Deutsche Bank CEO Returns Home Empty-Handed After Failing To Reach 'Deal' With DOJ: Bild

Tyler Durden's picture

Following the seemingly endless procession of short-squeeze-fueling trial balloons last week - from settlement rumors to German blue-chip bailouts to Qatari investors - Germany's Bild newspaper confirms the rumors that sparked weakness on Friday: Deutsche bank CEO John Cryan has failed to reach an agreement with the US Justice Department.

Having soared over 25% off the briefly single-digit price levels thanks to well-chosen rumor headlines of an "imminent settlement", news and facts on Friday started to eat away at that confidence...

 

And now, as Bloomberg reports, Deutsche Bank's Chief Executive Officer John Cryan failed to reach an agreement with the U.S. Justice Department to resolve a years-long investigation into its mortgage-bond dealings during a meeting in Washington Friday, Germany’s Bild newspaper reported.

The meeting was meant to negotiate the multi-billion-dollar settlement the bank will have to pay to resolve alleged misconduct arising from its dealings in residential-mortgage backed securities that led to the 2008 financial crisis, according to a Bild am Sonntag report.

 

The German lender is still considering seeking damages against Anshu Jain and Josef Ackermann, who are both former CEOs of the bank, the newspaper reported. Bild said the bank froze part of the millions in bonus payments to Jain and other former top managers.

 

A Deutsche Bank spokeswoman declined to comment to Bild about the outcome of Cryan’s Friday discussion or about clawing back former executives’ compensation. Mark Abueg, a Justice Department spokesman, declined to comment.

Cryan, a Briton who speaks fluent German, has sought for the last three weeks to reassure investors that Deutsche Bank can weather the formidable obstacles to its financial health. His arsenal of strawmen include: denials of bailouts, blaming speculators, rumors of informal capital raising talks with Wall Street firms, rumors of capital injections from Germany's blue-chip corporations, rumors (denied) of Qatari sovereign wealth fund investments, and the sale of key assets and elimination of thousands of jobs.

 

So what happens next?

Three things:

1) The "settlement-imminent"-driven 25% short-squeeze in stocks - completely decoupled from credit market's less optimistic perspective - is going to end badly...

 

2) Deutsche Bank will need to raise more capital and that just became more problematic after the bank quietly raised $3bn in a senior unsecured bond issue on Friday at a very wide concession...

Some have wondered why the need to sell new paper at such a wide concession: after all as we reported before, DB has no current liquidity constraints courtesy of substantial ECB generosity, which backstop DB's existing liquidity reserves of just over €200 billion.

 

 

 

... while issuing debt does nothing for the bank's net leverage, and in fact could lead to an erosion of certain credit metrics.

 

If anything, the push to obtain cash may be seen by some as an indication that management is taking advantage of the recent stock price rebound window to offload securities to investors, which alone could lead to more pressure on the bank.

 

After all, the question immediately emerges: "does DB know something investors don't?."

3) A "bail-in" is more likely than a 'bailout', and as we detailed earlier, and here's how it can be done... Jonathan Rochford, PM of Australian hedge fund Narrow Road Capital, explains that despite all the recent confidence-building rhetoric and posturing, Deutsche Bank will need a bail-in. In the following analysis he explains how it would (and should) be done.

Following the confirmation that hedge funds have started to reduce their capital and trading with Deutsche Bank its position is now perilous. It is correct to say that Deutsche Bank doesn’t have a liquidity crisis and that even if it did the Bundesbank could provide it with unlimited liquidity. But liquidity alone doesn’t guarantee a bank can continue to operate in the long term, solvency and profitability are essential as well. Deutsche Bank is at best borderline for both solvency and profitability with little prospect of either improving materially in the medium term. Deutsche Bank needs to substantially restructure its business activities and balance sheet, both of those will take time and capital neither of which Deutsche Bank has.

