Troubled financial giant Deutsche Bank saw its shares plummet again in New York last night, dragging Wall Street into the red.
Pressure mounts on Deutsche Bank Chief Executive Officer John Cryan who is scrambling to shore up the bank’s capital position, eliminating its dividend, firing workers, and selling off profitable businesses. Meanwhile speculation continues over possible state aid for Deutsche Bank, along with concern whether Germany’s biggest bank could survive without the bailout or become the next Lehman Brothers.
However, it is investors holding Deutsche Bank structured products who should not delay in taking action now.
The German lender’s New York-listed stock dived after reports emerged that several key funds have slashed their exposure to the bank. The news sent shivers through banking sector equity markets, with the S&P 500’s financial shares ending down 1.6 per cent.
Deutsche Bank shares closed down 6.7 per cent, at a record low of $11.18.
Its price started to slide after Bloomberg reported that around 10 of the bank’s derivatives-clearing clients, including Millennium Partners, Capula Investment Management and Rokos Capital Management, had decided to shift some of their listed derivatives holdings away from Deutsche to other firms.
Shares in Frankfurt closed down 7.5 per cent at €10.55 on Monday, after reports emerged over the weekend that German Chancellor Angela Merkel was not prepared to offer the bank state assistance, even as it faced a record $14bn fine from the US Department of Justice for mis-selling mortgage-backed securities.
Deutsche Bank’s problems highlight problems facing other European banks, including ultralow interest rates, a persistently sluggish economy, financial-market distortions and tighter regulation.
However, excessive leverage is at the heart of Deutsche Bank’s woes. Click here to learn more IMF: “Deutsche Bank Poses The Greatest Risk To The Global Financial System”, Shares Hit 30 Year Low
The lender’s leverage ratio—total assets to shareholder equity—is estimated to be north of 40-to-1. To put that into perspective, Lehman Brothers had a leverage ratio of 30.7 to 1 in 2007, according to a Yale University review of the investment bank’s 15 September, 2008 bankruptcy.
Concerns about the financial condition of Deutsche Bank are also raising questions about its structured products or exchange-traded notes, debt instruments issued by the bank that promise the performance of an index in exchange for a fee.
Unlike exchange-traded funds (“ETFs”) and mutual funds, which are legally structured as stand-alone entities, structured products or exchange-traded notes (“ETNs”) are debt obligations of the issuer. Furthermore, they are “unsecured” debt obligations without any type of collateral. Therefore, ETNs carry an additional risk, a risk that would be realised if the issuer were to default or declare bankruptcy.
If you own Deutsche Bank ETNs, then Deutsche Bank has borrowed money from you, and your loan to Deutsche Bank is not secured with any collateral.
The largest three of the ETNs out there are the $349 million Deutsche Bank FI Enhanced Global HY ETN, the $146 million DB Gold Double Long ETN and the $66 million DB Crude Oil Double Short ETN.
To make matters worse, almost the entire Deutsche Bank suite of ETNs is impaired. This is because, last November, the bank suspended new issuance of shares in most of the ETNs, meaning that their market value can deviate sharply from the value of the underlying index in bouts of buying; eight of these were shuttered earlier this month. Another, the DB Base Metals Long ETN, was delisted by NYSE Arca for having assets sink below a specified threshold.
Many structured products are sold without clients being fully aware of the underlying risk. For holders of many Deutsche Bank structured products, in addition to heightened credit risk, there is also the prospect of the instrument’s price veering far from the value of its index.
Whilst some question the comparison between Deutsche Bank and Lehman Brothers, which failed eight years ago triggering the 2008 Financial Crisis, the latter did so as a result of its corporate counterparties suffocating the bank by rapidly pulling out their liquidity lines. However, Lehman was lucky in that it didn’t have retail depositors, as its death would have likely come far faster as the capital panic was not limited to institutions but also included a retail depositor bank run.
This is where Deutsche Bank is very different from Lehman, and far riskier, because if the institutional panic spreads to the depositor base, which as the table below shows amounts to some €566 billion in total, and €307 billion in retail deposits then the consequences will be far more dramatic.
Do you hold structured products in your investment or pension portfolio? Despite an often attractive headline return, are you fully aware of all the underlying risks? Do you hold any Deutsche Bank structured products?