Wednesday, 07 December 2022

A Analysis

Reggie Middleton

Reggie Middleton

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Following up on "What Happens to Banks When the Real Funding Rate Appears?", we will take a look at could happen to Deustche Bank when LIBOR does this...

... and depositors realize Deutsche Bank as Ground Zero?, thus contemplate Deustche Bank and the Anatomy Of A European Bank Run: Look at the Situation BEFORE The Run Occurs, from which they may learn this...

... and this...

... consequently doing this...

As explained in "What Happens to Banks When the Real Funding Rate Appears?", bank funding and derivative benchmark costs are going up. In the past, banks have manipulated these numbers to increase their perception of creditworthiness and to synthesize profits from their derivative positions. Reference Wikipedia's description of the LIBOR scandal:

WSJ Libor study

Libor manipulation to lower rate

Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot.

Barclays Bank trader in New York to submitter,
13 September 2006[25]

On 16 April 2008, The Wall Street Journal released a controversial article, and later study, suggesting that some banks might have understated borrowing costs they reported for the Libor during the 2008 credit crunch that may have misled others about the financial position of these banks.[26][27] In response, the BBA claimed that the Libor continued to be reliable even in times of financial crisis. Other authorities contradicted The Wall Street Journal article saying there was no evidence of manipulation. In its March 2008 Quarterly Review, the Bank for International Settlements stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings."[28] Further, in October 2008, the International Monetary Fund published its regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar Libor-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar Libor remains an accurate measure of a typical creditworthy bank's marginal cost of unsecured U.S. dollar term funding."[29]

A study by economists, Snider and Youle, in April 2010, however, corroborated the results of the earlierWall Street Journal study that the Libor submissions by some member banks were being understated.[30]Unlike the earlier study, Snider and Youle suggested that the reason for understatement by member banks was not that the banks were trying to appear strong, especially during the financial crisis period of 2007 to 2008, but rather that the banks sought to make substantial profits on their large Libor interest-linked portfolios.[31] For example, in the first quarter of 2009,Citigroup had interest rate swaps of notional value of $14.2 trillion, Bank of America had interest rate swaps of notional value of $49.7 trillion and JPMorgan Chase had interest rate swaps of notional value of $49.3 trillion.[32] Given the large notional values, a small unhedged exposure to the Libor could generate large incentives to alter the overall Libor. In the first quarter of 2009, Citigroup for example reported that it would make that quarter $936 million in net interest revenue if interest rates would fall by .25 percentage points a quarter, and $1,935 million if they were to fall by 1 percentage point instantaneously.[33]

Central banks aware of Libor flaws

The Governor of the Bank of EnglandMervyn King, by the end of 2008, described the Libor to the UK Parliament saying "It is in many ways the rate at which banks do not lend to each other, is not a rate at which anyone is actually borrowing."[34][35]

The New York Federal Reserve chose to take no action against them at that time.[36][37] Minutes by the Bank of England similarly indicated that the bank and its deputy governor Paul Tucker were also aware as early as November 2007 of industry concerns that the Libor rate was being under-reported.[38][39] In one 2008 document, a Barclays employee told a New York Fed analyst, "We know that we're not posting an honest Libor, and yet we are doing it, because if we didn't do it, it draws unwanted attention on ourselves."[37]

The documents show that in early 2008, a memo written by then New York Fed President Tim Geithner to Bank of England chief Mervyn King looked into ways to "fix" Libor.[40][41] While the released memos suggest that the New York Fed helped to identify problems related to Libor and press the relevant authorities in the UK to reform, there is no documentation that shows any evidence that Geithner's recommendations were acted upon or that the Fed tried to make sure that they were. In October 2008, several months after Geithner's memo to King, a Barclays employee told a New York Fed representative that Libor rates were still "absolute rubbish."[37]

Alas, as you see in the first graphic of this article, LiBOR is going up, and it's going up for real this time. Banks are paying practically nothing to depositors who are now forced to take the brunt of the risk that banks entail, while others taking the exact same risks are offered considerably higer rewards and payouts. We're talking the EU bail-in laws that put unsecured creditors on equal footing - that includes depositors. So, using our favorite healthy bank, DB, how would this play out of the smarter of our constituency decided to either be properly compensated for this risk or opted not to take it at all?

DB balance sheet liquidity

Assets with maturity within 1 year or less held the major part of total financial assets of Deutsche bank. In 2014 & in 2015 it constituted more than 75% of total financial assets of Deutsche Bank. And assets on demand comprises more than 60% of total financial assets of Deutsche Bank.

The total financial assets of Deutsche bank decreased by almost 90 billion euros from 2014 to 2015. Deutsche Bank’s financial assets designated at fair value through profit & loss reduced by almost 122 billion euros during the same period. Deutsche Bank’s Derivative assets also reduced by almost 115 billion euros.

Among the total financial liabilities, on demand liabilities constituted almost 70% in both 2014 and 2015. And liabilities with maturity within 1 year or less comprises more than 90% of total liabilities.

