(Bloomberg) -- Deutsche Bank AG just ended a roller-coaster week. June doesn’t look any less harrowing.
Shares of Europe’s largest investment bank are trading near a record low, as short sellers pile on and credit derivative traders once again signal doubts about the firm’s health. It’s part of a painful pattern for the bank and its investors: Another spate of bad headlines keeps outweighing the good.
“They dodged a bullet,” said David Hendler, founder of Viola Risk Advisors and an analyst who’s followed the industry for more than three decades.
In coming weeks, the lender will carry out thousands of job cuts as Chief Executive Officer Christian Sewing pushes through a sweeping restructuring of the investment bank division. Before month’s end, virtually all of Deutsche Bank’s U.S. operations will finish undergoing the full scope of the Federal Reserve’s annual stress tests for the first time, with results to be made public. Sewing sought to shore up staff morale on Friday.
“Many of you are sick and tired of bad news,” he wrote in an open letter to employees. Yet the firm has also taken many important steps, reorganizing its business, reducing risk and building up capital, he said. “We’ll prove that we have earned a better valuation on the financial markets.”
The drama is the talk of Wall Street, with executives at rival companies hoping to poach Deutsche Bank’s top moneymakers and clients. Meantime, key barometers of the firm’s health show investors are jittery heading into a pivotal month.
Credit-default swaps on Deutsche Bank’s debt reflect a bearishness not seen with any of its major rivals. The contracts are now trading roughly in line with beleaguered Italian banks buffeted by their government’s turmoil.
By midweek, five-year credit swaps on Deutsche Bank almost tripled from the year’s lows, then eased some after S&P’s decision, ending the week at about 153 basis points. The surge resembles the kind of move last seen in 2016, before the Frankfurt-based bank carried out an emergency capital raise that allayed investor fears.
Unlike that time, the bank doesn’t look as shaky. S&P’s decision to lower the company’s rating to BBB+, the third-lowest investment grade, had more to do with the company’s ability to generate profits. Earlier this week, Deutsche Bank said the Fed has been focusing on internal systems and oversight, and that there are “no concerns with regard to the financial stability” of the parent company.
Indeed, Deutsche Bank has more cash to weather a storm. The firm has liquid reserves of 279 billion euros ($326 billion), almost 30 percent more than in September 2016, when the threat of a potentially crippling fine from the U.S. led some of its clients to flee. The company’s common equity tier 1 ratio, a measure of financial strength, stood at 13.4 percent at the end of the first quarter, up from 11.8 percent at the end of 2016.
Read more: For Deutsche Bank, high liquidity means this time is different
In recent years, U.S. rules have forced the bank to bundle U.S. subsidiaries into one legal entity, called an intermediate holding company. After taking a confidential trial run through the stress test last year, Deutsche Bank’s IHC is undergoing a complete exam this round. Reviewers will consider its risk controls, data-collection methods and capital planning.
Behind the scenes, the Fed has long been frustrated by the firm’s internal systems and oversight, with examiners failing the company’s custody unit in past stress tests. More recently, regulators privately lowered a supervisory rating on the bank for similar reasons, according to a person with knowledge of the situation. Mistakes that included transferring billions of dollars to wrong accounts are symptoms of inadequate controls, not the U.S. business’s capitalization, the person said.
The IHC’s capital levels far exceeded minimums at the end of the first quarter, according to its regulatory filings. Its CET1 ratio was 16 percent, and its leverage ratio, which ignores riskiness of assets on the balance sheet, 6.7 percent. The averages for the top eight U.S. banks for those two ratios were 12 and 6.5 percent respectively in the same period.
As a consequence of the lowered supervisory rating, the U.S. unit has had to seek the Fed’s approval for personnel decisions and acquisitions. Many banks get downgraded for short periods of time and reclaim their better grades when they fix their problems, the person familiar with the decision said.
The problem for investors, said Hendler, is that the firm has borrowed heavily to capitalize a business that’s still unable to churn out acceptable profits. And if the situation worsens, the company “may need a more rapid equity capitalization because they can’t earn it themselves,” he said.
©2018 Bloomberg L.P.