European Banking Crisis?

[John Hjorth]

DB News - not in the Investor Relations section :

 

https://www.db.com/newsroom_news/2016/ghp/a-message-from-marcus-schenck-deutsche-bank-s-additional-tier-1-at1-capital-en-11386.htm

 

https://www.db.com/newsroom_news/2016/ghp/a-message-from-john-cryan-to-deutsche-bank-employees-0902-en-11392.htm

 

To me, we are approaching "VRX IR quality level" here [throwing out internal e-mails instead of doing some serious work, thereby providing some [more] - perhaps a lot of - facts relevant for the situation. - Panic?

[SharperDingaan]

Deutsche Bank’s vast and opaque balance sheet is holding it back; but according to the finance minister & the co-CEO – trust us.

Yet the DB co-CEO has to twice come out & say the bank is ‘rock solid’; & no one believes him. And the finance minister Wolfgang Schaeuble ALSO has to come & say that he isn't worried; & no one believes him.

 

http://www.cnbc.com/2016/02/09/deutsche-bank-ceo-says-bank-rock-solid.html

http://www.businessinsider.com/wolfgang-schaeuble-on-deutsche-bank-2016-2

http://www.reuters.com/article/us-deutsche-bank-bonds-idUSKCN0VI266

http://blogs.reuters.com/breakingviews/2016/02/10/deutsche-has-enough-capital-but-not-enough-clarity/

http://afr.com/business/banking-and-finance/deutsche-bank-woes-not-an-american-lehman-brothers-moment-20160209-gmpwlc

 

Yet DB continues to execute on its emergency buyback plan of senior bonds, of which it has about 50 billion euros ($56.44 billion) in issue. To most folks, either DB is incredibly tone deaf; or there really is something badly askew.

 

And now DB & Lehman are being compared to each other; cannot happen, trust us – yet the share price & the volatility index say otherwise. Vast and opaque - and deadly. http://www.theguardian.com/business/2008/sep/15/lehmanbrothers.marketturmoil

 

"Like Northern Rock, it mattered less that 80% of its assets were rock solid if 20% were considered toxic. We don't know the exact proportions at Lehman and neither do the bank's trading partners, which is why they refused in growing numbers to do business or buy it once the bank was up for sale."

 

We wish them luck, but they clearly have a problem. They can continue to do business only so long as they retain the confidence of the market, & that confidence appears to be crumbling.

 

SD

 

[theasiareport]

I don't think DB is a good investment for obvious reasons... But on the reverse side,

 

do we really think Germany will not step up and back-stop DB in the case that confidence is lost, considering the political consequences, and its financial ability to do so?

[TwoCitiesCapital]

I don't think DB is a good investment for obvious reasons... But on the reverse side,

 

do we really think Germany will not step up and back-stop DB in the case that confidence is lost, considering the political consequences, and its financial ability to do so?

 

Look at the return on U.S. banks from pre-2008 to now and ask yourself if the gov't stepping in really means much in the way of putting a floor on your prospective losses...

[ni-co]

I don't think DB is a good investment for obvious reasons... But on the reverse side,

 

do we really think Germany will not step up and back-stop DB in the case that confidence is lost, considering the political consequences, and its financial ability to do so?

 

Look at the return on U.S. banks from pre-2008 to now and ask yourself if the gov't stepping in really means much in the way of putting a floor on your prospective losses...

 

Exactly. Also helps that we know that, with banks, once trust starts eroding it's a reflexive downward spiral until government has to intervene. It's like a bank run, only that here it's a run on the bank's equity. 

 

The bull case for European banks is that everybody calms down and we go back to business as usual (which is bad enough for European banks and which is made almost impossible by the rates environment and the already turning short economic cycle in Europe). Government intervening is definitely not the bull case for shareholders. Take a look at a long-term C or BAC chart and you know where the journey's going.

 

When I realized this I went short.

