Why Deutsche Bank is in analysts' sights

All eyes will be on Deutsche Bank as analysts pour over the ECB's stress tests. Germany, and its largest bank, appear to have dodged a bullet.

European markets will breathe a sigh of relief tonight.

In recent weeks, the world has been anxious about what would be revealed in the European authorities’ banking stress test. 

Many believed that the capital shortfall could run into hundreds of billions of euros. Instead €25 billion will cover it, and much of that has already been raised. More importantly, Europe’s largest bank, Deutsche Bank, and indeed all the major German and French banks, have passed and, according to the European Central Bank, would be able to survive a financial crisis or a severe economic downturn.

Two weeks ago, shares in Deutsche Bank fell to €23.26 -- when measured in US dollars, that's close to its lowest levels since the global financial crisis. There was great fear the German bank would fail the test and that would trigger another major capital raising and would further depress the German economy. There is little doubt it would have sent Germany into recession.

The low point in Deutsche shares triggered leaks that the report may be better than expected and last week Deutsche shares recovered somewhat and on Friday closed above €25. Even at those levels Deutsche is priced at only 0.4 times its book value and down substantially on the year. Some of Deutsche’s paper has been discounted in the market.

The ECB says that the €8.5 billion Deutsche raised in an issue at €22.5 a share earlier this year was sufficient. Overall, European banks have raised some €200 million since mid-2013.

The European Central Bank said that 13 banks in the eurozone -- including four in Italy and two in Greece -- showed clear shortfalls in their own capital. But overall, there were 25 banks that the ECB stated had capital shortfalls through the end of 2013. The total shortfall for those 25 banks was €25 billion.

While there is general great relief, which will help European sharemarkets, the Italian and Greek bond markets may suffer when they open. 

A large amount of material about all the European banks is now available and there will be a very close examination of that material, with a concentration on Deutsche. Many analysts are skeptical of the report and say it may not have been tough enough. The review also uncovered €136 billion in troubled loans that banks had not previously reported. Partly as a result, banks had overvalued their other holdings by €48 billion. The European Central Bank audit was conducted by 6,000 civil servants and outside consultants.

Next month the ECB will become the supreme bank supervisor for the euro region, assuming much greater powers for overseeing the biggest banks in the European Community. The arrangement gives the ECB powers similar to the US Federal Reserve. This stress test was undertaken because the European Central Bank wanted to discover the health of the banks it will regulate. Past European stress rests examined fewer banks and relied heavily on information from the banks’ national supervisors. They were next to useless.

The central bank will formally become the eurozone’s so-called single supervisor on November 4.