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Investment outlook

Banking turmoil continues; Deutsche Bank in the spotlight

Stone columns and ceiling

Key points


What's happening now?

Bank stocks are under pressure, with investors focusing on widening credit default swap (CDS) spreads of European banks with significant investment banking presence. Deutsche Bank in particular has been under pressure due to investor concerns over its commercial real estate business and ongoing corporate restructuring.

CDS spread widening was the proverbial canary in the coal mine in 2007 before the Global Financial Crisis, so unease and uncertainty is understandable.

How serious are these issues?

We see two issues causing the current stress. The first is that financial markets are still digesting the writedown of Credit Suisse’s AT1 CoCos. That is likely to be a short-term adjustment.

The second issue regards the ongoing uncertainty and confidence crisis around the banking system. That is harder to gauge.

At this point, we think CDS spread widening is due more to the first issue (market indigestion). But confidence will remain uncertain if spreads remain elevated for an extended period of time, creating the sort of self-fulfilling cycle that causes broader banking crises.

How is this different than what happened to Credit Suisse?

Critically, the pressures facing Deutsche Bank are focused on financial markets rather than the sort of deposit outflows that caused problems for Credit Suisse.

Additionally, the writedown of the AT1 CoCos was unique to Credit Suisse given Swiss regulations. In Germany and elsewhere in Europe, the writedown of common equity is required before AT1 CoCos would be written down.

What is the outlook for the banking sector?

European banks as a whole continue to look relatively stable, and we do not think they are in a similar situation to where they were in 2007: Banks are awash with liquidity and are well capitalized. Most European banks are actually either buying back stock or seeking authority to buy back stock.

Right now, most of the pressure is centralized on U.S. banks, particularly smaller, more specialized regional banks.

Yesterday, U.S. Treasury Secretary Yellen explicitly stated that the Treasury department was “not consider[ing] or discuss[ing] anything having to do with blanket insurance or guarantees of all deposits.” These statements effectively walked back her earlier comments about the possibility of raising insurance levels without Congressional action. These comments are likely to heighten pressure on these smaller banks. The good news is that the new lending facilities should continue to provide at least some measure of stability.

How long will this turmoil persist?

Ultimately, we think this will come down to confidence levels. If U.S. depositors believe that the additional lending facilities that have been put in place and capital injections will stabilize troubled banks, issues should be mostly contained. If confidence levels drop, and deposits are withdrawn, we could see more localized bank failures.

At this point, we do not expect a sharp contagion that would result in a broader global financial crisis. But ongoing stress, volatility, downgrades and regulator actions seem likely.

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