Anyone that has picked up a newspaper recently will know that Deutsche Bank isn’t having a great time of things at moment.
Its share price has tanked, there are talks of the German government intervening, parallels to Lehman Brothers and concerns that a whole new financial crisis could be sparked if Germany’s largest bank goes under.
But what has actually happened? The answer is that it is a combination of short-term catalysts and longer term systemic problems that are both coming home to roost and exacerbated by the short-term problems. It’s all rather self-fulfilling and cyclical.
What is the latest problem?
The US Department of Justice has slapped Deutsche with a $14bn (£11bn) fine for mis-selling mortgage securities in the US. It’s highly likely this isn’t what Deutsche will pay.
In such cases it becomes a bit of a negotiation until the alleged offending party agrees to a number – in this case most analysts suspect the final figure will be a single-digit fine, rather than double-digit one.
But if the bank has trillions of assets why doesn’t it just pay this?
The problem is that it doesn’t have trillions of cash to splash, and it also has to keep a considerable amount of cash in its buffers. So costs even at $4bn could wipe much of these out.
Read more: Deutsche Bank: Where did it all go wrong?
Can it not ask someone to lend it some money?
Of course – but the question is who will? With the share price dropping, would-be lenders have concerns as to whether they’ll get their money back if the company goes bust. This in turn spooks the market, drives the share price down and the merry-go-round continues…
What about Frau Merkel?
I’m sure she’d love to help. And behind closed doors the government probably is trying to fix this but the problem is that any assistance could be in breach of EU legislation on state aid.
The irony wouldn’t be lost on observers that a German government that played hardball on southern European countries in relation to their handouts to lenders, might have to provide a handout to one of its own.
Can shareholders help?
They could by agreeing to underwrite a rights issue. But with an unsteady share price, this would need to be heavily discounted – providing more downward pressure on the carousel of pain.
Surely Deutsche could sell some of its assets to raise cash?
And it has been – for example by raising nearly £1bn by selling Abbey Life today. But the problem is with the quality of some of the assets it holds. This is where some of the longer-term problems start to raise their heads.
What are the main structural problems?
Its an issue of complexity: of the financial instruments it deals in and the organisational structure it operates under.
At one point Deutsche had exposure to $72 trillion of derivative financial instruments almost a quarter of total global exposure. This had dropped to $46 trillion by the end of last year but is still considerable.
The bank grew its investment banking arm in the US quickly during the noughties. It was at the forefront of much of the packaging of toxic assets and investing in loans that have turned bad.
Post-financial crisis, investment banking is on the decline and it can no longer generate as much revenue from this division to cover any losses it incurs on its investments. Added to this is the lower interest rate environment that has further reduced fee incomes.
Finally there is the corporate governance. Like many of its rivals, Deutsche has been hit but a series of lawsuits.
Due to the complexity issues, corporate governance appears to have been flimsy in the past and may have given greater opportunity to individuals to indulge in more unscrupulous practices.
Would someone buy the bank?
Similar problems arise when purchasing the bank as would if any third party provides funding to it.
The fear is of the unknown. How bad are Deutsche’s loans? How much more potential litigation is to come out of the woodwork? What exactly is the value of the derivative exposure. Other banks aren’t having a good time at the moment either, so it is likely that they would put Deutsche in the “too difficult to deal with” pile.
So what next?
Deutsche is treading water. Like most banks it relies on a combination of long-term and short-term financing. The concern is that the those providing the short-term financing get spooked and turn off the taps – this would be the point that things get rather hairy and have echoes of 2008 and Lehman Brothers.
Lehman, you say?
There have been a lot of parallels drawn. But the key difference is that we all know that the Lehman implosion hit everyone hard. If Deutsche were to go pop then it could drag us back into a 2008 scenario.
Aside from those distressed debt funds that made a fortune buying Lehman debt, most people don’t want to see this happen again.
On the assumption that common sense prevails it could be a case of a combination of pressure from governments and co-ordination between the banks that would get Deutsche out of the current pickle that it is in.