OK, I admit the headline is a bit of a con. I don't have any earth-shattering revelations about Deutsche Bank (DB), so if that's what you're after, close your browser window now.
What I am looking at in this article is the reason why Deutsche Bank sometimes is, for a trading room, the equivalent of shouting "fire" in a crowded theatre. Is it because of its derivatives exposure? Is it because of its debt? Is it because of its stock performance? Let's see...
The derivatives issue seems to be the one that sparks the worst fears, so let's focus on that for now. Back in February of this year, Zero Hedge ran a story helpfully headlined: "Is It Time to Panic About Deutsche Bank?". It basically quoted another article by the same blog, from April 2013, which said Deutsche Bank's exposure to derivatives was the largest in the world, at $72.8 billion. The problem is that that's gross exposure, not net, and therefore it is not really that scary.
The article does explain about netting lower down --- offsetting positive and negative exposures against each other -- but does it in quite a dismissive way, saying that netting works in theory, but in practice it might not. That may be so, but in that case this is a problem for all banks. JPMorgan (JPM), for instance, was at the time the second-largest holder of derivatives in the world, not far behind Deutsche, with $69.5 trillion worth of the stuff in gross exposure.
To put things in perspective, total outstanding derivatives contracts in the world were $700 trillion at their peak in 2012 and are worth more than $500 trillion currently. That's according to Bank for International Settlements (BIS) figures quoted by John Kay in a Financial Times article debunking the myth of gross exposure to derivatives.
OK, these figures are huge (world GDP in 2013 was $75.59 trillion in nominal terms, according to World Bank data) so why hasn't Deutsche Bank (and JPMorgan, and all the other big banks for that matter) collapsed yet? Well, there's the effect of netting. This basically means that for every derivative position, the bank also holds a position the other way, and they roughly cancel each other out.
In other words, if banks bet that a certain price will increase by 10%, at the same time they bet that it will decrease by the same percentage. The net result of the position is zero. There are of course some differences, as banks usually seek to gain from exploiting price differences between positions, but these are not that significant.
Let's take the latest data in Deutsche Bank's annual report for 2015. It shows that the bank's total, notional exposure to derivatives transactions is 41.9 trillion euros ($46.8 trillion). While that's more than 35% lower than its 2013 exposure, it still looks huge.
However, after offsetting the positive and negative exposures against each other, the net exposure is a much more manageable 18.2 billion euros ($20.3 billion).
A look at JPMorgan's annual report for 2015 shows that actually, the U.S. bank has overtaken Deutsche Bank and now has world's biggest exposure to derivatives, worth $50.6 trillion. Incidentally, that's not because JPMorgan's exposure has been rising, but because Deutsche's has been falling faster.
Again, JPMorgan's figure, in the tens of trillions, is gross exposure. What about net? Netting out is done a bit differently under U.S. accounting rules than under European ones. U.S. GAAP allows banks to disclose positions after they have been netted, whereas International Reporting Financial Standards (IFRS), which European banks use, don't. (If you're interested in the technicalities, here's a link to an article that explains the difference between the two systems, and the pitfalls, pretty well).
Under GAAP, JPMorgan shows net derivative receivables worth $59.7 billion and net derivative payables worth $52.8 billion, therefore a net position would be more like a much less frightening $6.9 billion.
The discussion about derivatives took up a lot of space, so I'll address the other "fears" about Deutsche Bank briefly. Moody's earlier this week cut its credit rating to Baa2, "two notches above junk" as some reports said. Well, I would point out that two notches above junk is still investment grade.
Besides, John Cryan, the Deutsche Bank CEO, came out and told Bloomberg that the bank has enough money to pay its debt four times. Indeed, a look at the first-quarter financial results shows long-term debt worth 151.3 billion euros against loans of more than 424 billion extended by the bank, coupled with other assets worth more than 171 billion euros.
What about the share price's abysmal performance? Its shares lost a quarter of their value year to date (it's true that they've perked up a bit lately).
Well, this is where the real worry should be: Deutsche Bank is unlikely to suddenly collapse under the weight of its huge derivatives portfolio. Instead, it may well, gently but steadily, slide into oblivion, crushed by underperformance and an inability to grow its earnings.
But then, this sounds like the fate of many European banks in this low, or even negative, interest rate environment. It just so happens that Deutsche is the most visible right now.
