The Breakdown - Are Deutsche Bank and Charles Schwab Actually in Trouble or is it Just Doomporn?

Episode Date: March 28, 2023

Ever since the failure of Silicon Valley Bank, markets have been waiting with bated breath for another shoe to drop. Coming into the weekend, it looked like Deutsche Bank and Charles Schwab were the most wobbly. NLW explores whether there is actually reason to be concerned or whether fintwit (and short sellers) are just looking for another mark.  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Wong Yu Liang/Getty Images, modified by CoinDesk.  Join the discussion at discord.gg/VrKRrfKCz8. Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com.  

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Register now at Consensus.coindex.com and join CoinDest at Consensus 2023. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. The Breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Monday, March 27th, and today we are catching up on the latest, dominoes in the banking crisis. Before we get into that, however, a quick note, there are two ways to listen to the breakdown. You can hear us on the Coin Desk podcast network feed, which comes out every afternoon and also features other great CoinDesk shows, or you can listen on the breakdown-only

feed, which comes out a few hours later in the evening. Wherever you're listening, I would so appreciate it if you would take the time to leave a rating or review, it makes a huge difference. All right, guys, happy Monday. Hope you had a wonderful weekend. As for markets and the economy, This week is kicking off much the way the last one ended, which is, of course, to say that all eyes are on the global banking crisis and the potential fallout of some decisions made last week. Because, of course, last week the biggest macro event was the FOMC's rate decision. Now, going into that meeting, the market had priced the chance of a 25-bases point hike

at about 73%. While that sounds like consensus, it was actually the lowest conviction the market had had around a rate hike prediction in quite some time. the reason there was less clarity was, of course, that over the previous two weeks, the country had been engulfed in a banking crisis capstoneed by the failure of Silicon Valley Bank. So heading into the FOMC meeting, what might have been the logic for a rate pause for a 25 basis point hike or on the other side for a 50 basis point hike? A pause would have been a recognition that the banking crisis was a serious financial stability issue. And Powell could have said something along the lines of,

hey, we've had the fastest rate hiking cycle in modern history. We can give it some time to work its way through the system. Now, of course, the problem with this would have been that it might have confirmed all of the market suspicions about the end of the hiking cycle, thus supercharging a stock rally and contributing to the loosening of financial conditions, which could negatively impact the inflation fight. On the flip side, the argument for a 50 basis point hike would have been to make a profound statement that the Fed was, one, extremely focused on beating inflation, which has showed more stickiness than anyone would like, and two, that they were supremely confident in the new facilities that they had put forward to deal with bank turmoil in the short term.

Now, the downside to this might have been a significant contribution to financial stability in the short term. In the end, it was the market's predicted middle path of continuing to hike rates while saying that the bank term funding program and other Fed lending facilities would be sufficient to deal with any bank issues. That left the real question to be, would there be more bank dominoes, and over the weekend we definitely saw some wobbles. Take, for example, Deutsche Bank, the German megabank stock, ended the final trading day of the week down 8.5%, which marked its third consecutive day of losses. The cost of credit default swaps on Deutsche Bank jumped, with five-year contracts now sitting

at more than double their price at the start of the year. You'll hear a lot of people talking about credit default swaps or CDS right now because they're a form of market-based insurance against the default of a major institution. In other words, a way that the market might be telling you how convinced they are that an institution might fail. The concerns surrounding banks in the wake of the Credit Suisse takeover has rippled throughout Europe. German lender Commerce Bank was down 6.5% Friday, and British Bank Barclays and France's largest bank, B&P Parabas, both sat down around 5.8%. Now back to Deutsche Bank specifically, it's similar in size to Goldman Sachs, with around $1.5 trillion in assets. That makes it by far the largest

bank in Germany and firmly one of the top 30 global systemically important banks. Similar to J.P. Morgan, Deutsche offers a full range of banking services, from retail accounts to advising on corporate mergers. It also maintains a massive trading department acting as a major counterparty in systemically important markets. Unlike Credit Suisse, however, there doesn't appear to be any major sign of trouble in Deutsche's financials. There have been no significant outflows of deposits in previous quarters, and while Deutsche has some exposure to U.S. commercial real estate and a very large derivatives book, it's not clear whether these positions will see catastrophic impairment. The concern instead appears to simply be that stock investors want to get out of the way, just in case

there is another major European bank failure. Tatiana Grille Castro, a portfolio manager at Musnick and Co. said, the market is on edge. It seems to be just looking for targets. Paul de la Bam, a senior market strategist at Flowbank said, it is a clear case of the market selling first and asking questions later. So why Deutsche? Well, Deutsche Bank has long been a punchline in financial circles, with a laundry list of scandals, fines, and foolish market activities. Similar to Credit Suisse, Deutsche took an overhaul of its business in 2019. However, Deutsche managed to come out the other side a more robust institution, with last year being the bank's most profitable since 2007. A big part of the issue with Credit Suisse was a massive amount of money set aside to deal with

