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What's Next for Deutsche Bank (DB) After New 52-Week Lows

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Giving the markets jitters, struggling German banking giant Deutsche Bank AG (DB - Free Report) hit a new 52-week low of $11.23 on Monday, closing down 7% to $11.85 on the NYSE, marking the lowest level in decades. The price movement reflected investors’ concern that the bank may raise capital to settle the potential $14-billion accord with the U.S. Department of Justice (“DoJ”) related to mortgage practices. Notably, as of Jun 30, the bank had €5.5 billion ($6.2 billion) in its litigation reserves.

The plunge in share price of one of the world’s largest banks was also due to a weekend report by a German magazine – Focus – which stated that German Chancellor Angela Merkel had ruled out offering government support to Deutsche Bank before Germany’s national elections in Sep 2017.

However, the report was later denied by representatives of both Merkel and Deutsche Bank. A spokesperson for Merkel said that there was “no need for such speculation” about government assistance for Deutsche Bank, while a spokesperson for Deutsche Bank, Jörg Eigendorf stated, “This question [of a state aid] is not on our agenda: Deutsche Bank is determined to meet the challenges on its own,” adding, “The question of a capital increase is currently not on the agenda, we comply with all regulatory requirements.”

Despite dismissing Focus’ report, concerns over the bank’s capital position continue to weigh on market sentiments as any new issuance of shares will dilute current shareholders’ position, particularly considering the fact that shares have already been witnessing sharp declines. Notably, shares of Deutsche Bank lost more than 50% on the NYSE year to date, amid investors’ concern over the bank’s growth prospects.

The proposed $14-billion settlement by the DoJ is tied with the bank’s issuance and underwriting of residential mortgage-backed securities (RMBS) and related securitization activities during the period between 2005 and 2007.  However, clearly stating its unwillingness to pay the amount, the bank had noted in its release, “Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited. The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.”

Why a Turnaround Seems Elusive for Deutsche Bank

Threat from Litigation Burden: While $14 billion may not be the final settlement amount, anything substantial will certainly compound woes for Deutsche Bank. The bank has shouldered significant legal settlement in the past as well, which affected its financials. Notably, it reported net loss of €6.8 billion in 2015, its first full-year loss since 2008, reflecting the impact of several one-time items, including huge litigation charges.

Further, the company continues to struggle with numerous other cases, such as alleged manipulation of foreign exchange rates, rigging bench mark rates and investigations over suspicious ‘mirror’ trades in Russia.  

Chief Executive Officer John Cryan, who is expediting restructuring efforts to boost the performance of the bank, had stated earlier that he expects to resolve the company’s significant cases this year. However, litigation issues will remain a headwind.

Macro Concerns: Apart from legal issues, the profitability of Deutsche Bank is also threatened by a stressed operating environment with negative interest rates, sluggish European economy and global headwinds. Management continues to see a challenging revenue environment in 2016, especially following the Brexit episode.

Capital Worries:  Deutsche Bank remains focused on building capital levels through several efforts including shedding unprofitable businesses. Last December, the company inked a deal to sell its entire stake in China-based Hua Xia Bank. The bank had stated that in Jun 2016, the application has been formally accepted by the China Banking Regulatory Commission and the approval process is anticipated to be finalized in the third quarter of 2016. Though the bank has said that the stake sale is likely to close by the end of the year, uncertainty lingers.

Further, the bank has drawn regulators’ attention after the Federal Reserve objected to the capital plan of its U.S. unit – Deutsche Bank Trust Corporation – once again. While the unit remained well capitalized, the plan was rejected based on qualitative concerns under the U.S. Fed's Comprehensive Capital Analysis and Review (CCAR) 2016. Notably, for Deutsche Bank’s U.S. wing, this year marked the second straight year of failing the Fed stress test.

The Fed noted that the capital plan of the company was rejected due to “broad and substantial weaknesses" in its capital planning processes, and insufficient progress it "made toward correcting those weaknesses and meeting supervisory expectations.”

IMF Caution: According to a report released this June by The International Monetary Fund, Deutsche Bank, which is extremely interconnected with other large global financial institutions, is the riskiest lender in the world that could affect the broader financial system.

The IMF report noted, “Among the G-SIBs [Global Systemically Important Banks], Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse”, adding, “The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly completing capacity to implement the new resolution regime.”

Deutsche Bank currently carries a Zacks Rank #5 (Strong Sell). Some favorably-placed stocks in the foreign banks include Itaú Unibanco Holding S.A. (ITUB - Free Report) , Banco Macro S.A. (BMA - Free Report) and The Bank of Nova Scotia (BNS - Free Report) , each sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Year to date, while Itau Unibanco recorded a whopping gain of nearly 69%  on the NYSE, Banco Macro and  Bank of Nova Scotia surged 30.7% and 25.8%, respectively.

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