[ni-co]

Two things: DB just announced to buy back some of its senior bonds. I see why they do it but not how that changes anything. At least they can book a profit for the delta to the par value.

https://next.ft.com/content/d2e01b1e-cf57-11e5-92a1-c5e23ef99c77

 

I have to correct this. They didn't announce anything. This is just an anonymous source talking to the FT – which I find suspicious in its own way. Then even the rumor is only that they are "considering" it.

 

[petec]

Just trying to think the effects of -ve rates through further.

 

I see several possibilities and none of them are good.

 

1. Banks earn a -ve spread and either have to raise fees or take losses which impair their capital ratios.

 

2. Banks pull reserves from the central bank and make loans, but the world is so leveraged that an unpleasantly high proportion will go bad, so the banks impair their capital ratios.

 

3. Banks pass -ve rates onto depositors which creates a bank run.  This is a big assumption but it only takes a few withdrawals to start a run - and I'm sure that 2% or 4% or 6% of depositors will decide they have better options than paying the bank to guard their money.  That's enough to start a run at the weaker banks - especially if the banks have to pull in nonperforming loans and take losses.  This has the potential to trigger a deflationary crisis.

 

What am I missing here?  I'm deeply bearish and sceptical of central bankers but surely there is a more positive outcome that they are hoping for?!

 

On a related topic, the US banking system looks pretty sturdy after 7 years of building deposits faster than loans.  Where are the Europeans on this front?

[Guest Grey512]

Ni-co,

 

Some thoughts/questions.

 

1. Kudos. I think you've done a great job in getting ahead of a nice opportunity here and initially your post attracted skepticism. I hope you were short in size and made a decent profit.

 

2. I was short European financials on and off since 2014 and in my usual stupidity, I managed to close out the short just before things got interesting. I got tired of paying carry and got fatigued from tracking basket positions with many names. Same story with me every time: close out a short, and then the price drops massively. I'm an advanced profit avoider.

 

3. At what price would you be a buyer? E.g. if DB dropped to 8 Euros per common, would you buy?

 

The chart looks attractive and I am getting more and more interested. What is stopping me is (of course) is the balance sheet. I compare European banks leverage (e.g 25-to-1) with things like BAC, C & GS and there is just no comparison.

 

 

[petec]

Grey,

 

do you have a summary of Euro banks leverage vs US banks?

 

thanks

 

Pete

[ni-co]

Ni-co,

 

Some thoughts/questions.

 

1. Kudos. I think you've done a great job in getting ahead of a nice opportunity here and initially your post attracted skepticism. I hope you were short in size and made a decent profit.

 

Thank you very much! You're welcome. So far: yes.

 

2. I was short European financials on and off since 2014 and in my usual stupidity, I managed to close out the short just before things got interesting. I got tired of paying carry and got fatigued from tracking basket positions with many names. Same story with me every time: close out a short, and then the price drops massively. I'm an advanced profit avoider.

 

Dito. I was on and off the short side of European banks since the second half of 2014, too, and didn't make any money with it until 2016. Luckily, I didn't lose all that much. I wouldn't call it "advanced profit avoidance", it's just difficult to do that in a choppy market. Options are the only way (for me) to try shorting equities without the risk of suffering incalculable losses. 

 

3. At what price would you be a buyer? E.g. if DB dropped to 8 Euros per common, would you buy?

 

Honestly? At no price. I don't think the equity in those banks has any MOS. That doesn't mean that I would stay short until the bitter end – which might be, you know, a zero – but I certainly have no appetite for investing into them. My personal opinion is that the Golden Age of banking and finance is over. I expect banks to return to doing what they did before the 1980s in the next 10 or 20 years. 

 

 

[EDIT: I should add: We still haven't had a real crisis event – just prices falling. It's still only a working hypothesis – could also be just a scare.]

[frommi]

The Deutsche Bank has a lot of index swap ETF`s, has someone a clue if these can become worthless in case of a bankruptcy?

