Deutsche Bank’s financial health is causing concern for markets as any fall like Lehman could trigger a contagion effect. India’s surgical strikes inside LOC with Pakistan hurt market sentiments today with Sensex and Nifty down by over 1.5%. US Presidential elections is causing worries for markets, if trend goes towards Donald Trump who is seen as anti markets.
Gsec yields have dropped to seven year lows on expectations of rate cut by the RBI on the 4th of October. Bond yields rose by 6bps to 10bps on the back of Indo-Pak tensions and could rise further on profit booking at lower levels of yields as tensions continue. RBI rate cuts would not help markets till positions are consolidated. The government is slated to borrow Rs 2450 billion in the October 2016-March 2017 period with Rs 150 billion of weekly auctions over the next two months. Bond markets will prefer to absorb supply at higher levels of yields till domestic and global issues pan out.
The INR too will come under pressure as global investors wait and watch for Indo-Pak tensions to ease.
Global and Indian equities have been testing record highs post Brexit but with all three events mentioned here coming together, equities are falling from record highs or close to record highs.
Deutsche Bank is more likely to be bailed out by the German Government while Indo Pak tensions will ebb as no side is in a position to escalate matters. US will vote a new president in November and that can go either way, however in the longer term, whichever President will be forced to take the right economic decisions.
Markets will present good buying opportunity if it falls on the back of these short term events.
Deutsche Bank – Too Big to Fail
Deutsche Bank stock prices have been falling last week to fresh lows of $11.23 per share. The German lender was trading at an all time lows after falling more than 50% in this year. The stock price has recovered since then and is currently trading at a price of $13.14 per share.
The selloff triggered fears in European markets and the ripples were felt on all markets including India.
It is a publicly known fact that Deutsche is a troubled bank and news of its insolvency has been doing the rounds for a couple of years now. The latest nail in its coffin has been the slapping of a $14 billion fine by the U.S. Justice Department to settle civil claims related to its dealings in mortgage-backed securities in the 2008 crisis.
After a massive sell-off on Monday the 26th of September, Deutsche Bank’s market value shrank to $ 16 billion, which is only $2 billion more than the $14 billion penalty the bank faces from the United States Department of Justice.
This demand places further stress on the banks precarious financial situation. The woes of the bank has been on account of excessive leverage and it has not been able to extricate itself from the mess it is in.
The lender’s leverage ratio—total assets to shareholder equity—is estimated to be north of 40-to-1.To put that into perspective, Lehman Brothers had a leverage ratio of 30.7 to 1 in 2007 which then spiralled into bankruptcy.
The problem of Deutsche Bank is putting the German government in a difficult dilemma, as it must decide whether to save the bank, whose assets are valued at about $2.6 trillion, close to half the size of the German economy.
The record sell-off and then the resultant panic in markets all over the world was triggered by reports that the German Chancellor Angela Merkel has ruled out any state assistance and there was no rescue measures being worked out for the large German bank and they should raise fresh capital on its own.
The decision on the controversial bailout puts the German Chancellor in a politically sticky situation especially as elections are coming up next year.
Banking Analysts comment that low and virtually negative net income quarters are draining the ability of the bank to increase its capital position.Its capital position needs to be improved, and the ability of it to achieve this naturally is being severely questioned.
Deutsche is in position where their most heavy assets are their most illiquid and their most troubled.
The bank has been selling off assets, to shore up its financial position. Recently they sold their UK insurance business Abbey Life Assurance for $1.22bn. They are selling what can be sold, but in effect they will be left with the worst assets which will limit their turnaround ability.
It is clear that Germany is reluctant to rescue Deutsche Bank. German taxpayer is in the horrible position of having to keep throwing good money after bad. A bailout would also mean going against the European Union regulations.
The German government is loathe to indirectly pay the penalty for the imprudence of a domestic private firm.
So the question which is facing Germany in the face is this dreadful bailout.
What is our view? Will Deutsche Bank be allowed to fail?
We believe that if push comes to shove Deutsche Bank will not be allowed to fail and will be bailed out by the German government and tax payers. The reason is that it is too big to fail and if it is allowed to go under there is no telling of what the effect on the financial system will be.
Deutsche Bank bankruptcy would trigger a systemic banking contagion the likes of which the world has never seen.
It will push the fragile financial system over the brink and create unimaginable and unprecedented turmoil.
A worst case scenario if Deutsche Bank is allowed to go bankrupt than the immediate reaction on equity markets will be a bloodbath and a panic sell off. It may take years for it to recover.
In debt there will be a flight to safety and the US bonds will be the safe haven. Gold will surge as money will move to physical assets.
When Lehmann happened there was a massive squeeze in the credit markets, Deutsche is a much more entangled bank within the financial system so the reaction will be worse. At best lower rated credits yields will soar and at worst they will become completely illiquid.
There is low possibility of further QE support post the already $ 13 trillion support post 2008 crisis. It is estimated that globally the value of bonds trading at negative yields is upwards of $ 13.4 trillion which in itself is a big problem.There is absolutely no further room to lower rates further to support global economy if a systemic risk emerges.
So all in all we think Deutsche Bank is a colossal problem and no matter how reluctantly, Germany has to contain it .The hobsons choice with Angela Merkel is a bailout or a bailout.