 

Insufficient Capital

 

Unlike other global banks Deutsche Bank has failed to adequately lift its capital levels since the collapse of Lehman Brothers eight years ago. It has been allowed to remain undercapitalised due to weak European regulators, which are fighting against global efforts to have all banks increase capital levels. Whilst German and Italian regulators are fighting for lower capital levels and avoiding dealing with their problem banks Switzerland and the US are implementing much higher capital levels, particularly for the largest banks.

 

On Deutsche Bank’s preferred measure, risk weighted assets, it sits behind most of its peers. That’s after it has gone through a capital optimisation exercise which reduced risk weighted assets without reducing their balance sheet by the same proportion. On the more rigorous leverage ratio shown below, Deutsche Bank is dead last at less than half of its peer group average. When Europe’s most systemically important bank is the most poorly capitalised of its peer group that is a major problem that needs to be corrected as soon as possible.

Source: FDIC

 

Deutsche Bank’s current equity at book value is €61.9 billion but its market capitalisation is only €15.8 billion. Its total assets are 114.3 times its market capitalisation and its price to book ratio is 25.5%. The only peers with ratios this bad are Italian banks who have dubious solvency and very high levels of non-performing loans. To get from the 2.68% tier one capital ratio shown above to the 5% leverage ratio many consider the minimum acceptable level requires €40.1 billion of new equity.

 

Not Profitable

 

There are three primary ways for a bank to increase its capital. Firstly, profits can be retained rather than paid out as dividends. Deutsche Bank hasn’t been meaningfully profitable since 2011. The table below shows the net income after taxes for Deutsche Bank since 2009. The combined total of the last seven and half years is €7.8 billion, an average of €1.04 billion per year. That equates to a return on equity of 1.68% since 2009. Over the last four and a half years the cumulative loss is €3.8 billion with the average return on equity -1.38%.

The CEO has stated that 2016 will be a peak year for restructuring, meaning investors should expect a loss for 2016. The fine being negotiated with the US Department of Justice will have a significant impact this year. Further fines for new scandals, the difficulties of operating in a negative interest rate environment and the potential for another European or global downturn mean there is a material risk of losses continuing in future years. Given sufficient time and capital Deutsche Bank would restructure substantially, ridding itself of unprofitable and low return activities. Unfortunately, it has squandered the opportunities it had over the last eight years and now doesn’t have either the time or capital needed to facilitate the necessary cuts.

 

Assets Sales Not Sufficient

 

The second way to raise capital is to sell assets and Deutsche Bank is making a great deal of noise about its asset sale plans. The sales of the UK and Chinese insurance businesses will together raise approximately €4.5 billion. A sale of the asset management business might raise €10 billion. Altogether that’s €14.5 billion which is helpful but not nearly enough. The flipside of asset sales is that future profits are reduced, exacerbating the profitability issues already outlined.

 

Sufficiently Large Capital Raising Near Impossible

 

The third way a bank can strengthen its balance sheet is by conducting a capital raising. The problem for Deutsche Bank is that the amount needed is simply too high based on the current metrics. Any investment banker will tell you raising 254% of market capitalisation is extremely optimistic. To achieve that for a business with a history of being marginally profitable is near on impossible.

 

A Bailout or Bail-in is Needed

 

Taking into account the lack of capital and the very unlikely prospects for an equity raising or asset sales to be sufficient, Deutsche Bank needs either a bailout or a bail-in. A bailout by the German government is legally possible given the gaps in the regulation that can be exploited. The key question is whether the German government would be willing to do so. In recent years Angela Merkel and her key ministers have consistently denounced the possibility of the Italian government providing a bailout to Italian banks. In recent months they have been adamant they won’t bailout Deutsche Bank.

I’m cynical enough to know that politicians can change their minds extremely quickly when the pressure is on. I acknowledge there is a decent chance that the German government will do that soon. What the rest of this article aims to show is that there is a way to recapitalise Deutsche Bank without taxpayer funds. If there’s a decent solution that doesn’t involve taxpayer funds I think that solution can win out.

 

Bail-in Mechanics

 

The recently introduced European regulations lay out a framework for how a bail-in would work. Equity, additional tier 1 securities (Coco’s or hybrids) and subordinated debt can be written off completely if the bank is declared non-viable. Senior debt, particularly that provided by large institutions can also be converted to equity in order to lift reserves. By undertaking a combination of those two processes Deutsche Bank’s undercapitalisation could be quickly rectified.

