Bank Consolidation - Under the Hammer

LIKE plane-crash survivors forced to eat their fellow passengers, investment bankers have found some sources of nourishment amid the wreckage of the banking industry. Goldman Sachs notched up a 72% increase in equity-underwriting revenues in the second quarter, much of it from other banks. Now many have their eyes on M&A deals.

Why banks need to consolidate?

Weaknesses in funding and business models have been laid horribly bare. Some banks were too focused on the wrong markets. Wachovia, America’s fourth-largest bank, has suffered from outsize exposure to California’s imploding housing market and is a potential takeover target. Others face regulations that threaten their profits. Lehman Brothers is at the centre of many of them.

Problems for Buyer

More importantly, buyers are scarce. - Deutsche Bank is under pressure to bring down its leverage ratio. Barclays raised £4.5 billion ($9 billion) in June, but is still more thinly capitalised than many of its peers. HSBC has been burnt by its disastrous acquisition of Household.

Due diligence on banks structured-credit exposures remains a nightmarish prospect for would-be acquirers.

Liquidity is also now a big part of buyers’ calculations. Few want to bump up the amount of debt that needs to get rolled.

Accounting standards add to the complexity, by requiring acquirers to account for the assets and liabilities they buy at fair value.

Regulators themselves may set up roadblocks to deals, either because they take a generally dim view of capital-sapping acquisitions or because of the rules.

Banks Present Status

Banks’ need for capital is not yet satisfied and there is mounting concern that investors are less willing to inject cash into sinking assets. Disposals are the obvious escape route. Bidding is under way for Citigroup to offload its German retail operations.

The big question, of course, is whether that will keep bank finances shored up long enough for markets to stabilize. If losses continue to spiral, capital dries up, and disposable assets cannot find purchasers, banks will have little choice but to cut back even harder on lending, or to take whatever price they can get.

Deutsche Hit by $4 Billion Write-Down in Q1-08

Deutsche Bank expects first-quarter write-downs of 2.5 billion euros, ($4 billion) related to leveraged loans and loan commitments, commercial real estate, and residential mortgage-backed securities

Deutsche Bank said as it had indicated on Earlier (Mar 26) that 'markets remained difficult early in 2008', adding that 'conditions have become significantly more challenging during the last few weeks.'

Deutsche Bank expects a BIS Tier 1 capital ratio at the end of the first quarter 2008 of between 8 and 9 percent, consistent with the bank's published targets.

For the rest of 2008, the risks for the banking industry are accumulating, especially for those firms, such as Deutsche Bank, with significant exposure to the U.S. markets.

CNN Money – Deutsche Bank Sees Q1 Mark-Downs of Around 2.5 Bln Eur

Forbes – Bad News From Deutsche Bank

Ackermann Handles Subprime

Deutsche Bank AG, Germany's biggest bank, fourth-quarter profit fell 48% on lower revenue from trading bonds and higher compensation costs.

Net income declined to 953 million Euros ($1.39 billion), or 1.93 Euros a share, from 1.84 billion Euros, or 3.56 Euros, a year earlier. That beat the 923 million-Euro a median estimate of 12 analysts surveyed by Bloomberg.

For all of 2007, Deutsche Bank earned a profit of 6.5bn euros ($9.4bn), which is up 7% compared with 2006.

Net revenues for the fourth quarter were EUR 7.3 billion, up 2% versus the fourth quarter 2006.

"I am pleased to report robust earnings for the fourth quarter, which concludes one of our best years ever and a year of solid performance in challenging times," chief executive Josef Ackermann said. "We put up a good fight."

The investment banking division, which is the motor of the group's business, posted a 57% decline in pre-tax profit to 447m euros in the final quarter, due to sagging demand for debt products.

Deutsche Bank said it didn't take any write-downs related to subprime or other mortgage exposure in the quarter. And in its leveraged-finance operations, which had significant write-downs in the third quarter, the latest charges were kept below 50 million euros.

Dr Ackermann said Deutsche Bank's risk management policies helped it to weather the wild fluctuations in financial markets.

Last summer the bank made a bet that the markets would not bounce back after the collapse of the subprime housing market.

Deutsche Bank said it acted swiftly, reducing its positions in asset-backed securities and collateralised debt obligations

Ackermann is upbeat about 2008, He reiterated its full-year pretax profit target of 8.4 billion Euros, excluding one-time costs and charges, and plans to raise the dividend by 13% to 4.50 Euros a share. Analysts say bank may miss the profit goal because of slowdown in debt markets.

Compared to the losses taken by Citigroup, Merrill Lynch and UBS, Deutsche Bank has dodged the worst of the sub-prime mortgage crash. So no further write-downs, at least for the time being!!

My worries

My worry is that they're too geared to the fixed-income market. So even though they've been good at avoiding writedowns, it's very hard to replace the business they were doing last year.

How much was skill, and how much was luck? Ackermann says Deutsche Bank strategists last year recognized that the U.S. housing market was overheated and unwound their exposure. However the bank couldn't avoid some losses, writing off $3.2 billion in the last quarter. And in the most recent quarter, it wrote off about $74 million related to its leveraged finance business.