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Deutsche Bank Could Be the Canary in the Coal Mine

0 | By Shah Gilani

Germany’s biggest bank is in big trouble again.

What’s been happening at Deutsche Bank Aktiengesellschaft (NYSE:DB) is scary – because it may not be the only giant bank in trouble.

Of course, Deutsche Bank officials say they’ve got plenty of capital and liquidity.

But that’s what Too Big to Fail (or TBTF) banks always say, and what their regulators want the public to believe, even as they privately censure them because of their “troubled condition.”

Here’s what’s happening at Deutsche Bank, and what the Fed thinks about the giant bank’s health…

The Canary’s Still Singing

If you’re not familiar with the analogy, a “canary in a coal mine” refers to when coal miners would bring small birds down into the mines with them to detect dangerous gasses, like carbon monoxide. The bird would succumb well before the miners would, giving them plenty of time to get back to safety. Sad for the bird, sure, but it was an effective warning.

Now it looks like Deutsche Bank might be the canary; a flashing sign that the big banks could once again tank the stock market and the global economies.

Deutsche Bank’s U.S. operations have drawn regulatory heat for years. The Federal Reserve Bank of New York slammed DB in 2014 over repeated reporting failures and lack of follow-through on agreed-to fixes.

Deutsche Bank’s U.S. operations failed the Fed’s stress tests in 2015, in 2016, and again in 2017.

In each of those years, DB was hit with Fed enforcement actions for serious rules violations, including perceived lax controls tied to currency trading, money laundering, and Volcker-rule trading restrictions; as well as paying billions of dollars to settle allegations stemming from U.S. Justice Department investigations.

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Last year, the Fed quietly censured DB over controls measuring its exposure to clients and how it valued collateral on loans when examiners complained about the bank’s inability to calculate its exposures.

The Fed called DB’s condition “troubled.” That slap on the wrist came to light last week.

The censure by the Fed also landed the bank’s FDIC-insured subsidiary, Deutsche Bank Trust Company Americas, on the FDIC’s “Problem Banks” list of at-risk institutions.

Hours after Deutsche Bank’s stock crashed to all-time lows, Standard & Poor downgraded DB’s credit rating to BBB+ from A-, three notches from junk, citing “significant execution risks in the delivery of the updated strategy amid a continued unhelpful market backdrop.”

S&P said it initiated the review on April 12 this year after Christian Sewing, a DB-lifer most recently in charge of retail and commercial banking, replaced John Cryan as CEO.

The rating agency cited how repeated leadership changes posed questions over DB’s long-term direction and cited chronically low profitability. Specifically, S&P said the bank “appears set for a period of sustained underperformance compared with peers, many of whom have now finished restructuring.”

New CEO Sewing, in a letter to staff following the downgrade, said that the bank’s financial strength is “beyond doubt.” About its corporate and investment bank, Sewing said, “We have a clear, strategic direction and we’re well on the way to implementing what we recently announced.”

Unfortunately, what they just announced was disappointing first quarter revenues. Overall company revenues were down 5%, and net income was down 79%. Investment banking revenue was down 13%, fixed income trading was down 16%, and equities sales revenue was down 21%.

It looks like the bank is on its way down.

This Time Isn’t Different

After DB’s stock tanked on Thursday last week, the bank released a statement assuring investors that “Deutsche Bank AG is very well capitalized and has significant liquidity reserves.”

Reuters subsequently reported the European Central Bank saw Deutsche Bank’s liquidity as being at a good level, saying the lender has made significant progress regarding its responses to any concerns of the ECB supervisors (according to an anonymous source familiar with the ECB’s view).

Deutsche Bank spokesman Joerg Eigendorf made it clear that “This is nothing that keeps us awake at night.” As he said about the ratings downgrade. “We have refinanced ourselves this year at quite or very good conditions, so that’s not a worry at all for us. And we are able to react if necessary.”

Chinese investor HNA Group Co. Ltd., which controls an 8% stake in Deutsche Bank, said, “HNA remains committed to Deutsche Bank’s long-term success and looks forward to continuing to work with the management team in support of that goal.”

TBTF banks always lie about their financial condition. Their regulators support their lying, and the big investors in systemically important financial institution (or SIFI) banks are going to lie and say they support the bank, too.

Any admission by a bank that they’re having capital problems comes right before they fail – or, in the case of TBTF banks, they are bailed out.

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Any admission of liquidity issues is a death knell for any bank. Almost instantaneously, banks run and depositors flee as fast as they can get their money out.

Regulators responsible for backstopping troubled banks don’t want the banks to put themselves in jeopardy in the court of public opinion staffed by depositors and equity and debt investors. They want them – make that encourage them – to lie.

If you think for a second that that’s hyperbole, just look back at any statement by any big bank during the financial crisis. They all lied publicly in every statement they made, and so did all the regulators.

That is, until the black hole they’d descended into made it necessary to admit they were having trouble, and they were being guaranteed by the government.

This time isn’t different. The Fed censured DB privately. The bank’s stock was knocked down to all-time lows only after a dismal earnings report was leaked and the Fed cited the bank as “troubled.”

The fourteenth biggest bank (by assets) in the world, according to Worldatlas, is shrinking and losing money hand over fist.

It’s looking like they’re the canary in the coal mine.

While big U.S. banks cleaned up their balance sheets, recapitalized themselves, and have been making huge profits again, their European counterparts aren’t anywhere close to being fully healthy again.

Deutsche Bank is a patient one.

If it continues to falter, if its issues spill over onto other big European banks (as they easily could), we could be headed for some tough times ahead.

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In the meantime, the canary’s still singing.

But if it stops? I’ll be the first one to warn you to take cover.

Sincerely,

Shah

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