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September 30, 2016

Deutsche Bank Is Not Lehman....But Pretty Close

Counterparties lose confidence, withdraw cash.

Deutsche Bank, with $2 trillion in assets, amounting to 58% of Germany’s GDP, one of the most globally interwoven banks, with gross notional derivatives exposure of €46 trillion, right at the top along with JP Morgan (booked as €41 billion in derivative trading assets after netting and collateral) – this creature of risk and malfeasance, is finally starting to scare its counterparties.

This is how Lehman came unglued. Slowly and then all of a sudden.
[S]ome funds that use the bank’s prime brokerage service have moved part of their listed derivatives holdings to other firms this week, according to an internal bank document seen by Bloomberg News. Millennium Partners, Capula Investment Management, and Rokos Capital Management are among about 10 hedge funds that have cut their exposure, said a person familiar with the situation….
So far, these are just the first of Deutsche Bank’s 200 hedge-fund clients that use it to clear their derivatives transactions. Banking is a confidence game. When confidence sags, the whole construct comes tumbling down. And the first movers have a big advantage in getting their cash out in in time.Bloomberg:
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.
As the leak ricocheted around the world, Deutsche Bank shares plunged 6.6% in late trading today in Frankfurt to €10.25, having been down 8% at one point earlier. Shares are at the lowest level since they started trading on the Xetra exchange in 1992. They’re down 68% from April 2015. Just before the financial Crisis, they briefly traded at over €100 a share. By that measure, they’re down over 90%!

This comes after a 7.6% plunge on Monday. That rout was initiated Friday afternoon when Aunt Merkel, fretting about the general elections in the fall of 2017, informed voters via a leak that she had told CEO John Cryan in a “confidential meeting” that state aid was “categorically” out of the question.

Merkel’s popularity has recently taken a hit, and a big, immensely unpopular taxpayer bailout of bank stockholders and bondholders could cost her the election. The onslaught of contradictory denials that this episode has produced was a sight to behold.

So Tuesday, shares took a breath; Wednesday, they rose 2%; and today by mid-afternoon, they rose another 1% to €10.87, as falling knife-catchers were grabbing what they could, before all heck broke loose again.

Deutsche Bank’s market capitalization has shriveled to €14 billion ($15.7 billion), a few bad trading days away from the $14 billion in fines that the US Department of Justice wants in order to settle the allegations surrounding Deutsche Bank’s residential mortgage-backed securities that blew up during the Financial Crisis.

Deutsche Bank isn’t getting singled out. US Banks have already settled their RMBS allegations: Bank of America for $16.7 billion, JP Morgan for $9 billion, Citigroup for $7 billion, Goldman Sachs for $5 billion, and so on. They all settled for less than the original amount. Deutsche Bank will be able to settle for less as well. But its problem isn’t just the Department of Justice.

Today’s massacre came when evidence trickled out that the next phase has begun: that some financial institutions, particularly in the derivatives arena where Deutsche Bank is so exposed, are beginning to lose confidence and are withdrawing cash. When word got out that counterparties were losing confidence in Lehman, it started a stampede for the exits – and triggered the collapse.

Problems at a big bank are always categorically denied by both the government and the bank. Banking is a confidence game, and confidence has to be maintained at all costs or else the bank is toast. So, in that vein, Deutsche Bank spokesman Michael Golden, told Bloomberg:
“We are confident that the vast majority of [our trading clients] 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.”
But the government, looking at a financial system that might face an existential crisis if Deutsche Bank were allowed to collapse, appears to take this seriously. On Tuesday, the German daily Zeit Online reported that, “despite all the denials,” the government is working on a bailout plan as it “fears a financial emergency”:
Officials in Berlin [German government], Brussels [EU government], and Frankfurt [ECB] are working on a contingency plan for the largest German financial institution, according to information Die Zeit received. Also state aid could be paid.
It would become effective when the bank needs additional capital but cannot raise it in the markets.

The plan has several components. The bank could sell parts of it business to other financial institutions at inflated prices so that it would find relief but not lose money on the transaction. As incentive for reluctant buyers, the government could hand out guarantees. In addition, the government could buy a large stake in the bank – “25% is being discussed.”

This would dilute stockholders even further. But at the current share price, it would not even raise a lot of money. So if push comes to shove, with shares sinking further, the stake could be much larger with ugly consequences for current stockholders.

As by now expected, the government denied the bailout plan point blank via our hapless spokesman: “This message is incorrect. The federal government is not preparing any rescue plans. The reason for such speculations does not exist.”

But some counterparties with money on the line aren’t buying the denials; they’re already losing confidence and voting with their feet. 

Courtesy of Wolf Richter, Wolf Street

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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