What Is Going on With Deutsche Bank?

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Stocks were down for two reasons yesterday: First, markets are coming to grips with the fact that the BOJ decision last week was basically an admission it was out of bullets. Second, Deutsche Bank stock plunged 7% to a 33-year low, and dragged down financials and the broad market.

We’ve already covered the BOJ, and everyone knows why last week’s meeting was a disappointment, so the pertinent question yesterday was, “What’s wrong with Deutsche Bank?”

The simple answer is… a lot.

First, DB has made people nervous in a post-financial crisis environment because it’s not nearly as well capitalized as most of its European peers. While US and most European banks have massively increased capital levels in a post-2008 environment, DB has lagged.

According to the FT, DB has just a 10.8% Common Equity Tier 1 Ratio, substantially lower than the 12.6% average for the 10 largest banks in Europe. DB has been trying to address this by selling assets to raise cash, but it simply isn’t going so well (and its going to get worse now that sentiment has turned so negative).

So, broadly speaking, DB has always generated a mild level of concern.

But that concern got a lot worse two weeks ago when the Justice Department levied a $14 billion fine against DB for mortgage abuses. To put that $14 billion figure in perspective, DB’s entire market capitalization is $18 billion (not the US business, the whole business), so basically the Justice Department demand would decimate the company.

Now, no one expects DB to pay that amount, but even if they negotiate it down to $5 billion, that’s still a tremendous financial difficulty on the company, and it’ll further reduce its capital ratios (exacerbating worries about its future solvency should another crisis arrive).

All these issues have been known for a while (that’s why the stock was down over 40% year to date before yesterday). Yet what made things worse yesterday were rumors that DB CEO John Cryan asked German PM Angela Merkel for “help” in negotiating with the Justice Department, and /or potential help should DB need to raise capital.

And that’s where the real concern comes from. DB will certainly have to raise capital to not only improve capital ratios but also to pay whatever the Justice Department fine ends up being. So at best investors are looking towards more dilution, and at worst DB can’t raise the capital, and ends up being taken under by Commerzbank or some other larger competitor. Regardless, it’s not a particularly good scenario for DB shareholders, and it’s making the rest of the market nervous.

Bigger picture, is this a systemic issue we need to worry about? No, not yet. Zero Hedge is all over trying to make this a hint of 2008, but that’s a stretch at this point. DB is mostly an isolated case because of the Justice Department issues. So this is not, at this point, representative of some bigger banking issue. But, it will weigh on markets until there is some clarity on DB’s future.

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