Deutsche Bank struggles with rising funding costs

Deutsche Bank struggles with rising funding costs

Deutsche Bank is set to lose as much as €200m in revenue a year unless chief executive Christian Sewing can reverse a recent surge in funding costs.

Executives have made reducing the cost of issuing debt a top priority after a chastening summer for the German lender, people familiar with their thinking said.

The push comes after its credit rating was downgraded, its shares continued to tumble and the price of insuring its debt doubled on fears of contagion from political crises in Italy and Turkey.

Illustrative of the deteriorating situation Mr Sewing faces, every unsecured bond Deutsche has sold this year is trading below the issue price. When several German banks issued a new type of ultra-safe senior debt for the first time last month, Deutsche had to pay a coupon more than double that of smaller domestic peer Commerzbank.

Deutsche had historically benefited from being seen as a “de facto” extension of the German state — with an implicit guarantee it would be bailed out — and so was able to raise money at a rate approaching that of the sovereign. However, post-crisis rules mean even senior bondholders are explicitly on the hook if a German bank fails, causing funding costs to skyrocket.

“Deutsche’s ability to fund at a cheaper rate than its peer group was a cornerstone of its competitive edge . . . regaining it should be the number one strategic imperative,” said Jernej Omahen, banking analyst at Goldman Sachs.

Paying more than big rivals such as France’s BNP Paribas and JPMorgan Chase in the US leaves Deutsche’s investment bank vulnerable to being priced out of business for its most important institutional clients, which would exacerbate market share declines in key trading and lending businesses, analysts say.

“Small changes in funding costs can have a massive impact on a bank’s profitability,” a top-20 shareholder said. “If funding costs go up by 10 basis points, 20 per cent of profits can be wiped out.”

While Deutsche executives recognise the problem needs to be addressed quickly, one cautioned there has to be a trade-off between mollifying rating agencies and debt investors by running a very conservative balance sheet, and reviving lacklustre earnings by taking on more risk.

“We believe our creditworthiness is not fully recognised in our credit spreads,” a spokesman said, citing Deutsche’s above-target capital position and large deposit base. “As we continue to demonstrate progress, we are confident that our ratings and spreads will improve.”

In March, finance chief James von Moltke said heightened funding costs had become a €150m drag on the bank’s income, and the situation has worsened since then.

For example, the cost of buying credit default swaps — derivatives that pay out if Deutsche defaults on its debts — has more doubled this year. Its benchmark five-year CDS trades 55 basis points higher than BNP, having begun the year trading in line with its French peer.

Deutsche’s CDS is now only 20 basis points shy of Italy’s UniCredit, which is saddled with billions of euros in non-performing loans and caught in the midst of a populist political surge in its home market.

“Their old business model was ‘we can fund cheaper than Goldman Sachs, leverage that and make a decent amount of money’,” another investor said. “The fact they don’t have this any more is a big problem.”

Adding to the gloom, last week Deutsche dropped out of the list of Europe’s top-50 blue-chip companies after a 39 per cent plunge in its stock this year.

While a €200m annual hit is unwelcome, in the context of annual revenue of €26bn it is not yet material enough to force the bank to turn away clients or change its strategy. However, the bank has made three consecutive annual losses and former boss John Cryan was forced out in April for acting “too slowly”.

Nonetheless, some grounds for optimism exist. Analysts consider Deutsche’s capital and liquidity positions to be strong and it only has to renew €10bn of wholesale market funding this year.

Additionally, EU regulators recently gave it permission to use retail deposits at its Postbank unit to fund more profitable operations elsewhere, and a change to German law in July means it can now issue a new form of cheaper “preferred” senior debt.

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