Friday, September 30, 2016

Much Ado About Deutsche?

Evelyn Cheng of NBC reports, How US regulators may be creating panic around Deutsche Bank:
Deutsche Bank finds itself in the center of a panic, and some analysts are pointing fingers at U.S. regulators.

Germany's biggest bank fell under fresh scrutiny beginning on Sept. 16 when it surfaced that the U.S. Department of Justice was demanding it pay a $14 billion fine for its mortgage lending activities during the housing bubble. Shares of Germany's biggest bank plunged on Thursday on reports that a handful of its big hedge fund clients were limiting their exposure to Deutsche Bank, though the bank has characterized those media reports as "unjustified concerns."

Certainly, the Justice Department is not the only organization scrutinizing Deutsche Bank: The IMF released a report this summer stating that that Deutsche Bank poses a greater risk to the global financial system than any other bank in the world.

But the size of that Justice Department fine has many analysts talking.

"We see little practical or political upside for the Justice Department to press Deutsche Bank for a penalty that is so large that it could destabilize the bank and provoke a new financial crisis," Jaret Seiberg, managing director at Cowen, said in a Thursday note. Like many analysts, he said he expects the final settlement to be negotiated to a lower price.

The Department of Justice declined to comment to CNBC, as did Deutsche Bank.

Some market participants worry that Deutsche Bank can't pay the billions in fines without some help from the German government or the European Central Bank. As of June 30, the bank had 5.5 billion euros ($6.17 billion) in litigation reserves.

"Certainly this appears to be severe. The size of the fine is severe. It may be intended to be severe. It may in fact prove to be devastating, and I wonder if the regulators thought that through," said Michael Farr, CEO and founder of financial consulting firm Farr, Miller & Washington.

He said he does not think a failure of Deutsche Bank would cause a banking crisis. "I think it really depends on how nervous investors get," he said, adding that a possible outcome for the bank could be a merger with another bank.

A plunge in Deutsche Bank's shares to record lows in New York trade Thursday temporarily left the financial institution with a market value of less than $17 billion, though the stock rebounded sharply on Friday.

Size of US bank settlements compared with issuance of mortgage-backed securities

Indications of diminishing confidence in the firm picked up this week. Selling began Monday following a weekend report that German Chancellor Angela Merkel ruled out state aid for her country's largest lender and any interference in the Justice Department investigation, according to a Reuters translation.

One of the messages the German chancellor may have wanted to send was to tell the United States, "if you take down Deutsche Bank, it's going to affect you as much as it did us," said George Friedman, chairman of Geopolitical Futures, an online publication that forecasts global events.

The last few days have seen various statements in which German authorities and Deutsche Bank representatives, including CEO John Cryan, have repeatedly said there is no need for government support.

The Department of Justice has been relatively quiet in contrast. Principal Deputy Associate Attorney General Bill Baer said at a conference Tuesday how banks generally could receive credit for their cooperation with investigations into residential mortgage-backed securities. And rather than make an official government announcement, The Wall Street Journal was the first to report two weeks ago that the Justice Department had proposed the $14 billion settlement. Deutsche Bank then confirmed the news in a press release.

"My guess is the U.S. regulators would (have) called it off if you thought it would really damage Deutsche Bank," said Maris Ogg, president at Tower Bridge Advisors. "You've got to worry about, certainly the U.S. regulators are not going to bring a bank down that's going to jeopardize the system."

Foreign bank, bigger fine?

Even if the fine is eventually negotiated lower, some speculate one of the reasons for the huge starting figure from the Department of Justice is the fact that Deutsche Bank is a European bank rather than an American one.

The DOJ "ran into a political green light because there was action to punish," David Bahnsen, chief investment officer of HighTower's The Bahnsen Group, said in an email. And since Deutsche Bank is a "non-U.S. bank they could take a shot at it."

Deutsche Bank would be the first European bank to settle on residential mortgage-backed securities with the DOJ. Others on the radar include Barclays, Credit Suisse, Royal Bank of Scotland and UBS.

On Friday, the Financial Times reported, citing sources, that the U.S. Department of Justice hopes to combine cases against Barclays, Credit Suisse and Deutsche Bank into a multibillion dollar settlement. All four parties declined to comment to the newspaper.

Looking at the relative volume of mortgage-backed securities issued by U.S. banks during 2005 and the actual fines they paid, Goldman Sachs analysts in a Wednesday note estimated Deutsche Bank will likely face a settlement in the range of $2.8 billion to $8.1 billion.

'Individuals commit crimes'

Certainly, prominent critics both within and outside government, as well as the U.S. public at large, have repeatedly said that big banks in general have not paid a dear enough price for the role they played in triggering the Great Recession.

Bartlett Naylor, a shareholder activist and a member of financial watchdog group Public Citizen, said the U.S. regulators should go after the individuals who misrepresented mortgage-backed securities rather than the entire bank.

"We're looking for individuals, because individuals commit crimes, not shareholders," he said. He's owned shares of Deutsche Bank for at least five years.

