Call Eliot Ness: Deutsche Bank Is Untouchable

 | Jul 27, 2016 | 1:30 PM EDT
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Jeff Gundlach, noted bond guru and CEO of DoubleLine Capital, has been out front in his criticism of Europe's banks. My Real Money column yesterday highlighted the spotlight about to hit European banks with the release Friday of the results of the European Banking Association's (EBA) 2016 stress tests. So it's good to be on the same page as an industry titan, and in fact Gundlach has heaped specific scorn on Deutsche Bank (DB) , a stock I have repeatedly panned in this column. On July 7, he was quoted by Reuters thusly: 

"Banks are dying and policymakers don't know what to do," Gundlach said. "Watch Deutsche Bank shares go to single digits and people will start to panic... you'll see someone say, 'Someone is going to have to do something.'" 

Well, Deutsche Bank shares were down 4% in Frankfurt trading this morning after second-quarter results, but at about 12.30 euros per share, they still haven't hit single digits. Deutsche's results were more fodder for the shorts with the headline figure of a nearly 100% drop in net income, and the internal figures actually much more disturbing than the bottom line. 

Deutsche's top line was quite weak in the quarter, down 20% year on year on a reported basis, and 12% adjusted for Deutsche's pending divestiture of its stake in Hua Xia Bank and the exclusion of operations deemed non-core. It's just impossible to grow value for shareholders without revenue growth, and the top-line erosion in Deutsche's individual units was eye-opening (all figures 2Q16 vs. 2Q15): 

Global Markets (-28%)

Corporate and Investment Bank (-12%)

Private Wealth & Commercial Clients (-5%)

Asset Management (-8%) 

Deutsche did post a revenue gain in the Postbank business it acquired in 2010, but that asset has been written down several times. The most worrisome business trend was in Asset Management, a division that has seen declines in net new money for the past three quarters. Negative interest rates are not a great selling point for an asset manager, and the risk is that euros that leave "the house" never come back.

 As an equity analyst, it is just impossible to recommend shares of a bank that is not growing revenue. So really, Deutsche is an untouchable, and the stock market is trying -- to the tune of a 58% decline in DB's market value in 12 months -- to recalibrate Deutsche's market capitalization to the true value of its assets net of liabilities. That's a painful journey. 

The positive for Deutsche remains the strength of its loan book. While the company announced write-downs across divisions for loans it flagged in the shipping and metals and mining sectors, the total loan loss ratio is still quite low. As of June 30, Deutsche Bank's impaired loan ratio at the group level was about 1.7% and at the core bank level about 1.4%. So with a CET1 ratio of 10.8% (11.2% pro forma for the Hua Xia transaction), Deutsche is adequately capitalized. 

Deutsche has enough capital to handle the current environment, but we won't find out until Friday night whether the EBA thinks Deutsche has enough capital to weather a downside scenario. While Deutsche correctly noted in its presentation that the EBA stress tests aren't graded as a simple pass/fail, for equity holders the math is much more simple. Any stock is either a buy or a sell, and at this point, even after DB shares' collapse, I'm sticking with my call and sticking with Gundlach: Deutsche's a sell.

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