Deutsche Bank’s total financial liabilities increased by almost 75 billion euros from 2014 to 2015. Out of the total on demand liabilities dues to bank and customers both increased by almost 50 billion euros in aggregate during this period. Financial liabilities designated at fair value through profit & loss also increased from 2.6 billion euros in 2014 to 18.42 billion euros in 2015. This increase was mostly driven by increase of 16.2 billion euros in securities sold by Deutsche bank under repurchasing agreement.

There's an imablance of about 3.5:1 of truly liquid, stable liabilities to truly liquid, stable assets. This means, if depositors really started withdrawing overnight and on demand deposits from DB, DB goes bye-bye! Why would this happen? Ask the ECB, the Fed and their Z/NIRP propensities.

banks charging for deposits

I'll close out with a video from everone's favorite old school investor, Warren Buffet.

We have posted a deep dive analysis of:

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During the financial crisis of 2008, money market funds who subjectively agreed to hold their NAV (net asset value) unit prices at $1 “broke the buck”. That is, the unit of share of the fund fell below $1 (the $62.5 billion Reserve Fund, to be specific, one of only two funds to “break the buck”), which was a significant problem for the investors who used (and considered) said money market funds as cash in the bank. All of a sudden, everyone’s cash account at the Reserve Fund just dipped in value. Uh Oh! This caused short term credit to literally freeze, worldwide, because others were concerned that their bank-like security and liquidity was no longer that secure nor liquid.

Regulators stepped in to make sure this didn’t happen again by demanding that all money funds who do not invest in sovereign securities (those entities who “should” be able to print their own monies, but we’ll get into that in a later post) allow their NAV to freely float with market prices.

The result? Money flew out of prime money funds into perceived safer vehicles.

Demand for government short term paper has increased (to the tune of hundreds of billion of dollars).


... and demand for private commercial paper, ie. banks, have dropped by a similar amount, materially driving costs - materially, as in doubling it!

What does this mean?

No, this is not a punishment. This is actually a good thing, for it forces money to have an appropriately derived price tag attached to it. Risky banks were being funded at the same risk rate as (less risky) sovereign governments. That didn’t make sense. Now the system makes more sense, and banks should be repriced according to their access to, and true cost of, capital. The true cost of capital means that banks can no longer hide behind fake LIBOR quotes to conceal their deteriorating credit metrics. Reference Wikipedia:

The Libor scandal was a series of fraudulent actions connected to the Libor (London Interbank Offered Rate) and also the resulting investigation and reaction. The Libor is an average interest rate calculated through submissions of interest rates by major banks across the world. The scandal arose when it was discovered that banks were falsely inflating or deflating their rates so as to profit from trades, or to give the impression that they were more creditworthy than they were.[3] Libor underpins approximately $350 trillion in derivatives. It is currently administered by NYSE Euronext, which took over running the Libor in January 2014.[4]

Look at what happened to LIBOR consistently after NYSE Euronext took over adminstration. Those spikes that you see previous to that takeover stem from the European sovereign debt crisis. Those numbers had been faked! No telling what the true level of stress really was. Well, this time around we may get to find out. To put this into perspective, the global money market industry is $2.6 trillion in assets. Deutsche Bank’s (a bank that is in trouble) balance sheet is almost $2 trillion dollars. JP Morgan’s balance sheet is $2.4 trillion dollars. Both of these banks have been shrinking their balance sheets.

As excerpted from Bloomberg:

With a seismic overhaul of the $2.6 trillion money-market industry weeks away from kicking in, money managers are bracing for a last-minute exodus of as much as $300 billion from funds in regulators’ cross hairs.

Prime funds, which seek higher yields by buying securities like commercial paper, are at the center of the upheaval. Their assets have already plunged by almost $700 billion since the start of 2015, to $789 billion, Investment Company Institute data show. The outflow has rippled across financial markets, shattering demand for banks’ and other companies’ short-term debt and raising their funding costs.

Interestingly enough, and as is par for the course, we see things differently from the Street, as also excerpted:

Financial firms paying higher rates to attract investors to their IOUs will push three-month Libor to about 0.95 percent by the end of September, according to JPMorgan Chase & Co.

Click here to read more about rising Libor rates.

Although bank funding costs are rising, it isn’t a signal of financial strain as in 2008, said Jerome Schneider, head of short-term portfolio management at Newport Beach, California-based Pacific Investment Management Co., which oversees about $1.5 trillion.

“This is not a credit stress event, it’s a credit repricing due to systemic and structural changes,” he said.

He’s right. It’s not a credit stress event… yet! But, the credit repricing will force a reality and discipline on an industry accustomed to near zero and negative interest rates that it is ill-fitted to handle, and thus in due time, it will likely provide at least a partial impetus for… “a credit stress event”.

NiM (net interest margin - the profit from actual old school banking businesses, ie. lending) is still quite sparse in banks. So, revenue is slim, but expenses to access said capital to conduct business are going up. That's never a good sign. Worse yet, the Fed has signalled it will, yet again, hold off on an interest rate increase - As I have been telling you since December of 2014.

