On Thursday, the news-flow got mighty rough on Deutsche Bank’s stock (NYSE:DB). Yet its credit seemed almost oblivious. Here is how its Credit Default Swaps (CDS) performed: 1y Sr -2bps, 5y Sr -10bps, 1y Sub -16bps, 5y Sub +12bps. Yes, all DB’s CDS were (are) close to historic wides, but they bucked the headlines of clients tightening up their collateral with the bank.
The CDS curve for remained also quite flat but not inverted (which is at least as important as the absolute levels of the credit default swaps). And perhaps the most positive data point for Deutsche Bank from Thursday was that the CDS curve on subordinated debt steepened significantly.
Move on to Friday morning trading, and the bits and pieces I was picking up while away from the screens was that DB stock and credit was melting down… Until, that is, headlines began suggesting that the DOJ would slash its extortion demands from $14B down to $6B. Deutsche Bank’s stock price (DB) ripped higher and so did the 5y CDS. But here is the catch: the 1y CDS’ blew out and actually closed near the worst levels of the day. In other words, if yesterday the CDS’ ignored the headlines and stock action, today they acted pretty horribly in the face of seemingly good news, and a sharp positive reversal in the stock.
So just what the hell is going on?
I won’t pretend to have a definitive answer, but at risk of sounding like I have my head in the sand, I just don’t see how Deutsche Bank (DB) blows up based on its fundamentals. Yes it has A LOT of leverage but there is no sign that its underlying credits are going bad. And if the jitters are based upon the potential need for $14B of new capital, I bet you dollars to donuts that people would pile all over themselves to buy $14B of preferred stock at mid/high single digit yields.
The obvious and real risk is that despite a recapitalization, DB would suffer a run-on-the-bank based only on a loss of confidence in its balance sheet. Such an event would be obviously disruptive and scary, but if there ever was a financial backdrop capable of handling such a wreck, what we have now is it. US financial institutions are in better shape than they have ever been, and given their lack of exposure to anything risky it’s hard to envision how DB presents a systemic risk for them. Second, if there is anything bulls and bears should be able to agree on, is that none of the derivatives DB is lugging around are anywhere close to the US money markets; Dodd-Frank took care of that bit of business for good, and without spill over damage to the money markets, widespread panic is unlikely. Third, Bloomberg this week noted that in the US alone there’s $950B of dry capital looking for opportunities: that’s almost 5 times what was necessary to rescue AIG, and AIG had derivatives exposure up the wazoo, at a time when the rest of the world was imploding around it. Lastly, for all the utterly useless efforts of central banks to pump up the real economy, I would hope most would agree that if there’s one thing that they have mastered, it is the art of the bailout.
I’m not saying that a DB meltdown would not shake things up; the stock market would take a sharp, albeit brief, hit and lots of people would probably get hammered. But that’s a far cry from a systemic financial collapse. Away from DB, the financial system is nothing – and I mean NOTHING – like the mess it was in 2007-2008.
My guess is that the DB story will have many more positive and negative twists and turns before it cools off for good, but even if its faith were to turn for the worst, betting that its demise will prove the catalyst for a repeat of ’08-’09 will be yet another disappointment for the ursine crowd.
A financial meltdown will eventually occur, and I believe it will be way worse than ’08-’09, but in my humble opinion it won’t arrive on the back of Deutsche Bank, let alone in the near future.
Twitter: Â @FZucchi
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
