Deutsche Bank Probably Won't Spark Lehman Moment but Capital Call Likely - TheStreet

Concerns over the stability of Deutsche Bank (DB) - Get Report may have sparked mass panic among European banking investors. But the German lender is unlikely to trigger a Lehman-style financial meltdown, observers say.

July 29 European Banking Authority stress tests, although mixed, confirmed the capital strength of leading lenders has improved significantly since tests in 2014 and is almost unrecognizable from 2008, when lenders across the continent toppled into an abyss - or teetered close it.

The average common-equity-tier-1 capital ratio for EU banks stood at 9.4% by the end of the EBA stress scenario while the ratio for Deutsche was 7.8%.

"The global financial system is now much better capitalized and able to withstand shocks than it was in 2008. And in any case, Deutsche Bank seems unlikely to collapse," noted Jennifer McKeown, at Capital Economics in London.

McKeown also said a large pool of liquid assets and Deutsche's diversified exposure to different economies and sectors make it unlikely that the bank will fail.

The EBA and the European Central Bank are, for obvious reasons, working hard to reassure investors.

On announcing the July 29 stress tests results the EBA noted that the sector "has significant shored up its capital base in recent years" even while acknowledging the pressures on profitability caused by ultra-low rates.

And ECB President Mario Draghi at a post-policy meeting press conference earlier this month emphasized that the sector has transformed from the days of the financial crisis.

At the same time a new EU regulatory system has prepared for the worst in a bid to limit the economic contagion of a bank's collapse. The new EU Bank Recovery and Resolution Mechanism is designed to prevent tax payers from having to foot the bill for bank rescues and requires that, before a government can rescue any financial institution, bond investors and uninsured depositors are tapped for an amount equivalent to 8% of the bank's liabilities. That happens through a bail-in tool which converts liabilities to equity.

Deutsche stock has hovered near record lows since announcing on Sept. 15 that the Department of Justice asked for $14 billion to settle an investigation relating to the sale of retail-mortgage-backed-securities. Deutsche Bank stock fell 6.7% in New York on Thursday after a Bloomberg report that some hedge funds that do derivatives business with the bank had reduced their exposure. The stock started the year at €22.59 and in Europe on Friday was recently trading up 4.9% at €10.75 after CEO John Cryan issued a memo reassuring his workforce - and investors - about the bank's financial health.

Although most observers expect the actual DoJ settlement negotiated by Deutsche to be substantially lower than $14 billion, the bank's already-fragile health prompted instant speculation that a bailout could be in the pipeline.

Germany's Finance Ministry on Wednesday denied it was working on a Deutsche Bank rescue plan.

"Deutsche Bank is much more solid than it is being portrayed in the news," said Markus Huber at City of London Markets.

But he added that " there is no doubt in my mind that [German Chancellor Angela] Merkel will do whatever is necessary to stabilize the bank if there would be need to."

Deutsche, designated one of the world's most systemically important banks by the International Monetary Fund in July, announced the sale of its Abbey Life insurance division to Phoenix Group Holdings plc in the U.K. on Wednesday, raising $1.2 billion. But this was quickly overshadowed by the bailout speculation.

"DB remains the favorite fantasy of financial pundits so we are not surprised when a sparkle turns into a wildfire," said Gildas Surry, an analyst at Axiom Alternative Investments in Paris.

He sees this week's headlines as being the result of Chinese whispers stemming from initial reports suggesting that the German government had rebuffed a request from Deutsche for help in negotiations with the DoJ.

Deutsche CEO John Cryan insisted in a Bild interview yesterday that a bailout isn't on the cards - and neither is a capital raising. But Surry believes that it is only a matter of time before the bank has to tap shareholders.

"We think that the bank needs to raise capital, but not urgently," he said.

He noted that Deutsche Bank could fall short of the amount required for it to meet coupon payments on its AT1 co-co bond securities.

A Deutsche Bank spokesman said: "The question of a capital increase is currently not on the agenda, we comply with all capital requirements."

Co-cos are hybrid bonds that convert into equity when a predetermined trigger point is hit. At Deutsche Bank their conversion into equity is triggered when its common equity Tier One capital ratio falls below 5.125%. The ratio was 10.8% as of June 30.

Surry, who invests in European bank co-co bonds at Axiom, sees the Deutsche business model facing long-term difficulty but is still confident on the credit strength of the bank, given its €230 billion of liquid assets.

He also sees opportunity in the German lender's AT1 bonds, or co-cos, but said prices will be volatile due to ongoing concerns over the bank's ability to meet coupon payments.

Credit Suisse analysts on Friday said they doubt the lender will meet its capital requirements organically. They were referring to is a fully loaded common equity Tier 1 ratio of 12.5% in 2018. That implies a capital shortfall of nearly €7 billion over the next two years. Regulatory requirements will rise at the same time, so that the 2018 target will only be 25 basis points above the minimum Tier 1 ratio of 12.25% that year.

Deutsche Bank late on Thursday once again denied a capital raise was on the agenda.

Jonathan Braude contributed to this report.