February 11, 2016
The fall of Deutsche bank's stock price appears to have been arrested by rumours of a bold plan to buy back a good chunk of its senior debt. Trouble is, there is no official confirmation, and if the bank disappoints market expectations and doesn't follow through one can expect another negative reaction. The longer the bank dithers after the plan is leaked, the smaller the financial benefits of executing the buyback, as the market price of the bonds recovers. And, of course, that Deutsche Bank gets itself out of trouble does nothing to solve the broader problems of the European banks as a whole. But, for the time being, crisis over!
Deutsche Bank's share price regained most of the losses from the previous day on reports that it is considering a €50bn buyback of its senior bonds according to Frankfurter Allgemeine. This would be a show of force demonstrating that the bank has liquid assets to spare in an astonishing amount, comparable to the €69bn book value of equity reported by the bank in Q3, and over twice the current market valuation of €20bn. Deutsche Bank regularly reports liquid assets in excess of €200bn. The market clearly does not think this is a bluff, despite the lack of official confirmation.
The bond buyback is an attractive option because the bonds now have a market price lower than their book value, and the bank would realise the difference as a profit. The paper notes the effect would have been larger had the bond buyback been executed by surprise, as word of the buyback has already lifted bond prices closer to their notional and negated some of the possible benefits. Because Deutsche Bank is so highly leveraged - nearly 25 times at the end of Q3 - the move would have a proportionally small, but positive, effect on the capital ratios, and of course leverage would be reduced as the balance sheet would shrink by about 4%. The profit the bank might make from the bond buyback might be negated by a possible writedown of the book value of its retail unit Postbank - which sources told Reuters might be revalued by about 40% from 4.5bn to 2.8bn prior to a sale - though the bank told Reuters it was too early to speculate on that.
FAZ contrasts this bold plan with remarks by Unicredit CEO Federico Ghizzoni, who said in a Bloomberg TV interview that the major central banks should together send a signal that would encourage investors back on the equity markets and set a floor to market valuations, as he believes the market is in a selloff without a specific logic. According to FAZ, Deutsche Bank's chief investment strategist believes coordinated action by central bank would be helpful. Neither said anything on the nature of he necessary intervention. The head of the association of German chambers of commerce DIHK told FAZ that German firms are worried about the generalised weakness of the banking sector which he attributes to excessive regulation and capital demands reducing profitability and cause banks to retrench. He also criticised the excessive public debt holdings of some banks.
As to the broader picture, George Magnus writes the last thing the global economy needs now is a broad banking crisis, but that we may be getting one as a result of the unintended consequences of unconventional monetary policies. Unlike in the previous crisis where the problem was overleveraged and undercapitalised balance sheets, today the problem is the squeezed interest margins in the income statements. Magnus argues that the negative interest rate policies are flattening the yield curve as negative yields creep out to longer and longer maturities. He also points out that cocos may make the problem worse in the future, because the banks always have the option to turn them from higher-yielding bonds to equity. With interest margins being squeezed the banks may end up doing just that.
We also have stories on the moves towards suspension of Greek from Schengen; on rumours of early elections in Greece; on the political costs of the French constitutional amendment; on Italy's consolidation of its cooperative banks; on lack of progress on EU financial regulation; on the IMF's strong warning of Ukraine; on Francesco Papadia's proposal for the ECB to trade inflation derivatives; and on George Soros' idea that Russia is in a time race with the EU to avoid disintegration;