Don’t look now, but the eurozone crisis is back from the dead. Call it the zombie crisis.
The concerns over Europe’s banks, fresh bailout troubles in Greece and political turmoil is Spain is adding to an already long list of worries for Wall Street.
The Russell 2000 small-cap index has returned to levels not seen since the summer of 2013 for a total loss of roughly 26 percent from last year’s high.
Deutsche Bank AG (USA) (DB) in particular is getting hammered, pushing the stock price below the 2008-09 financial crisis lows.
Below, I’ll explain why.
Political Climate Hitting DB Stock
Eurozone sovereign bonds (the cornerstone of European bank balance sheets) are taking it on the chin as political risk pops back up. Spain is suffering political volatility. And Greece is once again having bailout issues, with a big repayment schedule later this year and disagreements over needed budget and pension cuts.
This is hurting the banks, as asset price declines add to rising capital requirements amid a tougher regulatory environment and falling profitability as loan volume remains anemic and net interest margins are pinched by a recent downward turn in long-term interest rates (with a growing share of rich-world countries carrying a negative interest rate on their long-term bonds).
DB is being singled out as the sharks — I mean traders — in the credit markets as they smell blood in the water.
The attacks are happening in the obscure areas of the European debt market, with the value of Deutsche Bank contingent convertible, or “CoCo,” bonds plummeting (on fears of conversion into equity) while the value of its credit default swaps (a measure of fear) soar to levels last seen in 2011. Deutsche Bank became a target after reporting disappointing quarterly results, leading analysts at CreditSights to highlight rising default risks.
The kicker is that the recent move by the European Central Bank and the Bank of Japan to push policy rates into negative territory weakens banks by pushing net interest margins (the gap between loan and deposit rates) even lower. Investors are kind of freaking out about this, because it risks undermining the thesis that more monetary policy stimulus is always and everywhere a good thing.
More negative rates now would only further weaken the banks. More asset purchases would further reduce the supply of the high-quality collateral banks need for inter-bank lending. And CoCos were created in the wake of the financial crisis as a way to “bail in” investors should banks get into trouble again, providing a relatively easy way to restructure troubled bank balance sheets by converting debt to equity.
Deutsche Bank responded late in the New York session Monday by issuing a statement defending its liquidity position, attempting to reassure investors that it has enough cash (more than $1 billion in 2016 payment capacity) to pay more than €700 million in payments due this year.
Embarrassingly, based on the losses the stock suffered most of Tuesday, the gambit didn’t work.
The latest news, as reported by the Financial Times, is that DB stock is considering a multibillion-dollar bond buyback in an effort to boost the value of its own securities. It has more than €220 billion in liquidity reserves, some of which could be applied to some of its more than €50 billion in outstanding senior bonds, more than €5 billion in CoCos, more than €6 billion in junior subordinated debts and more than €5 billion in legacy tier 1 debt.
Questions linger over DB stock’s €4.3 billion in 2017 payment capacity, to be hit by 2016 operating results — results that will be made worse if the Spanish political situation worsens or Greek bailout talks falter over budget and pension issues.
There has also been chatter about possible insider sales at the bank.
The stakes have been raised for the European Central Bank’s next policy meeting in March as officials keep searching for a solution to an intractable problem.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