[ni-co]

The Deutsche Bank has a lot of index swap ETF`s, has someone a clue if these can become worthless in case of a bankruptcy?

 

I don't think it's significantly higher than with a physical ETF, they have to buy the derivatives after all. The risk in the case of an index swap ETF is the solvency of the counter-party to DB – though this might be another DB entity or another European bank, of course. What is a significant risk, though, are ETNs because they are senior debt notes, what a lot of people don't realize.

[John Hjorth]

Just for info here: I just checked up on the Web and on the SAN webpage several places I thought could be relevant to look. Conclusion : So far SAN has been mute.

[fareastwarriors]

Is there a Wells Fargo equivalent somewhere in Europe?

[petec]

Is there a Wells Fargo equivalent somewhere in Europe?

 

Svenska Handelsbanken comes to mind.  But personally I wouldn't touch a bank in a NIRP environment.  Nor would I touch WFC because I think the risk of NIRP in the US is significant.  Much as I love Wells.

[ni-co]

But personally I wouldn't touch a bank in a NIRP environment.  Nor would I touch WFC because I think the risk of NIRP in the US is significant.  Much as I love Wells.

 

+1

 

Since it also fits this discussion I cross-link my thoughts on US banks from the BAC thread – apologies to those who follow them both because of the repetition:

 

I think the market is having a really difficult time figuring out exactly what BAC's business model looks like in this world we live in. 

 

I completely agree with you on your big picture. What I'd point out – and I consider this as especially relevant for banks and their business model – is that cause of all this is the change in the long-term debt cycle. Debt is expanding and contracting in

. At least since 2008, debt has been contracting all around the world, and all central banks (and governments) can do about it is trying to ease this contraction, which is what Ray Dalio has been saying – and been consistently right on – for many years now. It boggles my mind that he's been so spot-on with his model – correctly predicting the financial crisis, the CB action resulting from it, that QE wouldn't cause inflation, and now that CBs will be experiencing "pushing on a string" – and yet people are still blaming the CBs for everything that goes wrong (Dalio is literally the only fund manager out there who says that CBs are doing a good job. At the same time he is the most successful one – shouldn't this give people some pause?).

 

If you take Dalio's model it's very clear that the banking business model is under siege. This is because of the long-term debt cycle contracting and this will remain the case for many years to come. So, NIM won't come back for a very long time. Of course, banks will always be needed and they will figure out how to do their business in a contracting debt cycle but this is going to be a very painful process. Against this background, being a bank shareholder seems to be a bad risk/reward proposition – even in the long term. In my view, people who are expecting BAC, or any other bank, to simply go back to normal like it was in the 1990s or early 2000s are delusional because they completely miss this big picture. The late 1930s and the 1940s provide a far better model to think about the challenges and risks that banks will be facing in the coming one or two decades. When you view the world through Dalio's eyes everything that's happening right now with banks is completely logical and not surprising in the least. Brushing this aside as "ZH talk" is ignorant at best. I don't say that you have to follow this model but at least acknowledge that it exists and that it provides what seems to be a logical explanation for what is going on right now.

 

Since I am a value investor at heart it took me some time to internalize this model for the really big picture. But ever since, it has been extremely useful and rewarding.

[petec]

But personally I wouldn't touch a bank in a NIRP environment.  Nor would I touch WFC because I think the risk of NIRP in the US is significant.  Much as I love Wells.

 

+1

 

Since it also fits this discussion I cross-link my thoughts on US banks from the BAC thread – apologies to those who follow them both because of the repetition:

 

I think the market is having a really difficult time figuring out exactly what BAC's business model looks like in this world we live in. 

