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Deutsche Stumble Poses New Capital Questions
JANUARY 14, 2009, 2:38 P.M. ET
How much longer can Deutsche Bank continue to convince investors it doesn't need to raise new capital?
The German giant has successfully maintained its high wire act since the start of the credit crisis despite being one of the most highly leveraged banks in the world. But Wednesday's warning of 4.8 billion euros lost in the fourth quarter is a major stumble.
Everyone knew the quarter would be grim, given the extreme volatility after the collapse of Lehman Brothers and the subsequent shock to global economic activity. But the scale of the loss puts Deutsche Bank's capital adequacy firmly back on the agenda.
What makes Deutsche's warning most troubling is that the losses have arisen not from traditional problem areas such as leveraged lending and commercial property -- exposures now mercifully virtually eliminated -- but across the bank's trading activities. Deutsche Bank consistently cites the supposed lower risk of these activities to justify its high leverage relative to other major banks -- Deutsche Bank has a tangible equity to total assets ratio of 1.8% the second lowest in its peer group, according to Morgan Stanley research.
True, Deutsche has promised to reduce leverage by scaling back on prop trading and shed 300 billion euros of assets over the quarter -- although this was partially offset by the rise in the value of derivative contracts as a result of increased volatility. Slashing the dividend and paying for its stake in Germany's Postbank in shares rather than cash should also help Deutsche achieve its target of 30 times leverage by the end of the first quarter, down from 38 times in mid-2008. The bank expects to continue to hit a Tier 1 capital ratio target of 10%.
But resisting pressure to raise capital is becoming an increasingly risky gamble. The shares have fallen by two thirds since September in line with the rest of the sector, suggesting the market is skeptical of Deutsche's claim to special status.
That skepticism is justified. Deutsche has less exposure than rivals to consumer and corporate loans and thus to the sharp deterioration in the real economy. But the ballooning stock of assets no longer marked to market -- including Level 3 assets and securities transferred from the trading book to the banking book -- has left the bank's balance sheet less transparent.
If investors conclude a major capital injection is necessary, raising the prospect of substantial dilution, Deutsche may find itself having to act against the backdrop of a confidence-sapping downward spiral in the shares. Best not to wait until that moment arrives.
Deutsche Stumble Poses New Capital Questions
JANUARY 14, 2009, 2:38 P.M. ET
How much longer can Deutsche Bank continue to convince investors it doesn't need to raise new capital?
The German giant has successfully maintained its high wire act since the start of the credit crisis despite being one of the most highly leveraged banks in the world. But Wednesday's warning of 4.8 billion euros lost in the fourth quarter is a major stumble.
Everyone knew the quarter would be grim, given the extreme volatility after the collapse of Lehman Brothers and the subsequent shock to global economic activity. But the scale of the loss puts Deutsche Bank's capital adequacy firmly back on the agenda.
What makes Deutsche's warning most troubling is that the losses have arisen not from traditional problem areas such as leveraged lending and commercial property -- exposures now mercifully virtually eliminated -- but across the bank's trading activities. Deutsche Bank consistently cites the supposed lower risk of these activities to justify its high leverage relative to other major banks -- Deutsche Bank has a tangible equity to total assets ratio of 1.8% the second lowest in its peer group, according to Morgan Stanley research.
True, Deutsche has promised to reduce leverage by scaling back on prop trading and shed 300 billion euros of assets over the quarter -- although this was partially offset by the rise in the value of derivative contracts as a result of increased volatility. Slashing the dividend and paying for its stake in Germany's Postbank in shares rather than cash should also help Deutsche achieve its target of 30 times leverage by the end of the first quarter, down from 38 times in mid-2008. The bank expects to continue to hit a Tier 1 capital ratio target of 10%.
But resisting pressure to raise capital is becoming an increasingly risky gamble. The shares have fallen by two thirds since September in line with the rest of the sector, suggesting the market is skeptical of Deutsche's claim to special status.
That skepticism is justified. Deutsche has less exposure than rivals to consumer and corporate loans and thus to the sharp deterioration in the real economy. But the ballooning stock of assets no longer marked to market -- including Level 3 assets and securities transferred from the trading book to the banking book -- has left the bank's balance sheet less transparent.
If investors conclude a major capital injection is necessary, raising the prospect of substantial dilution, Deutsche may find itself having to act against the backdrop of a confidence-sapping downward spiral in the shares. Best not to wait until that moment arrives.
