Another week, another bank.....

Not good!

It feels obligatory to at least say something about Deutsche Bank. Like Credit Suisse, the German bank is a major and systemically important bank that has struggled to find a new identity and working business model for years. Also, like the Swiss lender, Deutsche is also closely associated with a single, very wealthy European country. Of course that country is Germany.

For Deutsche, the last decade plus has been a long and very sordid tale that is both unique to itself in parts and emblematic. They were the bank that defined the swinging days before the Great Financial Crisis and since then have become a byword for just how hard it is to overhaul and change the culture of a "too big to fail" financial institution.

For years, they shared this status with Credit Suisse though, to be fair to them and as we lay out below, they are both very different and in recent years arguably in better shape than their Swiss counterpart.

That isn't to say they aren't a mess, just a very different sort of mess. Right now, from the heart of the vortex, the identification as a mess may be all that matters however.

But to try and put a little more context around their current travails:

Deutsche Bank is a struggling bank in the sense that they are perpetually trying to get out from under the mistakes of the pre and post-crisis years and get back to profitability while also carving out a new business model that does not rely on the risky and volatile flows from investment banking and proprietary trading.

Directly thanks to those business silos and their cutlure, the years after the financial crisis brought endless regulatory headaches, profit warnings, trading losses and, above all, anger from the German state and German voters.

But these days, Deutsche Bank have actually been doing remarkably better:

• For one thing, unlike Credit Suisse, Deutsche Bank hasn't had a major regulatory black eye since 2017 (money laundering). We stress the word "major" there.

• Second and perhaps most importantly, unlike Credit Suisse again, they have lots of stable deposits, two thirds of which are insured. Huzzah!

• One of the many impressive aspects of these deposits is, to put it a bit unkindly, Deutsche was a serious dumpster fire for over a decade and those deposits generally didn't budge. There was endless "sturm und drang" and huge public anger in Germany where most of the deposits are located and yet they generally stuck around.

• Furthermore, Deutsche even made money last year! At $6.1 billion net equivalent profit that is the most money they have made since 2009 (!) and will likely do relatively well this year as well (meanwhile, Credit Suisse lost $8 Billion last year). Retail banks do well in rising environments because they can clip a significant arbitrage between what they pay their depositors and what they can get from the yield on safe securities like government bonds.

• Most importantly, their leverage, their Hold-To-Maturity securities, their available Tier 1 Capital (don't ask), all of the issues that classically expose banks to real risk of insolvency, are in excellent position and incredibly low or high, as the case requires. Their leverage might be a bit high, relative, but a lot of that is for historical reasons tied to old (bad) assets.

Basically, because of their past (very real) travails, Deutsche Bank is now a very low leverage, low risk, sticky deposit, boring retail bank. Because of the many problems in the recent past and the huge amount of criticism and regulatory oversight, the bank is now de-risked.

This makes it an uninteresting investment but it also makes it, perhaps already, "too good to fail."

So, what is happening? If DB is supposedly fine and doing better than at any time in the last 15 years, what is going on?

Well, there are a few threads to the current unraveling:

Part of what is happening is that, all of a sudden, there are still lots of fear, uncertainty and doubt (FUD) about the global banking system. Higher interest rates have broken several banks and people are justifiably wondering who could be next.

Obviously some speculators - and many of them of the "highly aggressive hedge fund fast money" variety - have zero'ed in on supposedly the next weakest of the herd - the unlucky Deutsche.

The fact that they are being blamed for past transgressions and have tried hard to put this all behind them may not matter much at present.

Because, as we have discovered with the bank runs in the US, one of the problems with this crisis is they can rapidly become a self fulfilling prophecy. Everyone becomes concerned about the safety of their (unsecured) deposits in a bank and suddenly that can become an existential question in a heartbeat.

At its core, this is likely driving quite a bit of the current trend of speculators buying the Deutsche credit default swaps - which are derivatives that payout if a company goes bankrupt - and causing the share price to plummet as a result. Above all, they may be hoping that they make a lot of money from a time period when trust is low in the financial system and poorly run banks.

Here are the DB credit default swaps. As a reminder, these are complex derivatives but rise in price as the price of insuring against default rises. As you can see, these levels are elevated but not extreme:

These contracts are both illiquid and also must be held for a minimum of 60 days which suggests they may also be purchased by investors who are owners of the stock (and are therefore "long") and trying to hedge their position. So, ironically, the current anxieties could be driven by current investors IN Deutsche simply trying to smartly de-risk their exposure.

Ha.

Aside from that irony there is also the fact that once we are confronted with individual investors doing what is not just rational but also prudent and yet collectively causing very unpleasant questions to be raised.

In that line of thinking, from our dive in DB's recent numbers, there is perhaps one exception to our semi-glowing assessment however:

Their exposure to commercial property loans.

This portfolio is supposedly well diversified and also well-managed but considering the issues with high priced commercial property and the drop off in office-use could this mean that defaults could be rising in this book which will hurt profits and possibly even necessitate raising more capital?

The problem with this thesis is it is very plausible but it is also plausible for many other banks, German, American and otherwise.

Moreover, this could be true in the quarters to come but it seems difficult to imagine now. After all, those loans are fine as of last quarter's earnings report and nothing has deteriorated that much since then.

In the end, we would argue that this feels more like a combination of existing shareholders taking prudent care to hedge their exposure AND a speculative attack from the fast money sharks that smell blood in the water and want to capitalize on a time when banks - and regulators - can be easily bullied because of depositors being on edge.

As a reminder, we typically hike interest rates until we break things. Time will tell if Deutsche will join SVB, Silvergate and Credit Suisse on the heap of broken things but we doubt it.

The bigger problem might be that the current regulatory shift in Europe might make it even less attractive to work or bank with an institution that can't catch a break. As a few people have asked over the year, what is the point of an institution like Deutsche?

Speaking of breaking things, what about the wider economy?!?

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