 

The table below lays out the liabilities and equity on Deutsche Bank’s balance sheet. Equity, additional tier 1 and subordinated debt securities are broken out. Senior debt has been broken into two categories, the portion which could be expected to be bailed-in and that where it is uncertain. For the purpose of this exercise a conservative approach has been taken, the amount that could be bailed-in is likely much larger.

How Much More Capital is Needed?

In determining how much additional capital is needed a target capital level must be chosen. If a bail-in is executed it needs to be a one-time exercise that removes all concerns about Deutsche Bank’s solvency. Lifting the core equity tier 1 ratio just to the average level of its peers is not enough, it must go much further.

 

A core equity tier one leverage ratio of 9% would lift Deutsche Bank to the top of the list amongst its global peers. This would provide strong reassurance that another bail-in won’t be needed. It would also provide breathing room to undertake the overdue restructuring of unprofitable and marginal businesses. At a 9% level, another €111.5 billion of tangible equity is required. This would come from the write-off of additional tier 1, subordinated debt and €98.5 billion of senior debt being converted to equity. This implies that 63.1% of the senior debt able to be bailed-in needs to be converted to equity.

For every €100 they are currently owed bailed-in senior debt holders would receive €36.90 in new senior debt as well as material value in new equity. To assist the transition, the regulators and Deutsche Bank should work together to see that those who receive new equity can be offered a transparent and orderly means to sell down those shares. Whilst Deutsche Bank could theoretically just restart trading after the new shares were issued, relisting without an opportunity for new shareholders to sell down to more natural equity owners could be substantially disorderly and may result in much greater losses in value and confidence in banks than would otherwise be the case.

 

Potential Capital Sell-Down Process

 

There’s two types of approach that could help facilitate the sale of shares by those who are seeking to exit; a rights issue model and an IPO model. The table below summarises some of the different features of each that could apply in the case of a Deutsche Bank bail-in.

 

The rights issue model is the most efficient, but it doesn’t allow for Deutsche Bank management to prepare a solid pitch to potential new investors. Management would have only a few days to develop their strategy for making the bank profitable again and limited time to explain that to the many large global investors that may want to buy shares. The IPO model takes longer, but would allow management to put forward a clear plan on what businesses it will exit, what that will cost and the additional profitability that could be generated over time. The downside of the additional time is that it increases the potential for contagion to other banks as investors remain unsure of what recovery they will receive on their new shares for a longer period. Allowing over the counter trading to continue on senior debt would allay some of these concerns.

 

As a guide to the possible recovery for bailed-in senior debt, other European banks were generally trading at 0.5 to 1.0 times book value in early September. This implies the new equity is worth €89.2 – €178.4 billion. When combined with the new senior debt of €57.5 billion this a total recovery of 94.0% – 151.1% on the old senior debt. If an IPO process was used this would open up the opportunity for the old subordinated debt, additional tier 1 and equity owners to receive some value. If a bookbuild ended up realising more than a 100% recovery for senior debt holders, which is reached if the price to book is 0.55 or above, the additional value could be allocated to the subordinated capital owners via the natural order of priority. This process would largely eliminate arguments that value wasn’t maximised, neutering the possibility of ongoing litigation as has been the case with Fannie Mae and Freddie Mac.

Conclusion

Deutsche Bank’s position is currently marginal as it is woefully undercapitalised and has no clear prospect of becoming meaningfully profitable. As the world’s largest derivative trader and Europe’s most systemically important bank this is untenable. Deutsche Bank is three times larger than Lehman Brothers, making the possibility of an unexpected and uncoordinated failure completely unacceptable. Deutsche Bank needs substantial time and capital to execute a turnaround, neither of which it now has. It does not have the profitability to grow its capital base quickly or to support a capital raising of the size it needs. Deutsche Bank needs either a bail-in or a bailout.

An orderly bail-in process would deliver Deutsche Bank the additional time and capital it needs. In the first instance, the bank should be declared non-viable with all equity, additional tier 1 and subordinated debt written off. By converting 63.1% of long term senior debt to new equity the leverage ratio would increase to an unquestionably strong 9%. Based on recent peer comparisons, bailed-in senior debt holders would receive a recovery of at least 94% of their current position. Using an IPO model, where management develops and presents a new strategy to potential investors over a 2-3 month period, would allow the recipients of newly issued equity an orderly process to sell-down their equity. It also creates the possibility of a substantial recovery for subordinated debt, additional tier 1 and equity investors.

*  *  *

If the Lehman playbook continues to play out as it has done - denials of any problems... blame speculators... unleash short-squeeze on heels of rumors of foreign sovereign wealth fund investments... and finally acceptance - this will not end well...

 

Perhaps it's time once again to listen to DoubleLine's Jeff Gundlach, whose advice was simple: don't touch it. "I would just stay away. It's un-analyzable," Gundlach said about Deutsche Bank shares and debt. "It's too binary."

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What a mess_man's picture

This sucker's gonna blow!

ACES FULL's picture

Very informative article. Thanks Tyler.

kliguy38's picture

Dear DB.....You've been tagged for extermination by the boyz.......gl

Loftie's picture
Loftie (not verified) kliguy38 Oct 9, 2016 1:03 AM

The SAUDIS withdrew their $ following Congress's stupid Sept 11 Bill.
https://goo.gl/oehIgG

philipat's picture

This is more than just a war between the boyz. This is an economic war between the US and Europe. It started with the VW plant in Russia, then the US penalties on VW for emissions software (You think that US manufacturers weren't doing the same?), then Apple tax, now DB penalties. I am NOT a supporter of Deutsche Bank but do you really think that they committed more fraud than the US Banks (In the US?) and, if not, why were the US Banks not fined by similar amounts? Or were they all just doing God's work? This is all a bit of a joke really.

If I were Germany, I would bail our DB, leave NATO and stop supporting US war efforts in the ME, then stop supporting US sacnctions of Russia and move into a stronger alliance with Russia and China. In a war, one has to do what one has to do?

EasterBunny's picture

Don't forget TTIP. The US seems desperate to push the trade agreement through. I can't help feeling like this is also related; pressure to fall into line and sign.

philipat's picture

It seems that TTIP is basically dead. There is too much open public opposition and, probably in response, the politicians in core Europe, Germany and France, had to pull back support. TPP is more of an open question because the nations in the Pacific rim have much less individual negotiating power and have no collective bargaining unit like the EU. Obama seems determined, despite widespread oposition, to try to push TTP through the lame duck Congress (As instructed by the fascist "elites" to whom he reports) where many of the corrupt assholes can be bribed and payed-off with promises of future lucrative income without worrying about re-election. The US political system is totally corrupt and broken.

Tarzan's picture

In the future, if we live to see it, all that will matter is SKILLS!  You either have the ability to produce something needed, something useful, or you will go without.  You work or you don't eat.  It's a powerful motivation, the gut...

 

So, all of these people expect to get a huge amount of spending power without producing anything. At the same time, workers expect to get spending power that is equal in value to what they are giving. They all can’t be satisfied."

 

This is the problem with a debt ponzi scheme, everyone expecting to prosper on someone else's dime.  If it's worth a dime we want a quarter for it.  If someone else gets a quarter, you want even more, everyone is trying to get over on the other guy, and there are a hoard of middle men between what you produce and the purchaser of your labor, sucking up the wealth of both.

In a debt free society, I know, they're so rare it's as though it's an ancient myth, Barter is based on equal value, when the deal is done, the art of barter is that both parties leave happy!  It's such a far removed financial system, that most don't even believe it's doable, as the Bankers would like you to think.  The whole world has been baffled by the "brilliance" of crooks!

In a debt free system where all work and nobody eats free, people would actually work less away from home.  You could feed an entire family on one mans work, there would be no free loading middle men sucking up your labor, and anyone selling his goods for an inflated price would shortly find no one to trade with!

I know, then you would all have to work hard, and sweat, what a stupid idea, go back to slaving away, go back to sleep, the sand man calls....

American Psycho's picture

I am sensing an inverse relationship between the the solvency of the bank and the number of news headlines pointing to clear skies. 

eforce's picture

With Soros shorting them did they really expect a deal with the DoJ? 

ThaBigPerm's picture

Couldn't a bail-in itself trigger a CDS avalanche, something a bail-out would avoid?  And might this not be part of the consideration?  Swaps on DB have probably been selling like hotcakes lately, so who's the counterparty(ies) holding the brown end of those sticks?  And how much will they have to shell out if DB has to write off billions in liabilities?

BullyDog's picture

Short soros life,, Invent that time machine and tell his mum to swallow.

RAT005's picture

The Illary (s)election committee has not finished using the mileage of Trump attracted to women story yet to monetize a DOJ deal with DB.  The Democrap party to Europe rescue only if needed for the (s)election, otherwise better the DB carcus be thrown to Illary pay to play contributors for them to take what they can.

azusgm's picture

RE: Tarzan's remarks

Exactly why I choose to transact in cash. I love the feel of cutting out the banks as much as possible and delivering that "discount" to the person/entity who delivered the goods or service. I pay my taxes. I expect them to pay their taxes. There is no reason to create a fee for them to pay if I don't have to. This also keeps more of my business my business. My spending habits are my business.

I use my mother's rewards card at the grocery store and pay cash. She lived with me for the last 5 years of her life. The coupons come here.

GreatUncle's picture

Agree but more simplistic what you have stated is too complex.

You got 100 billion in debt it costs how much YOY to support it, just a figure say 10 billion.

You have a real economy of say 20 billion struggling to service the YOY payment and losing.

DB, so big ... blow that fucker now.

100 billion = 0, 10 billion YOY = 0, economy probably collapses to 4 or 5 billion a massive hit (NEEDS ECONOMY REMAINS).

Now lend the economy 10 billion (you were paying that fucker already).

10 billion, 1 billion YOY, real needs economy 4-5 billion and you grow again.

THE BACKSTOP IS THE REAL NEEDS ECONOMY REST GOES TO SHIT.

That is what they did not comprehend in 2008 with the TBTF and it is still on the cards but the longer they leave it the greater the amount and turmoil. The continual 10 year Keynesian reset of the economy and recession is to play and extend the game by burning out malinvestment accrued during the 10 year cycle. Now in 1990's some fucker decided to stop playing this game and now we got a 25 year exponential supercycle of bust to do and the amount is growing because bad debt has now got compound growth YOY.

It really is a no win situtation.

 

 

DeadFred's picture

Who knows if they committed more fraud? The whole system is opaque. What is clear is the DOJ knows that this poses a big systemic risk and they are doing it anyway. The evidence suggests that the end game has finally arrived.

Arnold's picture

I agree with your perception,Fred.

The accommodation Tarot card has not been dealt.

But we have seen the train coming in the tunnel a long time, so forgive my skepticism of your certainty.

nscholten's picture

Everybody can see that; that is why there are 27 up votes.  But to think that is the only layer of the onion is ignorant. 

RAT005's picture

Well said.  I bet more than half of Germany already feels the same way.  Well more than half not counting the rapefugees.

philipat's picture

Hey Loftie, a/k/a mofio, santafe, Aristotle of Greece, Gargoyle, bleu, oops, lance-a-lot and others. Lance-a-lot got banned very quickly so time to re-use another old persona (non grata)?

You are a serial spammer and a serial pain in the ass. Might I politely suggest that you go fuck yourself? And get a life.

nscholten's picture

Again, why don't you just stop being so concerned about what links a posted fat fuck phili.  Ah, just don't read it you jew fuck.

booboo's picture

Thrown off Kazan Island (after they have rifled through your belongings to see what they can pilfer

Fisherman Blue's picture

"This sucker's gonna blow!" I really hope so, could be why they have been smashing gold .

