DEUTSCHE BANK DRAMA SHOWS THAT THE DAYS OF ‘ TOO BIG TO FAIL’ MAY BE NUMBERED.
One rule of executive communications is to approach declaratives with caution. In other words, avoid them. For one thing, they put you in a box — nobody knows exactly what is going to happen down the road. You want to leave some room to move. More importantly, when the perception is that things aren’t going so well, a declaration that they are tends to beggar belief. You never want to say anything that will likely prompt your audience to say, “Yeah, right.”
And yet, chief executives — of countries and companies — do it anyway. Nixon’s “I am not a crook.” The elder George Bush’s “Read my lips: no new taxes.” More recently, in the corporate world, Thorsten Heins, then- CEO of Research in Motion, had his “RIM is not in a death spiral” moment.
And this February, Deutsche Bank AG co- CEO John Cryan declared that Germany’s biggest financial institution was “absolutely rock solid.” Yeah, right. The troubled behemoth — Deutsche Bank ( NYSE: DB) has assets of nearly two trillion euros ($ 3 trillion), and operations throughout the world — has foundered this year, hit by declining revenues, by low interest rates and post- recession regulations that are hurting profit- ability, and lately by a potential mega-fine over its mortgage-backed securities transactions in pre-crisis America.
Maybe it’s not a perfect storm, but Deutsche Bank has inspired plenty of Sturm und Drang.
This is clearly a big, big bank in crisis, and investors have been entirely skeptical of its rock-solidity. The company’s shares dipped below US$ 12 earlier this week, down more than 20 per cent since Cryan made his declaration on Feb. 9. Over the past year, DB stock has lost more than 50 per cent of its value.
On financial results alone, the market’s battering is understandable. Just weeks before Cryan’s letter, the bank reported a Q4 2015 net loss of 2.1 billion euros ($ 3.1 billion) and a full-year loss of 6.8 billion euros ($ 10.1 billion). In the first quarter of 2016, it managed to eke out a net income of 236 million euros ($350 million), but that was down more than 50 per cent year- over- year; revenues slumped by 22 per cent year over year. In Q2, the company reported pre- tax profits had declined by 67 per cent; revenues declined 20 per cent year over year. ( What did Cryan say of those results in late July? “We are satisfied with the progress we are making.” Uh-huh.)
Things have only worsened this quarter. In mid- September, the company disclosed that the U. S. Department of Justice has proposed a US$14-billion fine to settle allegations of bad dealings in mortgage-backed securities back in 2007. At the end of the second quarter, Deutsche Bank had less than half that set aside as legal provision.
Not only its share price, but also its so- called coco bonds ( short for contingent convertibles) have plummeted since the DoJ action became public, as investors worry that capital reserves will dip below the threshold at which the bonds convert to equity — and there aren’t many who want to be holding that right now.
This raises the big “what if ?” What if Deutsche Bank doesn’t survive? According to the International Monetary Fund, it “appears to be the most important net contributor to systemic risks” among all globally important banks. If it fails, yeah, that would be bad. It could prompt a contagion of non- confidence about other European banks, especially Italian ones, which are saddled with bad loans. A full-blown eurozone crisis, and maybe a global one, could follow.
But we’re not there yet. For one thing, the DoJ’s proposed fine is just that: proposed. Deutsche Bank has said it has no intention of paying that much and will try to negotiate it down. But U. S. regulators may not be inclined to give it much of a break. Other U. S. financials have been hit with similar settlements — JPMorgan Chase paid US$13 billion in 2013, and Bank of America agreed to pay US$16.7 billion in 2014.
Politically, a sop to a foreign bank might be a hard sell in the States, especially to one that has already benefited from U. S. largesse. In the wake of the financial crisis, U. S. taxpayers bailed out mega- insurer American International Group ( AIG) to the tune of US$170 billion — nearly US$ 12 billion of which ended up being paid to Deutsche Bank, among other domestic and international financial institutions.
Of course, Deutsche Bank might be able to afford the DoJ hit and it might pull its balance sheet up by its bootstraps. Cryan has been shedding non- core businesses and employees, and he has eliminated the dividend. But given its depressing financial results — outside of settlements — there’s reason for skepticism.
Despite Deutsche Bank saying no capital increase is in the works, the market clearly expects it will need to raise money. It could issue equity (which would dilute shares outstanding) or new bonds, but market conditions aren’t exactly ripe for either. That raises the prospect of a government bailout. But Deutsche Bank has been steadfast in saying it has not asked for it, and the German government has denied sporadic reports one is in the works. Earlier this week, Chancellor Angela Merkel would only say of the beleaguered bank that “we hope that all companies, ( even) if they face temporary problems, can develop in the right direction.”
That’s not exactly a Bernankean “Whatever it takes.” But it does highlight the fact that today, as opposed to nine years ago, it’s not a done deal that governments will immediately backstop a financial institution that once might have been too big to fail.
And if someone tells you they are, you can justifiably say, “Yeah, right.”