Deutsche Bank on Shaky Ground: Ghosts of Crises Past

October 7, 2016

Recent news about Deutsche Bank’s share price drops – down 51% so far this year – have raised concern among investors, drawing comparisons to the failure of Lehman Brothers,  the U.S. bank whose failure precipitated the global financial crisis of 2008. Some also fear that the problems with Deutsche Bank may reverberate throughout the rest of the European banking sector.

How is MD positioning portfolios in light of concerns over European banks?

The banking sector is one of the many sectors we monitor closely on a qualitative basis. Canadian and U.S. banks have been well positioned and their market performance has reflected this, while German banks – led by Deutsche Bank – have significantly underperformed over the last two years. We are not materially exposed to the European banking sector.

Our international portfolio managers typically avoid investing in European banks, as they don’t believe European banks to be a particularly attractive sector. On the whole, our portfolio managers don’t see any systematic risks related to Deutsche Bank, and believe that the German government would bail out the bank if necessary due to its importance.

MD believes that most market volatility related to Deutsche Bank will be contained within the European markets, and we do not expect a systematic failure of the European banking system. We remain underweight Deutsche Bank and European banks in general; as a result, our portfolio risk related to this issue remains very low.

What is causing the turmoil?

Deutsche Bank shares have been volatile in recent weeks over mounting concerns around the size of a looming $14 US billion payment to the U.S. Department of Justice (DOJ).The DOJ demanded the payment to settle an investigation into the selling of faulty mortgage-backed securities prior to the 2008 financial crash. This has caused concern among investors and financial markets, over whether the bank’s finances can manage a payment of this magnitude. The German government has said that they will not bail out the bank, further adding to investor fear. Deutsche Bank has been selling assets, has warned of cost cuts, and most recently announced a 1,000 job cut – adding to the 3,000 job losses announced in June.

2008 all over again … or is it?

In 2008, a lack of confidence in Lehman's finances caused clients — known as "counterparties" — to ask for their money back.  A cash-starved Lehman couldn't meet these demands, leading to its eventual bankruptcy filing. Conventional wisdom, in Deutsche’s case however, would suggest that even though the bank could end up short on capital, it's in no danger of failing, for several reasons:

  1. The bank has significant cash reserves on hand, and major assets it could sell, in order to pay off any liabilities
  2. Deutsche Bank is also significantly larger than Lehman was, with more clients and a more diversified business

Global regulators are now better equipped to deal with a financial crisis. After the 2008 crisis, central banks across the globe – including the European Central Bank – set in place a number of reforms to prevent another financial crisis. Many also think that it’s likely Deutsche Bank will be able to negotiate the DOJ payment to a more manageable amount.

MD continues to monitor the situation

At this time, MD believes any solvency concerns in regards to Germany’s largest bank, and comparisons to the 2008 financial crisis, appear to be exaggerated. We will continue to monitor this situation. If you have questions about how you or your financial plan may be impacted, we encourage you to contact your MD Advisor for more information.

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