Performance of Deutsche Bank has been dismal since the financial crises. While the US banks deleveraged. Europe was marred in one crises in Greece after another. ECB focus on the peripherial banks left DB a ticking timebomb.
The market is not being kind to Deutsche Bank with the share price this year has breached the 2009 lows.
Ostensibly current price at 0.3x book looks cheap. However it has a tinge of 2009 where would investors really trust the book value of a bank? Even the NAB spin off CYBG where there is light at the end of the tunnel with profitability trades between 0.5x to 0.75x book.
CDS swap spread on DB debt is moving up to alarming territory.
We have a few points on the bear case for Deutsche Bank going forward:
- The balance sheet is what is really scary. High leverage with headwinds on earnings, additional restructure costs and regulatory charges coming through. It will be hard to see the true performance of the business.
- Underlying business is challenged. Investment Bank is knee capped for the foreseeable future. The new CEO brought in is a turnaround specailist, we are skeptical of the macro environment which DB has to fight through.
- Bank earnings are dependent on the net interest margin of the loans it issue. Low European interest plus Kuroda firing off negative interest rate in Japan does not bode well for the core lending market in Europe. A weak lending market and low interest rate enviornment is not helpful for DB to move away from lumpy IB earnings (if any) and focusing on corporate lending.
- Deutsche Bank is too big to be taken over. National consideration will be in the forefront of any acquirer. Hence any white knight will have to be a strong German backed institution. But if you are a CEO of a strong financial institution. Would you really want to risk the chance that taking on DB will infect your own balance sheet? i.e BofA after taking on Merril Lynch and Countrywide.
- Equity holders face capital shortfall through capital raise which is not helpful for the current share price or through government backed support.
- Any government support will come with political backlash, especially after the perceived harshness the Greek banks faced from ECB. This is not good for equity holders. If DB recieve any government support, it will be an equity wipe out or through high interest preference shares. Either option it will erode current book value and result in current shareholder value taking a dive. (Ala Government rescue of AIG, Goldman Sachs and General Electric 10% preference by Warren Buffett)
With above consideration we are short DB as a systemic hedge for our portfolio. The goal is to protect our long positions which tracks the ASX 300 index if negative news continue to come out of Europe. As with any short position, not large enough to hurt us if the price takeoff but decent size that will offset any losses on our long side as the DB risk flows through the market.