Virus forces Deutsche Bank to confront old fears

Bloomberg

The mood at Deutsche Bank AG’s headquarters in Frankfurt was tense. It was late March, and clients were drawing down credit lines at such a rapid pace that the bank’s treasury department was on alert.
Liquidity never was an issue, according to a person familiar with the matter. But the episode, which also attracted the attention of the European Central Bank, underscored the still fragile health of the lender less than a year into Chief Executive Officer Christian Sewing’s radical restructuring plan.
Deutsche Bank is under the microscope as governments rely on banks to funnel trillions of dollars to companies reeling from the coronavirus pandemic. The historic downturn is raising questions about the impact on the German lender, which has posted five straight annual losses, and how much government guarantees will allow it to keep lending.
“This crisis is really terrible timing for Deutsche Bank,” said Ingo Frommen, an analyst at Landesbank Baden-Wuerttemberg in Stuttgart who has a hold recommendation on Deutsche Bank shares. “Sewing was delivering and winning back the trust of investors, but now that insecurity about just how solid Deutsche Bank is has come roaring back.”
The largest bank in Europe’s largest economy, and still a force in Wall Street debt markets, Deutsche Bank has tried to assure stakeholders that it’s entering this crisis stronger than it has been in a long time. It said in mid-March that business so far this year had continued the positive trend of the fourth quarter.
Yet as Sewing refocuses the bank on its traditional strength financing Germany’s exporters, many of those companies are at the center of the storm. Even after cutting risky assets, Deutsche Bank still has one the largest piles of hard-to-value holdings at big banks. And in the US, the crisis has revived the debate about the lender’s relationship with President Donald Trump.
Privately, top executives including Sewing are now considering cutting their mid-term revenue goal for the second time in less than a year, people familiar with the matter said. A decision probably won’t be made until the impact of the crisis is clearer, but the bank — along with a slew of other companies — already said in March that the pandemic may put its targets at risk.
Analysts polled by Deutsche Bank doubt that the German lender will come anywhere near its medium-term revenue target of 24.5 billion euros ($26.7 billion), with their consensus forecast anticipating 21.3 billion euros by 2022.

Still Deutsche Bank is this year’s second-best performer on the Stoxx Europe 600 Banks Index with a 14% decline. As shares tumbled across the industry, some of the worst stocks have dropped by 50% to 60% in 2020.
Deutsche Bank wasn’t the only lender to experience rapid drawdowns in March, but it’s most at risk from customers drawing down credit lines simultaneously, analysts at JPMorgan Chase & Co. said in a recent note. It doesn’t have the largest volume of undrawn credit and liquidity facilities, but at 40% of total loans, they weigh heavier than at any other European lender except Barclays Plc and Natixis SA, according to the analysts. What’s more, Deutsche Bank would see the biggest hit to its key capital ratio if those lines are tapped to the degree JPMorgan estimates in its base case.
To account for the risk that more clients may be unable to pay back their loans if lockdowns continue, U.S. banks set aside some $25 billion in the first quarter. Europe’s lenders are seeking to avoid such a hit because they don’t have the financial strength, Bloomberg reported on Friday.
Deutsche Bank set aside less money for bad debts over the last decade than most euro-area peers, saying it’s focused on high-quality borrowers. Such charges were equal to 0.17% of its loans last year, the fifth-lowest of the region’s top 24 publicly-traded banks and less than half the average for the group, according to data compiled by Bloomberg.
“I haven’t seen Deutsche Bank granting credit excessively and the loan book seems well diversified,” said Andreas Meyer, who helps manage more than 3 billion euros including bank bonds at Aramea Asset Management in Hamburg.
Deutsche Bank has also sold off billions in risky securities and has exited equities trading, but as of December, it still sat on more than 24 billion euros in hard-to-value assets, such as distressed debt or illiquid loans. With the market for high-yield bonds and leveraged loans effectively shut since March, banks could face losses on assets they or hold and get stuck with new loans they agreed to make.
Deutsche Bank is among Wall Street banks that have committed to providing billions to junk-rated companies by mid-year, Bloomberg has reported, including an $11 billion financing for the leveraged buyout of ThyssenKrupp’s elevator unit. It’s one of 16 banks that have to come up with $23 billion of loans to T-Mobile US Inc. in order to allow the mobile carrier to close its planned acquisition of Sprint Corp. It’s also among lenders stuck with debt backed by MGM Grand and Mandalay Bay properties in Las Vegas, people familiar with the matter said last month.
Deutsche Bank says its efforts to reduce risk in recent years, rigorous underwriting policies and most importantly the strategy overhaul announced in July have put it on a better footing. Like other banks seeking to draw a contrast with the financial crisis more than a decade ago, it has portrayed itself as part of the solution this time.
Given it’s key role in financing German companies, the bank has been in close contact with Berlin over the government aid package. Management board member Karl von Rohr said in a newspaper interview last week that there was no reason to worry about the lender’s strength.
“A lot of companies are currently making full use of their existing credit lines with us,” he told Die Zeit. “Beyond that, we’re in talks with supervisors how to expand bank balance sheets to create even more credit volume for the economy as a whole. It feels good being part of the solution.”
Indeed, Deutsche Bank built up a relatively strong capital cushion over the past years, with a common equity Tier 1 ratio of 13.6% at the end of December. But with investors unwilling to cough up more cash after years of losses, it was counting on using some of those buffers to pay for its latest restructuring, which includes some 18,000 job cuts over three years.
Deutsche Bank has since halted plans for widescale firings during the crisis. It’s also considering scrapping bonuses for top management this year as regulators urge banks to preserve capital and keep lending, people familiar with the matter have said. At least one unit inside the bank is considering additional cost cuts to cope with the worsening business outlook, one person said.
Regulators, mindful of European banks’ generally low profitability, have encouraged them to use what flexibility accounting guidelines provide to delay provisioning for bad loans and soften the impact of a crisis that many hope will be short-lived. The ECB has also freed up 120 billion euros of capital by allowing banks to tap certain buffers while national authorities in the euro area have released more than 20 billion euros.
Still, analysts at Barclays predict Deutsche Bank will post losses this year and next, and warned it’s among the weakest banks on several metrics for asset quality and capital. If they’re right, that would make it seven straight losing years for the largest German bank.
“The bank is always put in this box and just can’t get out,” said Meyer at Aramea. “Every piece of negative news then serves to fulfill those ‘expectations,’ reinforces the negative bias and pushes the bank further into that box. I like Deutsche Bank best when I hear nothing about them.”