 

I completely agree with you on your big picture. What I'd point out – and I consider this as especially relevant for banks and their business model – is that cause of all this is the change in the long-term debt cycle. Debt is expanding and contracting in

. At least since 2008, debt has been contracting all around the world, and all central banks (and governments) can do about it is trying to ease this contraction, which is what Ray Dalio has been saying – and been consistently right on – for many years now. It boggles my mind that he's been so spot-on with his model – correctly predicting the financial crisis, the CB action resulting from it, that QE wouldn't cause inflation, and now that CBs will be experiencing "pushing on a string" – and yet people are still blaming the CBs for everything that goes wrong (Dalio is literally the only fund manager out there who says that CBs are doing a good job. At the same time he is the most successful one – shouldn't this give people some pause?).

 

If you take Dalio's model it's very clear that the banking business model is under siege. This is because of the long-term debt cycle contracting and this will remain the case for many years to come. So, NIM won't come back for a very long time. Of course, banks will always be needed and they will figure out how to do their business in a contracting debt cycle but this is going to be a very painful process. Against this background, being a bank shareholder seems to be a bad risk/reward proposition – even in the long term. In my view, people who are expecting BAC, or any other bank, to simply go back to normal like it was in the 1990s or early 2000s are delusional because they completely miss this big picture. The late 1930s and the 1940s provide a far better model to think about the challenges and risks that banks will be facing in the coming one or two decades. When you view the world through Dalio's eyes everything that's happening right now with banks is completely logical and not surprising in the least. Brushing this aside as "ZH talk" is ignorant at best. I don't say that you have to follow this model but at least acknowledge that it exists and that it provides what seems to be a logical explanation for what is going on right now.

 

Since I am a value investor at heart it took me some time to internalize this model for the really big picture. But ever since, it has been extremely useful and rewarding.

 

Ni-co, totally agree with the thrust of your post and the use of the 1930s as a model.  Also interested by your last sentence, because I went down the same path from thinking macro was unpredictable and didn't matter to thinking it might, at this point in time, be the only thing that matters. 

 

What I don't agree with is the idea that debt has been contracting since 2008.  That is true for the US consumer (though their debt levels remain fairly high).  It is not true for just about anything else: DM governments and companies, and EM everything.  The world is far more levered now than it was in 2008, and we have seen huge inflation as a result (mainly in asset prices but also in CPI if you use the 1980 method of calculating it - I'm not arguing that the method is correct, just that inflation compared with the past has been running much higher than we think www.shadowstats.com).

 

What I fear is that world debt is *now* starting to contract, driven by natural debt limits and also by Fed tightening while the other major central banks (ECB, PBOC, BOJ) are easing - this is driving a huge carry trade unwind.

 

That is deflationary, and so might the initial response (NIRP) be. 

[ni-co]

Ni-co, totally agree with the thrust of your post and the use of the 1930s as a model.  Also interested by your last sentence, because I went down the same path from thinking macro was unpredictable and didn't matter to thinking it might, at this point in time, be the only thing that matters. 

 

What I don't agree with is the idea that debt has been contracting since 2008.  That is true for the US consumer (though their debt levels remain fairly high).  It is not true for just about anything else: DM governments and companies, and EM everything.  The world is far more levered now than it was in 2008, and we have seen huge inflation as a result (mainly in asset prices but also in CPI if you use the 1980 method of calculating it - I'm not arguing that the method is correct, just that inflation compared with the past has been running much higher than we think www.shadowstats.com).

 

What I fear is that world debt is *now* starting to contract, driven by natural debt limits and also by Fed tightening while the other major central banks (ECB, PBOC, BOJ) are easing - this is driving a huge carry trade unwind.

 

That is deflationary, and so might the initial response (NIRP) be.

