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February 10, 2016


The banking union is not working

If the European Banking Union were working we would not be seeing headlines comparing Deutsche Bank to Lehman Brothers or wondering about the return of the financial crisis. There are some indications that the latest bank scare may have something to do with the banking union. One is the timing. The long-term slide in DB's share price got worse since the new year. The FT links the spike in Deutsche Bank's senior CDS to over 200bp and in bank CDS generally (of which €6bn notional were bought on Monday and at least a further €5bn on Tuesday) to worries over the unexpected losses suffered by some of Novo Banco's senior bondholders just before year-end. The likelihood of bondholder bail-ins has increased since the new year because of the European resolution directive BRRD coming into force. Concerns that we might see a return of the banking crisis are being downplayed despite an increase in market indicators of interbank market stress such as the Libor-OIS spread which Reuters writes is higher than at any point in the last year but far from 2008 or 2011 levels.

Investors are also concerned by junior debt and 'cocos' (contingent convertible bonds) which supervisors have been favouring since the financial crisis as a cheaper way for banks to raise capital, and presumably as a contributor to financial stability. The problem with cocos is that as equity deteriorates the probability that the embedded convertibility of the cocos will be triggered rises rapidly, and this leads to stress on the coco market. Not the best contributor to financial stability, in our view. The management of Deutsche Bank has sought to assuage the fears of investors and employees by releasing preliminary unaudited figures on the bank's capacity to pay coupons on its additional Tier 1 capital, that is, cocos.

It is not every day that a letter from the Chief Financial Officer to employees is disclosed to the public, followed the day after by disclosure of another letter from the CEO reassuring the employees that the bank "remains absolutely rock-solid". Some of the bank's largest stockholders, however, are said to be losing faith in the ability of the bank's management to carry through a planed 2-year turnaround, and are unwilling to give DB the benefit of the doubt, writes Reuters. While Deutsche Bank shares have been slowly but steadily losing value - they were down 60% between 2009 and 2016 - the latest slide started at the end of October, after the bank released negative Q3 resuts and announced it would be cutting 35,000 jobs worldwide. The bank also recently released annual results with losses over €6bn, mostly attributed to provisions for the future costs of litigation. But the bank has raised nearly €20bn in capital since 2010 and Reuters quotes analysts from Citi estimating a lingering capital shortfall of €7bn.

The share price slide makes Deutsche Bank "the cheapest globally systemic bank", but the German government is expected to intervene in case of a takeover attempt by a foreign buyer. But it won't come to that, will it, given that Wolfgang Schäuble told Bloomberg he was unconcerned about Deutsche Bank - about as reassuring as the public release of the employee letters.

Our other stories

Our main focus today is the fall in the share price of Deutsche Bank and what this says about the state of the banking union; we also look at whether this is the return of the financial crisis and, in a separate story, at whether this is the beginning of an economic downturn; the latter also includes a discussion on negative interest rates; other stories deal with the Greek review, the tight French assembly vote on the removal of the nationality of terrorists, and the open issues in the UK/EU discussions.

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