Deutsche Bank’s stock is falling at the same time as its CDS is rising. The CDS expresses the risk premium seen by the bank’s lenders and an increase in it expresses an assessment of the difficulty in repaying the debt compared to the previous situation. So at this stage the numbers do not express a debt default, but an increase in risk immediately rolls over to the company’s shares and its bonds.
The CDS (Credit Default Swap) is a type of option-derivative contract that actually enables the buying or selling of credit exposure. Let’s say you hold Deutsche bonds and you want to reduce exposure – you can sell the bonds in the market, or operate through the CDS that embodies the effective yield of the bonds and the bank’s risk.
It is basically a type of insurance where the buyer pays a fee to hold it, and the seller pays a high fee when the company cannot repay its bonds. Unlike other insurance products, the buyer of a CDS does not have to own the bond or receive payment in a credit event.
One way or another, Deutsche Bank shares lost 6% yesterday and another 8% today.
Deutsche Bank is the largest lending bank in Germany. Other banks in Europe also fell. The Euro Stoxx Banks Index (SX7E) fell 5%. Germany’s Commerzbank fell 7%, France’s BNP Paribas lost 6%.
The banking system is sick
Wall Street is worried about the banks. Investors understand that the banking system is sick. This manifests itself in two main places – the first, toxic assets on the balance sheets of the banks that are actually worth much less than what is recorded in the books, when most of the problem is bonds that are held by the banks and are not worth the amount that is recorded. It can reach huge sums, with Bank of America at $130 billion and in American banking, it is estimated at $600 billion.
Against the background of the falls of Silicon Valley Bank, Signature and Credit Suisse, the central banks took a step back in raising interest rates, which endangers stability because an increase in interest actually lowers the value of bonds.
The second place that hurts banks is of course credit quality. This is always true, but it is especially valid when it comes to a period of uncertainty and slowdown. The concern at Deutsche Bank, unlike what happened to Credit Suisse, is mainly in the loans given, although there is also concern about the assets on the books not being presented properly.
One way or another, the European Central Bank said last week that the banks are flexible and will handle an interest rate hike. Late last week, Swiss regulators stepped in to broker a takeover of Credit Suisse by UBS.
“We don’t see specific problems at Deutsche Bank,” said Niklas Kammer, an analyst at Morningstar who covers banks. “But after Credit Suisse, the markets are looking at who could be next in line. It’s mainly driven by fear”
Bank stocks in the US are also down today. And this is despite Treasury Secretary Janet Yellen saying that the administration will support the banking system. But the market has trouble believing and you can see this in the CDS. One of the problems for the banks is that the CDS has gone up and the wider spreads make financing more expensive for the banks That is, money becomes more expensive for banks and money is the main raw material of banks and if it becomes more expensive – and they cannot charge a higher interest rate, profits shrink. Take this alongside the problem of toxic assets and you will get drama in the financial market.
On the other hand, the administration and loss will not let the big banks fall. Yellen said in testimony to Congress on Thursday: “We used important tools to act quickly to prevent contagion, and they are tools we can use again. The strong actions we have taken ensure that Americans’ deposits are safe. Certainly, we will be prepared to take additional actions if possible.”
Yellen and Federal Reserve Chairman Jerome Powell have repeatedly argued that consumer bank deposits are safe, although last week Yellen said she was not considering expanding deposit insurance. Shares of regional banks, which are smaller than the largest and are not subject to the same insurance regulations Deposits fell due to fear that the public would switch to the big banks.
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