,” said Chris Wheeler, a financial analyst with Atlantic Equities LLP in London. “That’s what’s going on here. The thinking is ‘Deutsche Bank is fine, but there’s a slim chance it might not be, so why leave my money in there?”

https://twitter.com/JakeCordell/status/781766546251284480

Clients review their exposure to counterparties to avoid situations like the 2008 collapse of Lehman Brothers Holdings Inc. and MF Global’s 2011 bankruptcy when hedge funds had billions of dollars of assets frozen until the resolution of lengthy legal proceedings.

Liquidity Reserves

In a memo to staff outlining how to deal with client inquiries, dated Sept. 27, the bank said that customers broadly understand that “CDS are no longer a necessarily accurate reflection of counterparty risk,” according to a copy seen by Bloomberg. The bank’s funding costs have remained lower than CDS spreads indicate this year, according to the note, and liquidity reserves are more than three times higher than in 2007.

“Deutsche has many problems, but liquidity is not one of them,” Stuart Graham, founder of Autonomous Research, said in a note, adding the bank had a liquidity reserve of 223 billion euros as of the second quarter. “There can be no doubt that Deutsche could access significant additional liquidity from the ECB, should it ever need it.”

Investor concerns had eased on Wednesday after Deutsche Bank agreed to sell its Abbey Life insurance operations for 935 million pounds ($1.2 billion) and Cryan ruled out a capital increase. The shares rose 2 percent that day and gained another 1 percent in Frankfurt on Thursday, before news of the hedge funds’ moves broke.

Deutsche Bank has long struggled to adapt to an era of tougher capital requirements and diminished trading revenue. Since taking over last year, Cryan has unveiled plans to eliminate thousands of jobs, suspend dividends and cut risky assets to bolster capital and profitability at Germany’s largest lender.

Deutsche Bank’s stock has a price-to-book ratio of 0.233, the third-lowest among euro zone lenders listed on the 26-member Euro Stoxx Bank Index, according to Simon Ballard, a credit strategist who writes for Bloomberg.

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