The news that Deutsche Bank (DB) was raising additional capital to buff up its balance sheet was well received by investors. Past capital raises by the giant banks around the world have been greeted with aggressive selling, but the reactions to the large German bank’s move was fairly muted.
The bank announced that it had sold a 1.75 billion Euro stake to Paramount Holdings, an investment fund that is owned by Sheik Hamad Bin Jassim Bin Jabor Al-Thani, a member of the Royal Family in Qatar. DB will also do a rights offering in June that will raise an additional 6.3 billion from existing shareholders. The move bumps the bank’s capital ratio up above 11% as Deutsche Bank looks to pass the stress test being conducted by The European Central Bank.
The results of the stress test are expected to be released in October. The test assumes that the Eurozone slips into a two-year recession that causes a collapse in stock and housing prices. Interest rates would spike and unemployment in the region would climb to a staggering 13%. To pass the stress test, banks must survive this new version of the dark ages with a capital ratio of at least 5.5%.
I suspect we are going to see something of a mad dash for capital in the next few months as banks look to strengthen their balance sheet to pass the rigorous tests. We will also see a big upswing in asset sales as banks look to move riskier or poorly performing credit related assets off their books.
The situation in Europe reminds me very much of the banking sector in the United States back in late 2009 and 2010. Most of the big banks and many of the regional banks had to raise capital in order to get their balance sheets back in line after the credit crisis caused bad loans to spiral. Most of the banking stocks had sold off to well below book value, and once the dilutive equity offerings were done these shares were an incredible bargain. I suspect the European banks will play out in exactly the same fashion.
It is hard to know exactly which banks will raise capital at which point in time but we can identify those that are the cheapest right now. The way to play the Eurozone banks is going to be exactly the same as we did the US regionals in 2009. Investors looking to profit from the deleveraging of European Banks should look to buy a small position in some of the cheapest stock and be prepared to add to their stake after a capital raise is done. A more conservative approach is to wait for the raise to be completed, but you run the risk of missing a big move in bank that is able to de-risk without new money. It will be a volatile strategy, but I expect to see the same long-term results as we did here at home.
Some of the cheaper banks in the region right now include Commerzbank (CRZBY), Barclays (BCS), Societe Generale SA (SCGLY) and Deutsche Bank. It may be time to start accumulating these shares — but stay small and move slowly. Odds are very high you will be able to add to your position at lower prices as we get closer to the stress test results.
As of this writing, Tim Melvin was long CRZBY and SCGLY.