Reporting on those individuals is one of a bank's steps towards receiving cooperation credit, the Justice Department's Baer said in his speech.
I wasn't going to cover the trials and tribulations of Deutsche Bank (DB) or those of Wells Fargo (WFC) because they are covered in-depth by the financial media and I have more interesting topics to cover on the pension front which I decided to temporarily put off to next week.

First of all, I am not trading Deutsche Bank (DB) or Wells Fargo (WFC) and have no interest in trading any financial shares (XLF) in a deflationary environment, none whatsoever. If anything, I would use any major pop in big banks and other financials to continue shorting them.

The other thing I tell people is you want to avoid trading high profile companies that are in the news and are being heavily traded by hedge fund sharks. The volatility in trading these shares can make even the best prop traders stress out because of an intra-day event (announcement) risk.

Four days ago on LinkedIn, I commented on Mohamed El-Erian's update on Deutsche (click on image):

I'll repeat what I stated in case you couldn't read it: "I've spoken to senior pension fund managers who have told me DB will never go bust. Maybe not but the decline in its share price is very disconcerting to say the least and the scary thing is can easily experience another 50% haircut before it reverses course."

The senior pension fund manager I was referring to was HOOPP's Jim Keohane. We spoke earlier this month and I covered our discussion on my blog. Jim thinks a lot of big banks trading at or below book value are very cheap and he told me "there's no way Deutsche will go bust."

I agree, Deutsche won't go bust and it's hard to envision the German or US government allowing this because of national pride (Germans are proud of their national bank even if they hate financial bailouts) and because of the ripple effects to the global financial system (ie. major counter-party risk) would be intolerable and usher in a deflationary shock much greater than that of the Great Recession.

My point of another possible 50% haircut seems silly on Friday as Deutsche's shares are surging 14% at this writing but I've been trading long enough to know when to stay away from stocks that look really cheap but can get a whole lot cheaper before all is said and done and the dust settles.

Having said this, Deutsche Bank CEO John Cryan's letter, seen by Reuters, addressed reports of the departure of a few hedge fund clients, hitting out at "certain forces" that wanted to weaken trust in the bank. He rightly noted speculators are attacking the shares and wreaking havoc on investor confidence.

The doomsayers at Zero Hedge have been beating the drum on Deutsche's looming liquidity crunch, but I'm convinced this blog is in cahoots with short sellers and hedge funds funding it, looking to create major market dislocations because they can't deliver alpha to their investors that are desperate for yield.

I laugh when I hear "Europe doesn't have a Warren Buffett to save Deutsche Bank" And, so what? You don't think large global pension funds and sovereign wealth funds starving for yield and who collectively command a lot more money than all the world's top billionaires aren't ready to step in and back up the truck if Deutsche offers them preferred shares or bonds with an attractive yield?

Too many jittery investors get caught up on headline risks without properly thinking through how things typically go down when a major bank is in deep trouble.

What is more than likely to happen is Deutsche Bank will settle individually or collectively with other European banks the DOJ is rightly pursuing for mortgage fraud and the settlement will be far less than was is being asked (but enough to make a very important statement). In a worst case scenario, where these banks need to raise capital for any reason, they can explore many avenues including offering preferred shares with attractive yields to select investors.

Still, I wouldn't touch Deutsche Bank's shares right now, not until the dust settles after some agreement is made public and even then, I'm just not bullish on big banks and financials in a deflationary world where ZIRP and NIRP are here to stay.

[Note: If you want to average down on your position, go for it but in small tranches of a third or less at a time because shares can plunge further before they recoup their losses.]

Lastly, I have to say, the timing of all this is terrible but there's nobody in their right mind who doesn't agree that Deutsche Bank and other big banks engaged in egregious behavior and took unbelievably stupid risks in the past that brought the world economy to its knees. Deutsche was one of the worst offenders and it's the bank at the center of the ABCP crisis in Canada.

Unfortunately, banks haven't learned much from their past mistakes as evidenced by the fiasco engulfing Wells Fargo which is a core holding of Buffett (who finally spoke out on Wells) and long considered to be a conservatively well-run bank. I completely agree with Mike Mayo's scathing note on Wells Fargo CEO John Stumf as well as Senator Elizabeth Warren who said he should not only forfeit his $41 million stock award but resign and take the fall for what happened there (watch the clip below where she rips into him).

As far as Deutsche Bank, some think it can only be saved by the German government. I'm not too sure of that but agree with David Benamou, chief investment officer at Axiom Alternative Investments, who is short the stock and said even though it won't go belly up, it's not out of the woods.

Third, listen to Chris Wheeler, Atlantic Equities analyst, as he shares his take on the Deutsche Bank and possible systemic implications for the global economy. He covers a lot here and explains why it's highly unlikely Deutsche Bank will be allowed to go bust.

Lastly, as I end this comment, Bloomberg reports Deutsche Bank jumped the most in almost six months after a media report that the lender is nearing a $5.4 billion settlement with the US Department of Justice, less than half the amount initially requested.

We'll find out soon enough if there is any truth to this rumor but be careful trading on rumors (remember the old adage, buy the rumor, sell the news). Have a great weekend!

No comments:

Post a Comment