Deutsche Bank ‘splainer part 2

Is it a crisis now? not yet

Things have moved on a bit with this story reported by Bloomberg. Let’s be clear right at the top of the page — any time you can credibly establish that any clients at all are removing funding of any sort from a bank, that is Big News and needs to be taken seriously. Well done Bberg for the scoop. I’m not just saying that because they interviewed me this evening

So are we scared yet?

Not yet. In the first clip linked above, I explain what would get me scared — if I saw corporate or transactions clients moving balances. Hedge funds moving excess derivatives collateral or prime brokerages is … hmm, it looks like this explainer needs an explainer.

Basically this is surplus cash that hedge funds have which isn’t invested, or surplus treasury bills that they don’t need to pledge against their trades, but have hanging around in their collateral account anyway. Big hedge funds always have more than one prime broker, and they’re always moving their surplus around. It’s pretty much zero cost to shift it away from a bank that’s in the headlines and it allows you to tell your boss or your investors that you’re doing something.

But because these balances are so volatile, they’re basically unusable by the bank as a funding source. The excess cash is just invested in cash, the excess securities aren’t re-pledged or borrowed etc. The business is, frankly, garbage for the bank, not worth having except that it’s part of the service provided to a big client. No real funding for Deutsche has been pulled, so far, only excess balances.

Going back to non-italic font now, to indicate a resumption of the original explainer. If I saw corporate, retail or payments system accounts being moved, I’d worry, because these balances very much are part of the funding of Deutsche Bank’s business, and they do rely quite a lot on “behaviourally stable funding” (basically, in an overnight transactions account, it’s a different set of dollar bills every day, but the aggregate amount across the whole book of a big provider of transactions accounts is surprisingly stable). So far, nothing there.

How much would I worry? Well … as I said in the Bloomberg clip, it’s important to remember 1) this isn’t 2008 and 2) Deutsche isn’t Lehman Brothers. Taking these two points sequentially…

This isn’t 2008. It’s worth emphasising that the creditors referred to in the story are actually quite weird. Being an unsecured creditor of Deutsche Bank who isn’t a customer of the Transactions Banking platform is actually quite an unusual thing to do. The bulk of Deutsche’s short term funding is secured against securities pledged as collateral.

Lehman Brothers’ funding was also mainly secured against collateral. But in the innocent days before 2008, the world had not yet discovered that AAA-rated mortgage backed securities were not actually as safe as US Treasury bonds. And they yielded a bit more, so it was quite attractive to use them instead of T-Bonds to pledge in return for your funding. For obvious reasons, this is not done any more — as Eric says on the clip, nearly all of the short term funding these days is against genuinely risk free instruments.

Deutsche isn’t Lehman. Added to that, there’s a lot less uncertainty surrounding the valuation of Deutsche Bank’s unpledged assets, if they needed to be pledged to support further funding. In Lehman Brothers, the accountants’ joke was true “On the left side of the balance sheet (assets) nothing’s right and on the right side of the balance sheet (capital) nothing’s left”. That’s not the case in Deutsche. The uncertainty, substantial as it is, all relates to the right-hand side of the balance sheet. The capital might not be sufficient, and the equity might be impaired by a big charge for DoJ fines. Both of these threats come from somewhere other than the left hand side of Deutsche Bank’s balance sheet (one of them is, literally, a number chosen by a regulator, which rather starkly points out how not “out of control” the situation is compared to 2008). If you are a secured creditor — which is to say, someone who looks not to the quality of Deutsche Bank, but to the quality of the individual collateral placed specifically with you — you’ve not seen anything in the last six months to particularly change your mind.

Finally, Deutsche isn’t Lehman Brothers and it isn’t 2008. There are so many more ways for a bank to get hold of short term liquidity than a broker-dealer, and so many more ways for a bank to get hold of short term liquidity in 2016 than there were in 2008. And the global network of central bank swap facilities now means that if Deutsche can fund in Euro, it can fund in any major currency of the world. This matters because in Euro, all of the collateral concessions and facilities created by the ECB for the benefit of small Italian and Greek banks are also available for Deutsche. I am actually finding it hard to think of any asset of Deutsche Bank, now that it has sold the Cosmopolitan Resort & Casino in Las Vegas, which couldn’t be pledged at the ECB for funding.

So … no need to panic?

I wouldn’t want to give that impression at all. Losing customer balances is something you need to take it very seriously indeed. And here’s two sentences which don’t mean the same thing:

  1. Deutsche’s ability to find assets to pledge to roll over funding is practically speaking unlimited
  2. Deutsche’s ability to find assets to pledge to roll over funding without doing serious damage to its underlying business is practically speaking unlimited.

I’m confident that this is not Lehman 2008. It is, however, a state of clear and accelerating franchise damage, and there is certainly a point at which that franchise damage becomes so severe that it can’t support its cost base. The worry that ought to be on management and the market’s minds is not a fast and catastrophic collapse, but a gradual transition to a run-off situation in which no long-term funding can be raised and therefore no new business can be initiated. This company needs to raise equity, fast, and settle its litigation, as fast as it can, and not to worry unduly about the cost of doing so. Operating businesses will get you through times with no shareholder value much better than an excessive concern for shareholder dilution will get you through times with no operating business.