Europe’s problems with some of its largest financial institutions could spill over into the rest of the global market.
Deutsche Bank’s shares tumbled on Friday, before paring losses somewhat, on a report that a group of hedge funds were reducing their exposure to the giant financial institution
Earlier in the week, one financial blogger, Wolf Richter, wrote that deep-seated concerns about Deutsche Bank’s ability to raise enough cash to give the market comfort that it is on a sound footing speaks to a larger problem that Europe’s embattled banking sector must combat. Richter, the editor of financial blog site Wolf Street, said “the banking crisis [in Europe] has the potential to transmogrify into a financial crisis.”
He went onto say: “All it takes is for one of the big [banks] to suddenly topple. The flow of credit would freeze up instantly. In an economic system that depends on credit, and whose lifeblood is credit, such an event is a financial crisis.”
On Friday, Deutsche Bank’s shares fell more than 7% to a record low in Germany, after its U.S. listed shares DB, -1.95% DBK, +16.13% sank 6.7% on Thursday. The moves underscored a brutal week of losses for the Frankfurt-based bank. Most recently, its Frankfurt-listed shares were off just about 0.2%, while shares traded in the U.S. were up sharply as some investors rethought the severity of its fine from the Justice Department.
The bank, run by CEO John Cryan, has seen its cost of borrowing steadily ratchet higher as questions about its ability to pay a potential $14 billion fine from the U.S. Justice Department, according to a Sept. 16 report from The Wall Street Journal.
Against that backdrop, Deutsche Bank’s hardest hit debt securities are its so-called contingent convertible bonds, which have plunged in price as worries about its shrinking cushion have intensified. A U.S.-dollar denominated “CoCo” bond with a perpetual duration has been trading around 70 cents on the dollar, MarketWatch’s Joseph Adinolfi writes.
And it isn’t just Deutsche Bank swooning.
A combination of factors continue to dog European banks and Europe’s economy:
1). The emergence of negative interest rates, as central banks employ radical monetary policies to juice growth in Europe, has hampered eurozone banks’ ability to make money, by eroding profits between their short-term borrowing costs and what they can charge for long-term loans. The German 10-year government bondTMBMKDE-10Y, -26.76% known as the bund, was yielding negative 0.15% as of Wednesday. Bond yields fall as prices rise.
2). Also, many banks have been late to restructure in the wake of the 2008-09 financial crisis that roiled global markets.
3). Italian banks are saddled with billions of souring loans and are seen as a possible threat to the eurozone economy.
4). And many other banks, namely Deutsche Bank, are set to face sizable fines in the fallout from selling dicey mortgage-related securities, which could further tax their capital cushions.
In the following chart, Richter shows how eurozone financial institutions have performed since hitting recent 52-week highs.
The chart shows that German banks, represented in black with a red border, have been among the worst decliners. Germany’s second-largest bank, Commerzbank AGCBK, +1.71% is off 44% from its high, while Deutsche Bank is down more than 60% since its 52-week high.
On Thursday, prominent investor and founder of DoubleLine Capital Jeff Gundlachcautioned investors to stay away from Deutsche Bank.
Of course not everyone is fretting about the problem children of Europe’s banking system.
Indeed, Cryan denied reports by Focus magazine, citing unnamed sources, that indicated requested assistance from German Chancellor Angela Merkel as he sought to address the bank’s fines. In a Wednesday interview in German newspaper Bild, Cryan said the bank doesn’t need state aid.
However, U.S. markets have been rattled by the recent gyrations in Deutsche Bank’s stock price over the past week, with the S&P 500 index SPX, -0.46% down and the Dow Jones Industrial Average DJIA, -0.37% off nearly 200 points on Thursday, amid heightened concerns about the bank’s liquidity.