(Nasdaq) Deutsche Bank’s misleading CDS hide a wider truth

(Nasdaq) Pity poor Christian Sewing. As if the Deutsche Bank boss didn’t have enough on his plate, prices for the German lender’s credit default swap spreads have ballooned. That matters less than it might seem, but underlines a worrying scepticism towards the new CEO’s strategy.

In fact, the rise in CDS spreads has limited immediate consequences. It could theoretically affect up to 176 billion euros of funding that Deutsche raises from wholesale markets. But the bank only needs to renew around 25 billion euros this year, of which it has already issued 11 billion euros. The majority of the balance, around 7 billion euros to 9 billion euros, will rank ahead of unsecured debt and are relatively unaffected by CDS prices. That leaves just 5 billion euros to 7 billion euros of bonds left to issue.

Higher spreads might also spook funds and other banks that trade with Deutsche, making them less willing to do business. But the bank argues that counterparties rank above senior unsecured creditors under German law, meaning they should not be too worried about short-term changes in its CDS spreads.

However, the rise in Deutsche’s CDS does reflect growing concerns about its weak profitability – and whether Sewing will enjoy any more success in his restructuring than predecessor John Cryan. If Sewing struggles, the bank’s funding costs will creep up, and rating firms lower their assessment of its creditworthiness. Over time, that would hurt Deutsche’s profitability, and cause it to lose more market share.

Deutsche is targeting a 10 percent return on tangible equity by 2021. UBS reckons that implies 32 billion euros of revenue, or growth of 4 percent for the next four years. The last time Deutsche enjoyed that level of growth was between 2009 and 2012. Little wonder investors remain sceptical.

– The spread on Deutsche Bank’s five-year credit default swaps has more than doubled from around 70 basis points at the beginning of the year to 167 basis points on June 11, according to Eikon.

– Credit default swaps are contracts used to protect against the risk of a company defaulting, or to speculate on a change in its creditworthiness. A spread of 166 basis points means it would cost 166,000 euros annually to hedge 10 million euros of bonds.

– Deutsche Bank is currently undergoing a restructuring under new Chief Executive Christian Sewing to boost returns and earn a 10 percent return on tangible equity by 2021, up from a negative 1.4 percent return in the latest financial year. Sewing said on April 26 that he wanted to shift the bank away from volatile investment banking “to more stable revenue sources” and strengthen its core business lines.