Deutsche Bank and the Ghost of Crisis Past

Shares in the German lender fell about 9% Friday in a sign that worries about European banks are spreading beyond Credit Suisse. Deutsche Bank could be in focus for the same reason that Credit Suisse was until its cut-price rescue by UBS last weekend: Investors are wondering who might be next.

A related factor is Europe's junior-debt market, which is jumpy after the Swiss regulator decided to write off Credit Suisse's so-called AT1 “bail-in" bonds. Securities across the sector have been marked down, implying higher funding costs in the future. Other bank stocks also fell Friday, albeit by less: Barclays and BNP Paribas were down roughly 4% and 5%, respectively. Deutsche Bank offered to redeem a junior bond Friday at face value in an apparent effort to bolster confidence.

A few years ago Germany’s top lender was the sick man of European banking, but it is in better shape now. Net profit equivalent to $6.1 billion last year was the highest since 2007, and contrasts with almost $8 billion in net losses at Credit Suisse. Deutsche Bank is benefiting from rising interest rates, just as it long struggled with negative rates. Net interest income—the gap between the money it makes on lending and the cost of paying depositors—rose 39% last year in its bread-and-butter corporate lending division. Capital and liquidity ratios were solid at the year-end.

Deutsche Bank’s credit-default swaps—the cost of insuring against its default—jumped Thursday to levels last seen at the onset of the Covid-19 pandemic. On Friday, stock investors followed the lead of their credit peers. This makes sense in a circular kind of way: Worried creditors raise Deutsche Bank’s funding costs and make investment-banking counterparties more reluctant to deal with it. It is a different dynamic than the vicious spiral of asset outflows at Credit Suisse, but it is still perilous for the German company.

But Deutsche Bank isn’t completely healthy either. A cost to income ratio of 75% in 2022, while better than the 85% achieved in 2021, was above the European average: In the third quarter of last year, big lenders tracked by the European Central Bank had a ratio of roughly 61%. Deutsche Bank’s “core" business looks stronger, but its overall numbers are dragged down by its “capital release unit"—the bad bank it created in 2019 to wind down unwanted assets. Its leverage as measured by total assets against equity is also still on the high side.

These weaknesses, even as Deutsche Bank has emerged from its crisis days, have contributed to a persistent share-price discount. After Friday’s moves, the stock trades for just 32% of its tangible book value, compared with 45% and 62% for Barclays and BNP Paribas, respectively. In a sector where a nervous market can turn a low valuation into a self-fulfilling prophecy, Deutsche Bank’s old problems are coming back to haunt it.

The company these days may not have much to fear but fear itself, but in banking that can be everything.