2023-03-24 10:35:06 ET
Summary
- Deutsche Bank Aktiengesellschaft is a venerable institution, its inception dating back to 1870.
- Its credit default swaps indicate the market is worried about its position amidst the current banking turmoil.
- I believe this could be because it has certain characteristics in common with banks that have recently failed or have come under a lot of pressure.
- Fundamentally, Deutsche Bank looks sound to me, but lately, that doesn't always convince depositors.
In short order, we've seen Silvergate Capital Corporation ( SI ), Silicon Valley Bank of SVB Financial Group (SIVB), Signature Bank ( SBNY ), and Credit Suisse Group AG ( CS ) fail. Today the market seems to be selling off because of Deutsche Bank Aktiengesellschaft ( DB ) credit default swaps jumping .
I've been an investor in Silvergate Capital. It had an incredibly liquid balance sheet that I believed to be safe. But I underestimated the flightiness of its highly concentrated depositor base. I think this is the key issue that's plagued the banks that have done badly in 2023.
Many banks are suffering from the challenge of rapidly rising interest rates. Silicon Valley Bank likely suffered a lot more compared to the average bank, and it is no doubt a contributor.
Silvergate Capital
Silvergate Capital had ~1500 enterprise customers in the Crypto space. These depositors made up the lion's share of its deposits. Most of its deposits were, of course, uninsured. Once the crypto space came under siege, this tainted the safety of Silvergate. Well-known short seller Marc Cohodes identified its vulnerability before anyone else. I expected the enterprise depositors to be sophisticated enough to know that the bank's balance sheet was highly liquid and solid. It had very few loans, for example. But instead, a large majority of deposits were pulled in short order. You can read my most recent article on its situation here.
Silicon Valley Bank
Silicon Valley Bank served a concentrated customer base both in terms of geography and industry type. Lots of tech and biotech depositors with large uninsured deposit balances. Rumors reached all customers very rapidly, and the bank quickly succumbed when the large depositors started withdrawing their money.
Signature Bank
Signature Bank was known as a bank serving the crypto community as well. The bank was also known for New York real estate lending. The bank operated Signet network, designed to help companies move money around quickly. Initially it was intended for crypto companies that operate in 24/7 markets as opposed to the U.S. banking system. It required a $250k deposit minimum to use the Signet network. That's right around the FDIC insurance and mostly usable by enterprise customers. I think the enterprise nature (real estate, crypto, etc.) of its deposit base led to 90% of its deposits being uninsured. The deposits were more highly diversified than at Silvergate but still vulnerable.
Credit Suisse
Swiss banking used to be known for its bank secrecy. The Swiss banks likely attracted a lot of wealthy individuals from all over the globe that were highly interested in financial privacy. That advantage eroded over time, but it probably shaped Credit Suisse with its client base of ultra-high-net-worth clients. Credit Suisse Chair Axel Lehmann has blamed his bank's failure partly on a "social media storm." With these comments, he referred to an episode near the end of 2022. Credit Suisse also experienced a deluge of problems in recent years, earning it unfavorable headlines. When you combine a troubled image and a deposit base with a significant part of mobile high net worth clients with an ongoing banking crisis, it can apparently lead to outcomes that were unthinkable a few years ago.
Deutsche Bank
Deutsche Bank being in the news today doesn't surprise me. You only have to compare the share price development of Deutsche Bank and Credit Suisse over the past 10 years to a Euro financial index to see that these have been long-time underperformers.
Besides the many restructurings, Deutsche has something else in common with Credit Suisse and the other failed banks. It has a bit of an unfavorable deposit base. Retail banking in Germany is extremely competitive. It has thousands of banks just like the U.S. (and unlike most European countries), but many of these are not really commercial banks in the way U.S. banks are. They're more like mutual banks and cooperatives. To quote an 2022 IMF report :
German bank profitability is low by international standards. Although German banks rank more favorably in risk-adjusted terms, as low profitability is partially compensated by lower volatility of returns, their profitability ratios remain low. On other measures (such as returns on assets, equity, and risk-weighted assets), German banks, on aggregate, rank among the least profitable in Europe. Several factors affect bank profitability, including a complex tiered industry structure with barriers to entry and an explicit mandate of a large part of the banking system - cooperative and savings banks - to maximize welfare of stakeholders rather than profits.
When I look at Deutsche's funding sources, roughly half of the deposits are of corporate customers and half from retail customers. I suspect that Deutsche's retail depositors include a much higher share of affluent customers than at your average European bank. Not unlike First Republic Bank (FRC), which is under a lot of pressure in the U.S. markets even though other banks are offering assistance. I would venture to say First Republic is a sound bank that's vulnerable in terms of its uninsured deposit base (like the other U.S. examples).
Deutsche Bank appears to be on solid footing ( balance sheet -wise) but doesn't have the most advantageous deposit base while struggling with recent reputational issues.
In the U.S., the emerging "banking crisis" seems to be stemmed somewhat by the implicit deposit guarantees. Officially, deposits aren't guaranteed, but at the banks that have failed, depositors have been shielded. With European banks it is not yet clear how depositors will be treated. ECB Governing Council member Ignazio Visco argued this week :
The euro zone needs to quickly have a deposit protection tool like the one in the US.
There is a Eurozone deposit protection tool up to €100,000. If you have a corporate or high-net-worth deposit base, that doesn't help much to stem potential fear among depositors. I agree it would help European banks if there was a bit more clarity about what happens to depositors like U.S. regulators have created by safeguarding depositors in recently failed entities. I'm not sure what to think about the moral heart of it.
On a valuation or balance sheet basis, I think it is hard to argue against Deutsche Bank as a buy. For illustrative purposes, I have included a set of well-known banks in the Seeking Alpha data set above. It is a mix of a Swiss, European, and U.S. banks. UBS Group AG ( UBS ), ING Groep N.V. ( ING ), BNP Paribas SA ( BNPQF ), The Goldman Sachs Group, Inc. ( GS ) and Bank of America Corporation ( BAC ). Deutsche Bank is clearly a favorable outlier in terms of forward P/E and price-to-book value multiples.
However, I think it is better to be out (or just short) in the short term (please fully familiarize yourself with the risks of going short first). I'm short a very small amount of Deutsche shares as part of a basket that offsets some of my banking longs (typically regional and small banks). I don't think the bank, given the current chaotic banking environment, is likely to close the valuation gap with peers. Meanwhile, the other examples illustrate how more or less sound banks can quickly succumb to deposit outflows. If there's more clarity on the European depositor front or the crisis blows over, I think Deutsche Bank Aktiengesellschaft could very quickly become a very good buy.
For further details see:
Deutsche Bank: The Common Denominator Of Banks Under Fire