 

This is my hypothesis (of course not originally by me but by many what I consider to be good macro thinkers):

 

What we were witnessing with credit growth in EM were only the second order effects from money creation in the US. The Fed did QE 1-3 (which is money creation, not credit expansion) to soften the impacts from strongly tightening credit conditions from 2007/2008 onwards. They increased money creation to balance the shrinkage in credit, thereby keeping the total amount spent in the economy roughly the same (which is the reason why Dalio likes it). However, there are many – mostly unintended – consequences we now have to work through:

 

In the US, there were share buy-backs and bad car loans, but the most important unintended effect was on EM. The money sought its way around the globe and went where it yielded the most ("reaching for yield"). That's why you got huge credit expansion in EM, especially in China. This was not what I'd regard as "natural" (i.e. pro long-term-cyclical) credit expansion caused by booming economies. On the contrary, US consumers quit spending in 2008. This is when the world lost its "private consumer of last resort". Anyway, China used the money poring in from abroad to soften the blow from the 2008 financial crisis (i.e. the collapsing demand from US consumers) by spending it in an unprecedented scope for infrastructure projects (essentially doing what Neo-Keynesians demand from the US, the EU and Japan), with the right goal of raising living standards in order to replace lost consumer demand from the US by domestic demand by Chinese consumers (aka "re-balancing"). This process kept up the giant demand for commodities and, with it, commodity producing EM countries going. It also led to giant misallocations because it was a state-controlled process.

 

When China reached the limits of its borrowing capacity in 2014 or 2015 (always referring to public and privat debt taken together), the last man (consumer) standing after 2008 collapsed and with it commodity prices and the rest of EM. What we are witnessing now is a reversal of those money flows back into the US. Unfortunately, though, the US consumer is still in the process of deleveraging and will be for a long time.

 

This is why I think the process of credit contraction begun in 2007/2008. What we are witnessing since then are the attempts by CBs to stretch this contraction out over a long time-frame through QE (increasing the money supply) and other tools like ZIRP and NIRP.

[petec]

Nico my objections to that post are all on points of detail.  I agree entirely with the general direction.

 

 

[John Hjorth]

Is there a Wells Fargo equivalent somewhere in Europe?

 

Svenska Handelsbanken comes to mind.  But personally I wouldn't touch a bank in a NIRP environment.  Nor would I touch WFC because I think the risk of NIRP in the US is significant.  Much as I love Wells.

 

Yes, I would also mention Svenska Handelsbanken here, if any, not totally sure about it.

 

Please note that history of Swedish banks is quite special. Basicly the whole Swedish banking sector was in dire straits back in the beginning of the '90s. Then, The Swedish State stepped in with decisiveness, and cleaned up the mess. The Swedish banking sector therefore is much less fragmented now, compared to ie. the Danish banking sector, if I remember correctly [haven't checked the exact numbers here], but it is something like about 15 - 20 Swedish existing banks right now, compared to approximately 115 Danish banks.

 

The aftermath of the 08/09 FC here in Denmark was a bloody mess, which changed the national banking landscape totally, quite some [for Denmark] middle size regional banks were totally wiped out, together with a large number of small institutions. Basicly the method for cleaning up here was quite US-like. Basicly, the customers in the surviving banks "got the bill for the party".

 

The Swedish banks did not suffer in the same way under the 08/09 FC, I suppose based on the recapitalisation that took place many years before that, likely also based other things.

 

https://en.wikipedia.org/wiki/Swedish_banking_rescue

[NewbieD]

 

The Swedish banks did not suffer in the same way under the 08/09 FC, I suppose based on the recapitalisation that took place many years before that, likely also based other things.

 

https://en.wikipedia.org/wiki/Swedish_banking_rescue

 

I think the main reason the swedish banks were relatively okay in the FC was lending standards was raised after 1992. There was never a problem with defaults on mortgages. There was however a liquidity crisis that was bad enough that three of the four major banks had to issue equity in 2009 - Swebank, SEB and Nordea. The government participated in Nordeas issue. Handelsbanken avoided this - partly because they hadn't gone on any adventures in the Baltics and Russia but instead focused their expansion on the U. Probably many other factors.

 

Elsewere on this forum a book about Handelsbanken was mentioned: A Blueprint for Better Banking: Svenska Handelsbanken, Niels Kroner - now on my reading list.