ongoing and anticipated lawsuits. But Deutsche Bank has largely put their legal problems behind them. German Chancellor Olaf Schultz spoke publicly to the panic on Friday, stating that, quote, Deutsche Bank has thoroughly modernized and reorganized its business model and is a very profitable bank. There is no reason whatsoever to be concerned. Now, if we're trying to find reasons to be concerned, one of the reasons for alarm could be the collapse of financing options generally. Last week, for example, when we discussed the Credit Suisse takeover, we noted that about 17 billion of their AT-1 or Coco bonds had been zeroed out by emergency legislation from the Swiss government. These bonds are a critical component of bank capitalization in Europe,

and would be one path to raise additional capital if necessary. At least, they would have been if investors were still interested in them. The decision to zero them out in the case of Credit Swiss has sent shockwaves through the bond markets, with Deutsche's AT1s' collapsing to 70 cents on the dollar on Friday from 95 cents at the start of March. In a bid to assure bond investors that their bonds will be paid in full, Deutsche took the drastic step of offering to redeem an issuance of 2028 maturity bonds early, promising to pay back 100% of principal plus accrued interest. The move, they hope, will reassure markets that Deutsche has plenty of funding to continue to meet its obligations. And indeed, there's more than a few

analysts who say that this is just the market freaking out for no reason. Stuart Graham, an analyst at autonomous research, which is a unit of Alliance Bernstein, put it bluntly in his research report last week. We have no concerns, he writes, about Deutsche's viability or asset marks. To be crystal clear, Deutsche is not the next credit Suisse. That report also added that Deutsche's interest rate risk, which was, of course, the issue that toppled Silicon Valley Bank, is broadly in line with their European peers and well below the level of some U.S. regional banks. City Group analysts wrote in a note last week, quote, we view this as an irrational market. The risk is if there is a knock-on impact from various media headlines on depositors psychologically, regardless of whether the initial reasoning

behind this was correct or not. Still, in a counterpoint to the reassuring words plastered all over the financial press. On Sunday night, CNBC's website removed historical market data and the up-to-date ticker for credit default swaps on five large American banks. The German derivatives association also removed data on 12 German banks over the weekend. Now, this doesn't necessarily impact professional traders, trading CDS markets, or getting access to data and reposting. it on Twitter, but anytime you see media or professional associations removing data, making it harder to access data, it's going to raise people's suspicions. Indeed, on Twitter right now, the real narrative battle is, on the one hand, the German chancellor and the mainstream

financial media saying, Deutsche Bank is fine, and FinTwitt saying it's not fine. Now, the question is whether FinTwit is saying it's not fine because they have either better evidence or better thinking, or if they're saying it's not fine reflexively, because the mainstream narrative being pushed is that it is fine. This, I think, will be one of the hardest things for people in the new world of no consensus narratives. That is, trying to figure out if the counter-narratives are truly based on something other than just being contrary to the mainstream narratives. I think a world in which there is no media-manufactured mainstream consensus narrative could be healthier, but only if it allows for the possibility that the mainstream narrative will, in some cases, be correct.

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Anyway, back to Fin Twit and Deutsche. Like I said, it's not super clear to me the extent to which there are specific reasons to be concerned about them as opposed to others, other than the fact that it would be really bad if it failed. And there's almost a temptation to see it as the next domino, if only for historical parallelism. Finance a lot, for example, wrote so far we've had two investment bank failures in 2023. SVB's total assets were 200 billion. Credit Suisse was 700 billion. Deutsche Bank is $1.4 trillion, so that would be a Merrill-Linch scenario leading to the collapse of numerous other large. institutions. Now, one of the other phrases you'll see a lot on Fin to it right now is too big to save. Daniel LaCalle, the chief economist at Tresses, says Deutsche Bank is not too big to fail. It is too big to

bail out. Tetragrammaton says most GSIbs have assets worth many times more than the GDP of the country they reside in. They're definitely too big to save, but the G20 passed legislation back in 2010 to ensure government backstop, including bail-ins, would rescue G-sibs at any cost. Marcus Agrippa, right, if Deutsche Bank defaults, the Eurozone and European Central Bank under Christine Lagarde is going to have a hell of a headache, Deutsche Bank debt is so large that there won't be another bank coming to the rescue as there was with Credit Suisse. Now, as we try to parse out what's actually going on here, I think there is one thing that we have to keep in mind. The last decade, and especially the last few years, were characterized by speculative fever to the upside.

