Deutsche Bank drops to record low

There are concerns about its ability to withstand legal costs

DEUTSCHE Bank AG shares dropped to a record and its riskiest bonds declined amid concerns about the lender’s ability to withstand mounting legal costs, with some hedge funds moving to reduce their financial exposure.

The funds, a small subset of the more than 800 clients in the bank’s hedge fund business, have moved part of their listed derivatives holdings to other firms this week, according to an internal bank document seen by Bloomberg News.

Among them are Izzy Englander’s US$34bil Millennium Partners, Chris Rokos’ US$4bil Rokos Capital Management, and the US$14bil Capula Investment Management, said a person with knowledge of the situation who declined to be identified talking about confidential client matters.

In a memo to staff published yesterday, Deutsche Bank chief executive officer John Cryan responded to what he called media speculation causing some “unjustified concerns,” saying that the bank’s balance sheet has never been more stable over the past two decades.

“Ongoing rumours are causing significant swings in our stock price,” he wrote. “It’s our task now to prevent distorted perception from further interrupting our daily business. Trust is the foundation of banking. Some forces in the markets are currently trying to damage this trust.”

The shares dropped 4.4% to 10.40 euros in Frankfurt after declining below 10 euros for the first time. The lender’s 1.75 billion euros (US$2bil) of 6% additional Tier 1 bonds, the first notes to take losses in a crisis, fell as much as five US cents on the euro to 69 US cents, a record low, according to data compiled by Bloomberg. Credit default swaps on the lender’s junior bonds reversed an earlier increase, falling 17 basis points to 513 basis points, according to CMA. Contracts on the senior bonds pared an earlier increase to 247 basis points, the data show.

“The issue here is now one of confidence,” said Chris Wheeler, a financial analyst with Atlantic Equities LLP in London. “That’s what’s going on here. The thinking is ‘Deutsche Bank is fine, but there’s a slim chance it might not be, so why leave my money in there’”

While the vast majority of Deutsche Bank’s more than 200 derivatives clearing clients have made no changes, the hedge funds’ move highlights concern among some counterparties about doing business with Europe’s largest investment bank.

Deutsche Bank’s stock and debt have been under pressure after the US Justice Department this month requested US$14bil to settle an investigation into residential mortgage-backed securities. The bank has said it expects to negotiate that lower, as other Wall Street banks have.

Millennium, Capula and Rokos declined to comment when contacted by phone or email. The hedge funds use Deutsche Bank to clear their listed derivatives transactions because they are not members of clearinghouses.

“Deutsche has many problems, but liquidity is not one of them,” Stuart Graham, founder of Autonomous Research, said in a note, adding the bank had a liquidity reserve of 223 billion euros as of the second quarter. “There can be no doubt that Deutsche could access significant additional liquidity from the ECB, should it ever need it.”

In a memo to staff outlining how to deal with client inquiries, dated Sept 27, the bank said that customers broadly understand that “CDS are no longer a necessarily accurate reflection of counterparty risk,” according to a copy seen by Bloomberg. The bank’s funding costs have remained lower than CDS spreads indicate this year, according to the note.

Deutsche Bank has liquidity reserves of more than 215 billion euros, according to Cryan.

“This is an extremely comfortable buffer,” he wrote in the memo to staff. “This is clear proof of how conservatively we have planned.”

The financial pressure on the lender is spilling over into German politics, stirring speculation Chancellor Angela Merkel’s government might be forced to offer support. Cryan, who took over last year, told Bild newspaper this week that government aid was “out of the question.” Any taxpayer funded solution for the bank’s troubles would be Merkel’s downfall, said the leader of Germany’s biggest opposition party.

The International Monetary Fund in June said Deutsche Bank may be the biggest contributor to risk among socalled global systemically important banks. The bank has gross notional derivatives exposure of 46 trillion euros, according to an Investor Relations presentation published this month. After netting and collateral, reported derivative trading assets fall to 41 billion euros, the bank said.

“Deutsche Bank may be a victim of speculative attacks,” said Carsten Klude, chief economist at M.M. Warburg & Co in Hamburg. “The potential costs to settle the US mortgage investigation of course triggers horror scenarios. But fears of a potential collapse are farfetched.”

Clients review their exposure to counter parties to avoid situations like the 2008 collapse of Lehman Brothers Holdings Inc. and MF Global’s 2011 bankruptcy when hedge funds had billions of dollars of assets frozen until the resolution of lengthy legal proceedings.

Deutsche Bank, which is scheduled to publish its third quarter earnings next month, has long struggled to adapt to an era of tougher capital requirements and diminished trading revenue.

Cryan has already said that the lender may fail to be profitable this year, calling it a peak restructuring year, as he eliminates thousands of jobs.

“Until there is some new piece of substantive positive information on the bank’s situation, the bonds will probably remain under pressure or at least not recover substantially,” said Robert Montague, senior financials analyst for ECM Asset Management in London, which manages about US$9bil. – Bloomberg