 

One aspect that makes Handelsbanken stand out is they have no profit-share bonus. Instead the employees are rewarded with shares in a foundation that they can withdraw from once they turn 60. This part is equal for all employees, from CEO to clerk in an office and can amount to about 3 million USD over 35 years. All differentiation in pay is in the wage on the contract. This setup obviously lessens the incentive to take "heads I win, tails you lose" bets. It seems they are able to attract decent enough personnel anyway. Rumour says part of the upside of working there is you can get by without putting in so many hours.

[ni-co]

Good summary of the European banking malaise:

http://www.wsj.com/articles/european-banks-buffeted-by-bond-investors-fears-1455527280

 

What I find interesting is to think about is this:

 

The guiding principle behind the new [bail-in] standards is that investors rather than taxpayers should be on the hook for losses when a bank goes under.

 

To me, this principle sounds like a choice only politicians and ideologues are able to make-up as a guideline. Shouldn't it be obvious that investors will quit giving their money to (hugely fragile) European banks when they know that taxpayers will step in only after investors will be wiped-out? Anticipating that, a prudent bond- or shareholder will cash out long before his bank seems to be even close to the brink, thereby driving down the bank's equity and debt prices, in this way closing capital markets for this bank and, in the end, causing a rat-race to the bottom at which the bank will have to be bailed-out by taxpayers. This seems to be inevitable.

[petec]

On a slightly different note I was reading Handelsbanken's annual report over the weekend and was struck by their 21% CT1 ratio and 27% total capital ratio.  This is far higher than the banks I usually look at in the emerging markets.

 

However, their assets/equity ratio is nearly 20x, which is far higher.

 

Point being, the risk weights assigned to European bank assets are much lower - I'm not sure if this is still the case but a couple of years ago Greek government debt carried a 0% risk weight, which doesn't happen in EM even where the local government is far more creditworthy than Greece - making the capital ratios nonsensical. 

 

None of this is a knock on Handelsbanken which is an outstanding bank.

[frommi]

Good summary of the European banking malaise:

http://www.wsj.com/articles/european-banks-buffeted-by-bond-investors-fears-1455527280

 

What I find interesting is to think about is this:

 

The guiding principle behind the new [bail-in] standards is that investors rather than taxpayers should be on the hook for losses when a bank goes under.

 

To me, this principle sounds like a choice only politicians and ideologues are able to make-up as a guideline. Shouldn't it be obvious that investors will quit giving their money to (hugely fragile) European banks when they know that taxpayers will step in only after investors will be wiped-out? Anticipating that, a prudent bond- or shareholder will cash out long before his bank seems to be even close to the brink, thereby driving down the bank's equity and debt prices, in this way closing capital markets for this bank and, in the end, causing a rat-race to the bottom at which the bank will have to be bailed-out by taxpayers. This seems to be inevitable.

 

Sorry but why should taxpayers be liable for the downside, when all the upside goes to greedy bankers and investors? A well managed bank doesn`t need to issue equity. And if the taxpayers money is used to resuce the system, than all the upside from that move should go to the taxpayer, too. Makes shorting troubled banks easier, but maybe they will just forbid that when shtf.

[JBTC]

Anyway, China used the money poring in from abroad to soften the blow from the 2008 financial crisis (i.e. the collapsing demand from US consumers) by spending it in an unprecedented scope for infrastructure projects (essentially doing what Neo-Keynesians demand from the US, the EU and Japan), with the right goal of raising living standards in order to replace lost consumer demand from the US by domestic demand by Chinese consumers (aka "re-balancing"). This process kept up the giant demand for commodities and, with it, commodity producing EM countries going. It also led to giant misallocations because it was a state-controlled process.

 

When China reached the limits of its borrowing capacity in 2014 or 2015 (always referring to public and privat debt taken together), the last man (consumer) standing after 2008 collapsed and with it commodity prices and the rest of EM. What we are witnessing now is a reversal of those money flows back into the US. Unfortunately, though, the US consumer is still in the process of deleveraging and will be for a long time.

 

 

ni-co,

 

My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners.