Financial Contagion Risks – Are They Back Like in 2007?

One of Europe’s largest banks is telling us something…..and it is not good. The stock is near all-time lows. As of this morning, the stock price is only about one dollar above the banks all-time low of $12.75 in September 2016. This is quite reflective that Europe is not out of hot water by a long shot.

Enjoying this article? Receive our Fortrus 4-Minute newsletter for FREE - Sign-up now! Empower your investing today! For a limited time, receive our Precious Metals: Gold and Silver report, a $79 value for free!

It has been reported that Deutsche Bank shares are at a 16-month low after Germany’s largest lender cut the sale price of its asset management unit and said higher internal funding costs and a stronger euro would hit revenues at its investment bank.  The problems go much deeper, and their connection to numerous banks and institutions worldwide make them a significant systemic risk.

We live in a financialized economy which makes things as dangerous as we have ever seen. I am writing a book on this now and will clearly describe the fiscal and monetary risks of the path the world has gone. How the world puts up with announcements like Deutsch Bank’s decision last week of paying more than $3 billion in employee bonuses for the 2017 fiscal year, despite a 23% fall in the stock price and the banks third consecutive annual net loss.

They will argue that this is necessary to keep key employees happy but all this reflects is a bank who wants to suck as much capital out in case it fails. Who cares about the German society or for that matter, due to its interconnectedness, the world economy. Who cares about shareholders. This is one of the problems of financialized economies and crony capitalism.

Back to the bank and why we are very concerned.  Here is a stock price performance chart for the past five years:

The stock is down 72% from its high four years ago, but there was a belief the company was stabilizing at least a HOPE.  But over the past three months, the stock has crashed 31%. There are deep problems there, and if they fail, the world’s financial system will be in trouble.

Look at the stock since 1996:

Deutsch Bank stock is down more than 90% since it’s peak in the fall of 2007.  That is just ugly.

The International Monetary Fund has stated that Europe’s biggest investment bank Deutsch Bank, maybe the biggest contributor to systemic risk among the largest lenders in Europe.

As the accelerating negative news from Germany’s largest lender, Deutsche Bank (NYSE: DB), is piling up once again, the question has to be “how important is DB to the global financial system?”  So a good example to look at is what created the systemic failure in the 2007-09 financial crash, Lehman Brothers.

Lehman filed their assets prior to going bankrupt at US$639.4 billion and shareholder equity of $26.3 billion. By comparison, at the end of 2017, Deutsche Bank’s assets on the balance sheet at the end of 2017 was US$1.769 trillion. Assets are down about $1 trillion over the past five years, but they are still the 14 largest financial institutions in the world. That means DB is double the size that Lehman was before its bankruptcy. That is scary. As the stock price has plummeted, shareholder value has collapsed, but it still is $28 billion as of today. That is still larger than Lehman.

We are not saying we are at a Lehman moment with Deutsch Bank, but anyone who follows DB knows that they have been losing significant amounts of money; have a massive derivative position, and non-performing loans are too high. They pose a risk to the system as the IMF has stated.

I recently saw this chart comparing DB to Lehman stock price during their period of collapse:

This shows how Lehman performed for the last 2.5 years before they went bust.  Look at how similar the trading patterns are with Deutsche Bank today.  By the way, Fuld was the Chairman of Lehman and stated just before its demise that it had billions in highly liquid assets.  Still amazes me that no bankers were thrown in jail, but instead most walked away with 10’s and many with 100’s of millions of dollars. Again, crony capitalism and a financialized society – but you will hear more from me on this in the future.

Let’s hope that the correlation does not continue for the next number of months or the world will have a very serious problem.  Here is a chart that shows how Deutsch Bank, Commerzbank pose a major risk to other global systematically important banks:

To save you from trying to figure out how interconnected these banks are, there are eight major US banks; 14 major European Banks; and six major Asian banks on the list.  That is massive interconnectedness, and a failure of either of these banks would create chaos.  Let’s hope for all our sakes this does not happen.

News has been reasonable for DB over the past year. They achieved capital enhancement of $8 billion last year and are currently trying to sell part of their money management business which is a small portion of their overall model.

As much as it looked like things may improve as even the European economy has seen a minor uptick over the last year, years of mismanagement may be difficult to reverse. This can be seen with profitability or lace of as Deutsche Bank reported a worse-than-expected net loss of 2.2 billion euros ($2.75 billion) for the fourth quarter of 2017 and a 497 million euro loss for the full year.  Their capital ratio targets have been increased this year as well.

This is a situation to watch as the risk of a financial crisis is much greater in Europe than anywhere else. Between disastrous Italian, Portuguese and Greek banks….it is the big one in Germany that should keep up worrywarts at night.

Matt Sammut
Founder & Chief Investment Strategist