SPY - Deutsche Bank Stock Tumbles On Contagion Fears: Canary In The Coal Mine Or Irrational Fear?

2023-03-24 10:54:31 ET

Summary

• After a relatively calm week in banking, Deutsche Bank is now making headlines for a falling share price and rising CDS spreads.
• In an apparent attempt to show strength, the company announced that it would redeem a bond issue early, but the market had other ideas.
• Deutsche Bank doesn't look that bad to me unless the market knows something I don't. But we'll see.
• What happens at DB going forward is worth watching.

Shares of Deutsche Bank (DB) have come under increasing pressure this year after a spate of high-profile bank failures on both sides of the Atlantic. After the fire sale of Credit Suisse (CS), the market is indicating fears that DB might be next. There are several issues at stake, continuing a pattern where bank executives' and regulators' gambits to show strength have backfired. The proximate cause of the latest fears seems to be Deutsche Bank's decision to redeem some junior bonds in an attempt to show strength. But before that, an unusual decision by Swiss regulators to pay equity holders of Credit Suisse while stiffing junior bondholders seems to be causing some serious unease in Europe. This fueled the belief by traders that politics would trump property rights, and led to big selloffs in bank debt across the EU. EU regulators were reportedly upset about the Swiss favoring shareholders over bondholders, and it showed in their statements to try to ease investor fears. The worry over Deutsche could be much ado about nothing, but it's worth diving into why they're under pressure.

Deutsche Bank: What We Know

• In a problem common to many banks that operate in Europe, Deutsche Bank has had a poor return on assets and equity for quite a while . This has been a problem with European banks for a long time, and crazy policy experiments like negative interest rates made this worse. DB isn't as bad as Credit Suisse, which had a negative return on equity , but European banks generally aren't cash cows. I'm showing a return on equity for DB of about 7%. DB trades for about 0.25x book value right now, implying a high return for shareholders if they can turn things around. Deutsche has been undergoing a turnaround plan that has seen dramatic cost cuts, but the bank still has struggled to raise its return on equity to target levels.
• As with the Fed, inflation has forced the ECB to raise rates. But that's a problem if it means depositors flee banks holding a bunch of negative interest rate bonds and put their cash in money market funds because the banks won't have the money to pay depositors. The problem the US has with banks that took too much risk with depositors' money also is a problem in Europe. For strong banks that managed risk well, this isn't much of an issue because they can earn more interest income for themselves. But for weak banks that are overleveraged, it's highly problematic.
• DB credit default swaps aren't showing too much stress, but they're worth watching. Overall, the market is more worried about UniCredit ( OTCPK:UNCRY ), the second-biggest bank in Italy. This is getting fewer headlines however, because fear over DB is rising while fear over UniCredit has eased a little.

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