What happened
Shares of large German lender Deutsche Bank (DB 1.60%) traded as much as 11.3% lower in pre-market trading on Friday before paring some of those losses. As of 10:47 a.m. ET, the stock was down roughly 8%. The culprit appears to be an abrupt rise in the cost of credit default swaps (CDS) tied to the bank.
So what
This morning, the cost of Deutsche Bank's five-year senior CDS rose to 2.22%, up from 0.88% earlier this month. CDS are essentially a way to hedge against the risk of default, so if the cost of CDS goes up, it can be an indication that investors are more concerned about a company.
While Deutsche Bank has had its fair share of issues in the past, the bank does appear to have made significant progress in recent years, especially from a financial standpoint. After embarking on a significant restructuring plan in 2019, it has now reported a profit for 10 consecutive quarters. In February, the bank confirmed that it still expects to deliver a greater-than-10% return on tangible equity by 2025.
But the markets are very sensitive right now, especially after embattled bank Credit Suisse was forced into an acquisition last week. Regulators' decision to wipe out additional Tier 1 debt as part of this acquisition has also made a lot of European bondholders nervous.
Deutsche Bank looks to be in a very strong position when it comes to capital and liquidity. The bank has a common equity Tier 1 (CET1) capital ratio of 13.6%, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets. It also has a liquidity coverage ratio of 145%. This ratio looks at a bank's high-quality and shorter-term assets it could use to fund significant cash outflows over a 30-day stressed period.
Now what
Given what has happened with several banks recently and the velocity of deposit outflows they've experienced, it's easy to see why the market is jittery.
But in terms of capital and liquidity, Deutsche Bank is really as well positioned as any large comparable bank. It has also made strides in transitioning its business in recent years. I view this sell-off as an overreaction.
