Deutsche has abandoned its dream of keeping returns at the unsustainable, leverage-fueled levels seen before the crisis.
By Stephen Gandel
June 5, 2014

When banks sell their own shares, they almost always hire their own investment bankers to do it.

It’s an unspoken rule on Wall Street. First of all, it pads your numbers. Banks regularly credit themselves for their own deals in Wall Street’s ranking of top deal makers, even if the deals weren’t really up for grabs. Perhaps more importantly, hiring another bank to do your own deal just looks bad.

But then this happens: On Thursday, Deutsche Bank (DB) sold nearly 300 million of its own shares for $30.64 (€22.50). The problem is as of Wednesday night Deutsche’s stock was trading at $40.45. That’s what the market thought Deutsche’s stock was worth. And yet, Deutsche’s crack stock sales team was only able to get $30.64. We can convince investors your company is worth 24% less than they think is not a great sales pitch.

Of course, that wasn’t the spin Deutsche put on it. Instead, it said its bankers were able to sell more shares than they originally thought. But why is that notable? When you sell something for less than it’s worth, you typically have a lot of takers. I mean, it’s free money. Why would anyone turn them down?

Part of the problem, of course, is with what the Deutsche investment bankers had to sell. Deutsche is a European bank and Europe is still looking weak these days. On Thursday morning, European Central Bank President Mario Draghi for the first time ever cut the rate it pays on bank deposits to a negative 0.10% on fears that Europe could soon be hit with deflation. If that happens, a European bank will not be a great place to be.

A number of other European banks including Commerzbank and Barclays have sold shares in similar secondary offerings lately. And many of those deals have been at bigger discounts than Deutsche. But Deutsche, as Germany’s largest bank, is in much better shape than rival European banks.

Deutsche has been spending the last year or so trying to convince people of that. At the same time, it has gone around trying to raise a bunch of money. The bank says it doesn’t really need the extra cash to shore up its finances. It’s just adding capital to make nice with the regulators, particularly the Americans, which everyone knows has it out for European banks. After this last offering, Deutsche says it will have a capital ratio of 12%, which would rank it higher than most other banks, including the large U.S. ones.

If that was true, selling Deutsche’s shares would be easy to do. The issue is that many regulators and investors question Deutsche’s numbers. The 12% capital ratio is not based on all of Deutsche’s assets. Including all of its loans and investments and Deutsche’s capital ratio drops to around 3%. The 12% figure is based on a ranking of its assets by riskiness. Regulators have traditionally preferred this measure, but some have recently questioned it because it excludes a lot of assets deemed not risky and the banks haven’t proved to be so good at knowing what assets will be risky, and which won’t, which all banks do. But Deutsche’s math tricks seem shadier than others banks. For instance, a little over a year ago Deutsche had a quarter where it lost $2 billion. Capital is mostly retained earnings. So a loss of $2 billion should cause your capital ratio to go down. It didn’t. Instead, Deutsche’s went up, mostly because some risky assets magically disappeared.

“There is a question in a lot of people’s minds whether Deutsche is getting to its capital ratios dishonestly,” says Erin Davis, a European bank analyst at Morningstar. “It’s very difficult to verify their numbers.”

Capital is not the only problem Deutsche is having. As part of the offering, Deutsche said it may have to pay fines for misdeeds in foreign exchange market and elsewhere. Another problem: Deutsche says revenue at its investment bank continues to slide. And when your bankers are being forced to do your own deals at 24% less than they are worth that problem probably isn’t going away anytime soon.

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