10 Questions

Deutsche Bank's Road to Penny Stock

New Cryan Montage
Some shareholders in Deutsche Bank are beginning to think that designated CEO John Cryan is not going far enough, fast enough to right Germany's top financial institution.
  • Why it matters

    Why it matters

    The German government, the business sector and investors are all concerned that Deutsche Bank could be facing a prolonged crisis.

  • Facts

    Facts

    • Investors fear Wednesday’s rebound in Deutsche Bank’s shares, driven by reports of a buyback plan for billions of euros of its bonds, may be short-lived.
    • The bank’s market capitalisation has slumped to a point where it could become a takeover target — but its problems will likely put off any predators.
    • Many European banks face similar problems — falling margins, restructuring programs and recession fears.
  • Audio

    Audio

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These are dramatic, rollercoaster weeks for Deutsche Bank and its chief executive John Cryan. Its share price had plunged 40 percent since January 1 on fears not just over its profitability but its creditworthiness as well. On Wednesday, its shares shot up as much as 17 percent over the course of the day. Then, Thursday morning, it was once again down more than 7 percent. That kind of volatility is typical of penny stocks, not blue chips like Germany’s flagship bank.

Wednesday’s stock surge was triggered by reports that Deutsche was considering buying back several billion euros of its debt to shore up the value of its securities. Analysts are concerned that the recovery will be short-lived. What’s going to happen now? Handelsblatt answers 10 questions on the crisis at Deutsche Bank.

Why are investors so nervous?

Deutsche Bank is at the start of an extensive restructuring and has said it will scrap its dividend for two years. It’s totally unclear how successful the revamp will be and there are fears that the costs of the multiple legal risks it faces from thousands of lawsuits could eat into its profits and capital. Investors are also concerned that Mr. Cryan could be cutting back the bank’s operations too radically, leaving it with no area to grow. Those fears appeared to be borne out by the fourth-quarter 2015 results showing a 30-percent slide in revenue at the investment bank and an overall loss for the quarter of €2.1 billion, mainly due to writedowns, litigation charges and restructuring costs. For the year, the bank posted a record €6.8-billion loss.

 

A Record Loss for Deutsche Bank-updated feb 1 2016

 

Are the problems unique to Deutsche Bank?

No. Many of Europe’s top banks are being restructured and are weighed down by tougher regulatory requirements and low interest rates, which are squeezing margins. The concern is compounded by fears of a global recession that has rattled stock markets, and which would exacerbate the decline in earnings.

Why are investors worried about Deutsche Banks creditworthiness?

The legal risks remain incalculable. And if earnings plunge as well, there’s a growing risk that the bank will be unable to service certain bonds and that its equity capital may crumble. Chief Financial Officer Marcus Schenck conceded at the annual results news conference two weeks ago that an excessive loss in 2016 would cause equity capital problems. On Monday, the bank insisted it had enough reserves to pay the coupons on its highest-risk debt, known as Contingent Convertible Bonds, or CoCos, this year and next.

Deutsche Bank’s market capitalisation is just €21 billion right now. That’s less than a tenth of U.S. rival Wells Fargo.

Fears over Deutsche’s creditworthiness were also reflected in the cost of credit default swaps (CDS) which insure investors against defaults. The price of CDS fell Wednesday for the first time in two weeks. But insuring a €10 million loan to Deutsche Bank still costs €215,000, which is twice as much as in mid-January.

Why has the bank relied on such high-risk debt?

Deutsche Bank began using CoCos in 2014, issuing some €5 billion that year. Unlike regular bonds, CoCos can be automatically converted into capital if the bank’s reserves fall below 5.125 percent of its assets. Bondholders, in that case, would lose everything, though the bank is allowed to pay back the debt once it returns to a healthier state.

 

Nervous Investors-01

 

Why might the bank consider buying back some of its bonds?

By buying back bonds that have fallen below their nominal value, the bank could lock in a capital gain and save itself future interest payments. At the same time, it would create demand for the remaining bonds on the market and thereby halt their price decline. The bank has some €220 billion in liquid assets on its balance sheet, and could afford such a move.

Why wont it buy back the riskier CoCo bonds?

Because they’re considered part of the bank’s equity capital, since they could be converted into capital in a time of crisis. If Deutsche were to buy these bonds, it would reduce equity capital.

How worried is the German government?

There’s only one answer Finance Minister Wolfgang Schäuble can give. When asked to comment Tuesday on Deutsche’s troubles, he said he wasn’t worried. If he had said anything else, he would have added to the pressure on Deutsche’s share price. But of course the finance ministry is keeping a very close eye on developments at the bank. Its financial markets department is in touch with Germany’s top financial regulator, the Federal Financial Supervisory Authority (Bafin). Deutsche Bank is very important for Germany’s top globally active companies, which is why prolonged weakness at the bank isn’t in anyone’s interest.

 

Deutsche Bank Takes Its Losses-01

 

Will Deutsche Bank now become a takeover target?

Probably not. It’s hard to imagine another bank saddling itself with Deutsche Bank in its current state. The bank is protected by the uncertainty over its future. That may explain why Mr. Cryan, asked about a takeover two weeks ago, replied: “That’s not something we’re spending too much time on at the moment.”

Could the bank be targeted by activist investors?

The bank should be an obvious candidate for an activist, meaning an aggressive investor who purchases a small percentage of the bank’s capital and starts demanding changes in strategy or management. Deutsche Bank’s market capitalisation is just €21 billion right now. That’s less than a tenth of U.S. rival Wells Fargo. The bank needs to be restructured and there are many question marks regarding its chosen strategy, so shareholders may well call for a change of course. But the problems are so huge that no one seems willing to try to shake things up. “No activist has a clue how to actually earn money with Deutsche Bank,” said one investment advisor.

 

Deutsche BankUpsDowns-01

 

What options does Mr. Cryan have to stabilize the share price?

That’s not Mr. Cryan’s main goal. He has said he wants to manage the bank, not the share price. At the bank’s annual news conference, he stressed that if the tunaround is successful, “you will end up seeing that in the share price.” That’s what he’s focusing on. Despite all the doubts, Mr. Cryan’s vision remains an ambitious one: to make Deutsche Bank the most respected bank in Germany across all banking segments, to be Europe’s Number One bank for companies, institutional clients and investors and to be the best foreign bank in the United States and Asia.

 

Laura de la Motte is Handelsblatt’s lead correspondent on Deutsche Bank. Jan Hildebrand covers politics for Handelsblatt in Berlin. Daniel Schäfer is Handelsblatt’s finance section chief based in Frankfurt. To contact the authors: delamotte@handelsblatt.com, Hildebrand@handelsblatt.com and dschaefer@handelsblatt.com  

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