Summarizing Deutsche Bank's Systemic Risk

seekingalpha.com/article/4010231-summarizing-deutsche-banks-systemic-risk

Ivan Martchev

10/5/2016

Oct. 5.16 | About: Deutsche Bank (DB)

As the accelerating negative news from Germanys largest lender Deutsche Bank (NYSE:DB)
began to pile up last Friday, someone asked me: How big and how important is DB to the U.S. and
global financial system?
Twice as big as Lehman Brothers, was my blunt answer.
That was my initial guess, but after I sat down to write this column, I realized I had underestimated the importance of
Deutsche Bank. Lehman Brothers on May 31, 2008 (the last 10-Q it had filed before it went bust) showed assets on
its balance sheet of $639.4 billion and stockholders equity of $26.3 billion. By comparison, Deutsche Bank, as of
June 30, 2016, has assets of 1.8 trillion and stockholders equity of 66.5 billion. Given the size of Deutsches
balance sheet, it is three times as large as Lehman Brothers was.
The next question on everyones mind should be: Does this mean that the global financial crisis will get three times
as bad if DB fails? While no one actually knows, here is my answer. The Great Financial Crisis of 2008 was not
caused by Lehman Brothers. It was caused by failure of regulatory oversight, irresponsible lending practices, and
financial engineering that took over a decade to accumulate before it became the crisis of 2008.
If we go back even further, the 2008 crisis started with the practice of shoving debt down the throat of the financial
system every time the economy stumbled via negative real (adjusted-for inflation) policy rates, and later on by
global QE campaigns and negative nominal interest rates.
Lehman Brothers was simply a spectacular catalyst for the unravelling of a mortgage debt bubble that was going to
take probably a couple of years of accelerating losses and failures of smaller banks to unwind that is, if the U.S.
government had bailed Lehman out in September of 2008. The Lehman catalyst basically compressed two years
worth of declines in the debt and equity markets into a six-month period that is only comparable to the 1929 stock
market crash when it comes to historical U.S. financial crises.
Needless to say, nobody will let Deutsche Bank fail, given its size, even if it means nationalization and wiping out the
shareholders. If Lehman were too big to fail, Deutsche is much bigger. That, of course, raises an interesting
question: Could Deutsches depressed stock be a good value? After all, it registered all-time lows last week and the
shares trade somewhere in the vicinity of 20 cents per book value dollar.
My short answer is No (this is my opinion, of course).

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Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this
commentary.
German regulators and U.S. regulators, for that matter have the tendency to dilute shareholders on massive
bailouts. This can be seen in the share price history of 1-for-10 reverse splits in Commerzbank (OTCPK:CRZBY)
and Citigroup (NYSE:C), represented by the black and green lines, respectively, in the chart above.
While a history of diluting shareholders is not a guarantee that the same would happen to Deutsche Bank, it is not a
reassuring historical pattern, either. Plus, given that Commerzbank kept on sliding after the bailout, given the more
precarious deflationary situation in Germany, even though it is more domestically oriented than Deutsche Bank, this
historical record is definitely a warning sign to stay away.
Other than a possible dilution and governmental bailout, I think the global deflationary situation will get worse. If that
happens, DB is likely to be dead money for a long time, the same way Japanese financials have been dead money
for 25 years.

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Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this
commentary.
In previous postings, I flagged the close correlation between Deutsche Banks stock and 10-year U.S. Treasury
yields (see June 24 Marketwatch article, A look at the global economic malaise through Deutsche Bank). If we take
the chart back further (above), we can see the correlation has been there for a long time, although over the past year
it has been travelling in parallel patterns. I wondered how I had not noticed this previously.
My conclusion is that it is a little odd to think about government bond rates in the U.S. in the same paragraph as
stock in the largest bank in Germany. It would have been more appropriate to look at the German bund market to
make a connection between the two, but U.S. Treasury bonds?
The conclusion I reached last June is that the Treasury yield/DB-stock correlation is basically a reflection of how
global deflation is a negative for Deutsche Bank, since lower 10-year Treasury yields signify deteriorating
deflationary conditions that affect Deutsche bank negatively and vice versa. If you compare the 10-year Treasury
yield and DB shares over a year (below), the correlation becomes surreally close.

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Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this
commentary.
I dont know if there will be a rate hike in December 2016, but if there is one I expect it to be reversed as soon as
early 2017, given the accelerating global deflation we are experiencing at present. That will only get worse in the
case of a Chinese recession and devaluation that I expect to come as soon as 2017.
There weren't too many people looking for all-time lows in Treasury yields in 2016 at the time of the December 2015
rate hike by the Fed (see December 29, 2015 Marketwatch article, Will 2016 bring new Treasury-yield lows?). I am
not sure if there are that many people who are now looking for the 10-year Treasury yield to fall to 1%, possibly in
2017, given the same accelerating deflationary trends.
A 1% 10-year treasury yield certainly suggests a DB share price in the single digits, making the present dead-cat
bounce into the low teens a bad deal for value investors. Furthermore, there are numerous reports of clients pulling
money from DB. Such a run happened on Bear Sterns before it was devoured by J.P. Morgan, as well as to Lehman
before it failed. These asset runs can be very rapid and tend to feed on themselves. Those assets are not coming
back soon, if ever, so a dilutive bailout may not be avoidable.
Finally, there is a political problem. The Germans have been so outspoken about bailouts of irresponsible financial
institutions under ECB supervision that now, when they have their largest bank in a precarious situation, they seem
to have boxed themselves into a corner. I still think that a bailout will come, if need be, but probably at the 11th hour
and at a cost that shareholders wont like, similar to Commerzbank. (Please note: Ivan Martchev does not currently
own a position in DB, CRZBY, or C. Navellier & Associates, Inc. does not currently own a position in DB, CRZBY, or
C for any client portfolios. Please see additional important disclosures at the end of this letter.)

Oil Rebounds as Middle East Tensions Escalate

Based on recent troop movements and accelerated aerial bombardment, an attack on Aleppos rebel-held area
seems to be imminent, marking a major escalation in the Syrian conflict. I am trying to figure out the impact on the
price of oil, which has now entered its seasonally weak September-March period.

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It appears to me that the Aleppo attack will happen before the U.S. Presidential election, so it is unlikely that the U.S.
will intervene, which clearly has been taken into consideration by the warring parties. The potential for a much
broader escalation is here, but it is too early to judge if it will happen in 2016.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this
commentary.
One thing is certain: If it were not for the Russian intervention, the Syrian government may not have survived to fight
the Aleppo battle. The surge in the oil price over the past week is a combination of this geopolitical activity and the
OPEC deal to freeze output at some future date.
I recall that when Turkey downed a Russian bomber jet last year for the comical 17-second violation of its airspace,
oil failed to rebound and kept on going lower. Since the balance in the oil markets is more bearish now than it was
this time last year, and the number of U.S. oil rigs has been rising, I think the oil price will unwind this rebound even
if Aleppo flares up, provided the conflict does not escalate past Syria.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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profile that accompany this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be
aware of the risks associated with these stocks.
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