A few thoughts on Banking Stocks (Lehman 2.0, Deutsche Bank)
History repeats itself, at least it looks like this in the banking sector at the moment.
Stock prices are dropping like stones and CDS spreads are “exploding”:
Everyone it seems is looking for the next “Lehman”. So far the “favorites” within the group of global banks for “Lehman 2.0 – the sequel” seem to be Credit Suisse and Deutsche Bank. Here a quick overview on 1 month returns for a selected group of banks:
|1 Month return|
|DEUTSCHE BANK AG-REGISTERED||-30,3%|
|CREDIT SUISSE GROUP AG-REG||-29,1%|
|SOCIETE GENERALE SA||-22,8%|
|DEUTSCHE PFANDBRIEFBANK AG||-21,2%|
|UBS GROUP AG-REG||-18,5%|
|LLOYDS BANKING GROUP PLC||-12,9%|
|HSBC HOLDINGS PLC||-11,2%|
|VAN LANSCHOT NV-CVA||-3,2%|
|SKANDINAVISKA ENSKILDA BAN-A||-0,9%|
We can see two things in this table:
- German listed banks are hit hardest as a group
- Local banks (Van Lanschott, SEB, Lloyds) in general look better
Both, Credit Suisse and Deutsche Bank have new CEOs who of course, try to put everything bad into the old year which led to significant write-offs at year end. The majority of those write-offs were however Goodwill positions of acquisitions from long ago which have no impact whatsoever on what business they can write.
Additionally, and that was part of the thesis for my own bank investments, I do think that banks are now a lot less risky than for instance in 2007/2008. Let’s look at Deutsche for instance and compare 2007 vs now:
|Book value of equity bn||37||68|
|Total balance sheet bn||2.020||1.626|
|Equity/total balance sheet||1,8%||4,2%|
|Tier 1 Ratio||8,6%||14,7%|
I am well aware that this could be my “famous last words”, but I don’t think that Deutsche Bank will be the next Lehman. Deutsche Bank is now clearly better capitalised than before the financial crisis, plus the US and the EU have now all the rescue mechanism in place to prevent a disorderly failure of any bank.
Don’t get me wrong: I am not proposing to invest into anything with a large investment banking business. For me, investment banking is very similar to investing in a European Soccer team but without the television revenues. As in football, the bankers themselves still manage to get the biggets slice of the pie and the shareholder is almost always the idiot. From my personal contacts I heard that compensation across the industry in 2014 and 2015 was already at the same level or even better than before the crisis in 2007-2009.
Example for panic reactions: The “CoCo issue”
A good example how the current panic drives even Bloomberg to issue absolute misleading headlines are the socalled “CoCo” Bonds, issued by Deutsche BAnk 2 years ago.
The headline of the Bloomberg article/interview was as follows:
Deutsche Bank Says It Has the Cash for Riskiest Debt Payouts
This of course made many investors even more nervous. Whenever you hear a bank assuring the public that they have enough cash, then most likely they haven’t.
But what was wrong about the headline ? Well, the question is not if Deutsche Bank has enough cash to pay those instruments, but if it can fullfill the “covenant” of the bond. In order to qualify as Tier 1 capital, those bonds do have certain conditions attached.
In the “CoCo” case, one of the triggers is the local GAAP result of the holding company which could be a constraint. The important point however is: This has nothing to do with cash, only with Accounting and in this case some relatively “easy to influence” German accounting rules. The chart of the CoCo clearly doesn’t look nice:
I think Deutsche Bank made the mistake to call it “Payment capacity”. Only in the last sentence they somehow explain that it doesn’t has to do anything with liuidity:
The final AT1 payment capacity will depend on 2016 operating results under German GAAP (HGB) and movements in other reserves.
However I guess that few pundits actually read those announcements until the end.
Again, I am not saying that anyone should buy those bonds. I don’t think that the risk/return relationship of CoCos is attractive, but it clearly shows how people do not really pay attention to details at the moment.
CDS liquidity and “true refinancing” costs
Another aspect is often overlooked by people who show those scary CDS charts (like me before):
The single name CDS market has become very illiquid, partly because the banks themselves do not make the markets anymore.
Before the crisis, the CDS market was very liquid and CDS spreads were a good indicator on how banks could refinance themselves in the capital market. However a few years ago, theat connection “broke”. In the process of determining bond yields at issuance, CDS spreads don’t play a big role anymore. It is quite common that bonds price well “inside” CDS spreads theses days.
This is for instance an overview at current trading level for a 5 year Senior Deutsche Bank bond (12/2020, 1,75% ISIN DE000DB7XLP5):
What we can see are 2 things:
- Yes, the spread for the bond increased from ~50 bps over swap to currently 100 bps.
- But also the basis of the CDS increased by the same amount. The “basis” means that CDS markets require a much higher credit spread (at the moment 100 bps) than the cash market where the real bonds are traded.
At least form me this shows, that the CDS spreads seem to be driven by market participants which obviously try to “replay” the “Big Short” to a certain extent.
As I said before, this could be my “famous last words”, but in my opinion, at least for the moment, I don’t see a Lehman 2.0 scenario coming.
I clearly would stay away from investing into global investment banks anywhere in their capital structure because I think their business model is permanently challenged.
You can surely try to trade them but that is not my kind of investment style (anymore).
However I still think that there are opportunities for smaller, focused and well run banks. By the way, I am not buying the whole “Blockchain / Peer-to-Peer” hype but that is something for a seperate post….
For my own positions, I will keep all of them for the time being. I think Pfandbriefbank is a victim of the suspicion against Deutsche. I am not sure why Citizen dropped so much and the others (Lloyds, Handelsbanken, Van Lanschott) so far seem to be insulated to a lrage extend from the current panic.