DB - Deutsche Bank: Risk Perception Exploded The Next One To Tumble?

2023-03-24 12:31:52 ET

Summary

• Deutsche Bank stock sheds value on hypersenstivity in the markets.
• Despite healthy CET-ratios, Deutsche Bank is trapped in a fear driven market.
• The market has become irrational and regulators and central banks are making things worse.
• While Deutsche Bank on its own is a hold, selling could be an option to protect your portfolio from irrational fear.

On Friday, Deutsche Bank ( DB ) stock made a 6.7% nosedive bringing its one-month share price loss to over 20%. Reason for the nosedive: A spike in the credit default swaps or CDS, which is a financial derivative allowing investors to offsetting their credit risk. Simply speaking it is an insurance against default. Loosely interpreted by investors they are a gauge for default risk, but they actually reflect risk appetite for a certain company’s credit risk.

Why is Deutsche Bank stock falling?

The short answer is, the parallels one can see between Credit Suisse and Deutsche Bank. The stock prices tell the story. Just like Credit Suisse, Deutsche Bank has not been consistently profitable.

It was profitable only five out of the 10 past years and its recent profits were greatly helped by an overlap in areas that were in interest during the pandemic and the areas that Deutsche Bank was active in, but one can wonder whether this was just a pandemic effect or something that Deutsche Bank can build on in the future as well. Credit Suisse did even worse being profitable only four times in the past years.

That still doesn’t answer why Deutsche Bank stock is falling. I think the reality is that there's no imminent collapse driven by fundamentals. The capital ratios are strong, but as I pointed out with the Credit Suisse saga, your fundamentals are strong until they aren’t meaning that just the perception of risk from the markets and your responses to said perception determined the future of your company.

What we are seeing now is that the 5-year CDS for Deutsche Bank has spiked. Basically going into the weekend, investors don’t want that risk in their portfolio and that impacts the Deutsche Bank stock price.

A Banking Risk Aversion Explained

What I often observe with banks is that investors or speculators look for patterns. With Credit Suisse it was the case that Credit Suisse credit default swaps were connected to collapse rumors as they occurred reached 14-year highs and back then Lehman Brothers collapsed. The rule of thumb is that every seven years or so there is some sort of crisis and we are basically two cycles from the Global Financial Crisis-Great Recession, so it makes an easy case for speculators. So, the urge to look for patterns to validate a thesis is obvious but I would say a good amount of self-fulfilling prophecy is involved as well, because when it comes to banks the bank might be able to survive but our behavior such as contributing to a bank run adds to the collapse of a company that would have otherwise survived.

Going back to Deutsche Bank, the CET-ratios not in the slightest put Deutsche Bank in a risky position. It's the investor perception that puts Deutsche Bank at risk and we are once again looking for parallels. One parallel between Credit Suisse and Deutsche Bank is they have been haunted by scandals in the past. In 2016, Deutsche Bank was given an $14 billion fine which threatened its existence but the anti-parallel between Credit Suisse and Deutsche Bank which currently is ignored is that Deutsche Bank has been more successful in restructuring itself.

The next parallel is the spike for Deutsche Bank Credit Default Swaps. Again, we have to note just like with Credit Suisse it's not the spike that really signs the collapse it's the general appetite for risk and public perception that is created out of these events that causes it. With Deutsche Bank we see this clearly, the CDS has been at these levels before and in none of these events the bank collapsed. The market or speculators are somewhat misusing the CDS spike. But why did the default swaps spike days before the weekend? I wouldn’t say there's a good reason for it, but bondholders and investors know one thing and that is that the Swiss government brokered the deal between Credit Suisse and UBS over the weekend at a time where nobody could sell. So, really nobody has any appetite for carrying stocks or defaults swap on their portfolio during the weekend. That the CDS spikes now is driven by the way the Swiss government did things and brokered the deal during the weekend effectively trapping investors who did not get out before the markets closed.

Besides that, the deal between UBS and Credit Suisse rattled the bond market because junior bond holders or AT1 bond holders were wiped out while shareholders were not fully wiped out and while this was completely according to the rules and how the bond instrument is structured it reduced appetite for these contingent convertibles. In an attempt to save Credit Suisse, the Swiss government and regulator dislocated the bond market and the presumed hierarchy of capital losses which of course causes waves on the bond market that go beyond Credit Suisse.

Beyond that, central banks are continuing to raise interest rates. While the banking system is under pressure and the weaker players are collapsing, the central banks maintain their view that the banking system is healthy and it's almost as if they are waiting for one big bank to collapse and that is really contributing to the spike in the credit default swaps and the lower stock prices.

Conclusion: Deutsche Bank Stock Under Pressure Due To Fear

I'm not going to contest the statement that Deutsche Bank has had its problems, but what we're currently seeing is that the market is contributing to self-fulfilling prophecies and generally we're seeing that the UBS-Credit Suisse deal did not provide stability. While stability was desired the way the Swiss government brokered the deal during the weekend and wiping out AT1 bond holders sent a bad message to shareholders and the bond market. Not many want to hold this risk over the weekend and the Swiss government is to blame for this.

On top of that, central banks either are extremely confident in the health of the banking system or they have blinders on, but as they raise interest rates to keep inflation down they are also doing it to send a message to the market on the health of the banking system but it does not have the desired effect as it's quite clear that the risk is increasing for banking stocks and that leads to lower stock prices and higher credit default swaps which then spiral out and create a snowball effect. Even a company with healthy CET-ratios is bound to get into trouble if the market and clients become fear driven and regulators and central banks are not doing a lot to improve trust in the system.

As I don’t see when the turmoil in the banking sector which is mostly driven by fears and assumptions will end, I'm marking shares of Deutsche Bank a sell to protect your portfolio for further fear driven events and risks but also acknowledge that in a rational market there would be no issue for Deutsche Bank at all.

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