Raffie's picture

Yup.....

You'd think the DOJ could have gave DB a muffin basket so they don't leave empty handed.

This week should be highly interesting with China banks open as well.

. . . _ _ _ . . .'s picture

Monday's gonna' suck and blow.

38BWD22's picture

 

 

Have/Get some cash ready.  When this all goes to Hell, gold will briefly be even more of a bargain than it is now.  There will not be much time to buy gold cheaply if I guess correctly.

May even want to buy gold just on general principles...

truthalwayswinsout's picture

A depression will drive the price of gold to around $300.  Wait 2-3 years as the price starts to move from there and buy in and hold for 20 years and you will make a small fortune when inflation returns.

Your scenario is if a real depression occurs and government lets all the trash businesses die (like the 1920 depression) which only lasted 18 -24 months. Yes then gold will drop very hard and within a few months start a big climb out. But, most likely it will be a much larger version of the 1929 depression where government interference caused it to last 20 years.

 

philipat's picture

Which Organisation are you trolling for? The Global financial system is in a state of collapse. Tell you what, I will sell you a Futures Contract to buy ALL the physical Gold you can deliver at $300/Oz at ANY future delivery date. If you are so confident, get back to me for details of how to place this derivative?

nscholten's picture

Don't fucking worry about who is trolly fatphilli fuck.  If you don't want to read something, then don't fucking read it you jew fuck

Mustafa Kemal's picture

nscholten,

"Don't fucking worry about who is trolly fatphilli fuck.  If you don't want to read something, then don't fucking read it you jew fuck"

Do you have to use so many cuss words?

Erek's picture

"Do you have to use so many cuss words?"

What the fuck are you talking about?

Fisherman Blue's picture

Shit I'll make that deal at 1200

Deplorable's picture

Watch the lines grow at the ATM's

junction's picture

No lines if the ATM is offline.  DB Cryan's best move is to lawyer up, delay the case with discovery motions and hope Trump gets in.  If Trump wins, the federal government goes into gridlock as Trump says "You're fired!" to the tall trees.

JailBanksters's picture

Why would their customers keep their money in a insolvent bank so the bank can steal it and then loan it back to you with interest so the shareholders don't loose one Euro.

 

PontifexMaximus's picture

Do not forget to ask the same questions clients of monte dei paschi in italy

King Tut's picture
King Tut (not verified) Oct 8, 2016 11:22 PM

So Cryan had to prostrate himself before  the DOJ- AKA- the Bankers Goon Squad. until countries seize back control of their own money from the One World Order banking cartel this stuff will keep happening- AH tried it and they unleashed hell upon Germany for attempting to break the chains 

BarkingCat's picture

I think him invading annexing huge part of Czechoslovakia and then invading Poland, Belgium, France, Soviet Union as well as Greece amongs many others had something to do with that hell.

He should have just went after London.

Folkvar's picture

Actually Germany invaded Poland with the Soviet Union, it was a jointly planned and executed operation. Isn't it interesting that we're never told this fact. So the question is why did the world declare war on Germany for invading Poland but not the Soviet Union?

gregga777's picture

It's the United States of America's Feral Gangster Government DoJ (US Department of Corruption, Injustice & Persecution).

1980XLS's picture

Obama & Hitlary want their money. They want it NOW!

Erek's picture

Wrong!

They want YOUR money and they want it yesterday!

sinbad2's picture

If Germany started bombing Syria, the DOJ would settle for peanuts.

Bunga Bunga's picture

Or give Apple tax free status. 

GreatUncle's picture

Hard to swallow, Germans bomb Syria and the only themselves to blame when Syrian refugees appear.

To obvious.

azusgm's picture

Now let's talk about those derivatives, why don't we.

Joe A's picture

How about Germany and the EU go after GS and JPM for duping everybody into the MBS thing? Or expose Bill Clinton and Alan Greenspan for making it all possible in the first place?

DB is also responsible for it own shit but make no mistake, a power game is being played. It is all geopolitics again and some people would not hesitate to make Europe and the ME again burn in order to win that game.