In other words, people betting that things were going up, anything was going up, and probably going up way more than they probably should, in a rational market environment. We're now starting to see speculative fever to the downside, where shorts pile on and in many cases actively use the tools of social media to turn their case into self-fulfilling prophecy. First squawk, a market news aggregator, tweets, short interest in Deutsche Bank stock has doubled in last two weeks to 360 million. Short sellers have made over 100 million betting against Deutsche Bank stock in the last two years. Now, ultimately, short selling is an incredibly important part of price discovery and healthy markets. But how short sellers and short selling in general interacts with tools of mass citizen communication

is still worth thinking about, even if that's only to filter or apply a lens to how we view dire doom predictions that get made on Twitter. Alas, Deutsche Bank was not the only major financial institution under pressure heading into the weekend. The market for credit default swaps on Charles Schwab surged higher on Friday, now sitting 20% above previous highs for the year and 40% higher than their level earlier this month. Schwab customers removed $8.8 billion from money market funds over three days in the wake of the Silicon Valley Bank collapse, placing the money into government-backed bonds instead. Mike Peterson, as Schwab spokesman, said at the time, quote, those shifts from one category to the other happen all the time. This one is larger, but is part of a broad industry trend and is not unique to Schwab.

On Friday, Schwab's CEO, Wach Bettinger, told the Wall Street Journal that, quote, there would be a sufficient amount of liquidity right there to cover if 100% of our bank's deposits ran off without having to sell a single security. Other analysts, though, are not so sure. Porter Collins, a portfolio manager at Seawolf Capital, claim that Schwab, quote, mismanaged the balance sheet. Collins, who notably has an open short, said that, quote, the problem is that they made a big rate bet and it's gone the wrong way on them. According to last year's financials, Schwab had more than $11 billion in unrealized losses on its hold-to-matured bond portfolio, exceeding its tangible common equity of just over $6 billion.

While most of those bonds are government-backed and therefore eligible for Fed liquidity programs, such a large mismatch could still be a serious test of those fed facilities. You're definitely seeing some folks on FinTwit get panicky. Known as Dollar tweets, Charles Schwab showing signs of potential distress, has 7.13 trillion USD under management across all subsidiaries. This would truly be a Black Swan event. However, others presented the other view.

Joey Politano writes, just for context on this because people are acting panicky, 80% of deposits at Schwab's main partner bank are insured, compared to 5% at Silicon Valley Bank before its collapse. Much more of Schwab's losses on held to maturity securities, the kind that helped bring down Silicon Valley Bank, are already incorporated into regulatory capital components and ratios, too. Obviously, there's a level of withdrawals that no institution can survive, see Credit Suisse. And bank runs are hard to predict sociological phenomenon, but maybe discount forecasts from people who say,

quote, unrealized losses on deposits, instead of, quote, unrealized losses on assets. And speaking of Joey Politano, he also updated us about a resolution from an earlier part of the banking crisis. This morning, he wrote, Silicon Valley Bank has a buyer, first citizens. They're taking over all deposits and loans, though not 90 billion in securities and other assets. Branches of SVV will open as first citizens on Monday. The FDIC estimates the failure of SVV

will cost the deposit insurance fund $20 billion. The FDIC said Silicon Valley Bank had $119 billion in deposits as of March 10th, the day it was put into receivership, and it had $175 billion as of its last regulatory filing on December 31st, which means about $56 billion in deposits were pulled out during the initial run. First Citizens will gain all deposits and 72 billion of Silicon Valley Bridge Bank assets at a discount of $16.5 billion. End quote. Now, the market

liked the news this morning. Regional banks were up in general and For Citizens specifically, was up 44%. Now, one last end note to a story from before, you'll remember how the last phase of chaos in the Credit Suisse story was kicked off by the Saudi National Bank chair, the leader of CS's largest investor, saying that they would, quote, absolutely not be investing more into Credit Suisse. That was widely attributed to triggering or at least exacerbating a run that would ultimately kill the bank, which in turn obviously hurt that investment. Well, that bank chair is resigning for quote-unquote personal reasons according to a statement today. Life comes at you fast. Anyways, guys, that is the story of where banks are right now. I really do think it's important.

not to be glibber-Polyanish about the real issues that these banks are facing, but to also take each situation on its own terms and merits. To understand that by virtue of these being publicly traded stocks, there are incentives for people to want more turmoil and more failure, and to just incorporate that into how we're thinking about everything. In the same way that it would be silly to just assume and accept every mainstream media narrative presented to you about banks or anything else, I think there is a real risk of over-correcting and assuming that everything the mainstream media or government says is just a priori false. But over the next few months, I'm sure we'll get a chance to see who is closer to correct. Until tomorrow, guys, be safe and take care of each other.

Peace.