The issue is, the Fed does not truly control the market, it simply manipulates it to the best of its ability. When it's ready, the market will raise rates on its own. Reference where short term rates are trending now, likely as reflection of the Fed not raising rates.

This is particularly true for the European banks...

Our next post will describe how well Deutsche Bank is prepared for such an event. Stay tuned, and if you have not already done so, subscribe to our long/short, macro and educational research (including blockchain tech) - see Corporate Valuation & Equity Research.

We have a brand new DB report out today, reference Derivative Risk Exposure of Major Banks to Deutsche Bank.

Tuesday, 13 September 2016 12:14

These Handsets are Hot!

Samsung's Note 7 release has turned out to be an absolute fiasco. The latest incident is a Note 7 alleged to have exploded and set a Jeep on fire.

Nathan Dornacher claims the Galaxy Note 7 caused the fire

This looks and sounds bad, and apparently has (or will) cost the company billions in recall expenses, reparations and replacements. Reputation risk is no small deal either. Let's face it, this looks very bad. It feels bad for investors as well, with billions of dollars of market cap disappearing. As bad as it may look, keep in mind the media is giving a less then comprehensive view of the situation. I have found roughly 35 to 40 incidences of burning or exploding Notes. If one were to divide that by the approximate amount of Note 7s sold (2.5 million), it would be roughly .0000148, or just over a thousandth of a percent. The number is not even great enough to determine that there is a problem with the Note 7 in particular. Alas, due to the social and mainstream media exposure, it has not choice but to recall. The FAA has banned use on airplanes (despite the fact you'd have similar odds of the airplane itself crashing).   

Now, I'm sure many of you may disagree with my statisctical view of the situation, but if I'm wrong then iPhones are a risk that need to be recalled as well. I

've found just as many (possibly more) cases of iPhones catching aflame and exploding than that of the Note 7 with just a cursory search.


The major difference between the Note 7 incidences and the iPhone incidences is that people were serverely injured in many of the iPhone occurences and Apple has (at least according to my cursory research) done very little to remedy this as compared to Samsungs respones. I would chalk this up to the Note 7 incidences getting much more exposure than the iPhone incidences. 

Short Samsung long LG Veritaseum contract
A damaged iPhone that caught fire and burned through a man's jeans after it was bent in an accident.A damaged iPhone that caught fire and burned through a man's jeans after it was bent in an accident.

EDMONTON — Twice in the last week, an Alberta family has been forced to flee for their lives after a charging cell phone burst into flames, part of a rare worldwide phenomenon in which smartphones occasionally transform into tiny Presto logs. In Rimbey, Alta., 16-year-old Josh Schultz woke up surrounded by flames after his iPhone combusted in the middle of the night. The family managed to get the blaze under control, but not before Schulz had suffered third-degree burns, and the house had been rendered temporarily uninhabitable.Three days later, an Edmonton fourplex was evacuated in the wee hours of the morning after a charging cell phone began shooting out flames.

She said his iPhone unexpectedly began to smoke and melt, causing first- and second-degree burns. NewsChannel 5 on Your Side has been following cases of exploding smart phones for months. While it's happened across the country, this is one of the first documented cases that's occurred in the St. Louis area. "We were panicking and freaking out. I'm like 'Oh my god, my son is on fire!'" said Michelle Terry of St. Peters.

If you do a search, you can find dozens more, particularly surrounding the iPhone 6/6s series. It remans to be seen if Apple will get the negative publcity backlash that Samsung has recieved, but for some reason I doubt so. The Samsung affair was a strong opportunity to short the stock/ADR. If you missed that, we can wait around to see if the company that avoided the mistakes that Apple made and that Samsung unwisely followed. What mistake is that, do you ask? They both opted to seal in their potentially highly reacgive Lithium batteries, case of form over function. Apple should have been able to take advantage of Samsung's problems, but the iPhone 7 is just so far behind the Note 7 in terms of capability, they simple stand very, very little chance. As a matter of fact, sans a recall it's quite likely that the Galaxy Note 7 would have trumped the iPhone 7 Plus.

Very recently, a compettor of both has announced a flagship device that likely puts the iPhone 7 plus to shame and gives the Note 7 a good run for its money. That company is LG.... and guess what? It has a removable battery and an all metal, aviation grade body. A removable battery design would have saved Samsung over $1.7B, since they could have sent out new batteries in instead of recalling all devices.
Even Apple afficiandos are underwhelmed by the progress of Apple tech relative to Samsung's. While most have said the Note 7 is the best thint since sliced bread, not having it doesn't do anyone any good, and then there's that exploding thing.
LG has come up with just the right device at just the right time. According to one reviewer
Similar to previous LG phones, the more I use it, the more I like it. Also, the longer I use the LG V20 with the Note 7 now returned to T-Mobile, the possibility that I go for the V20 rather than the Note 7 increases as well.
Another reviewer detailed what makes this device ideal for a growing minority, yet influential section, or the smart phone population - the media producers (in contrast to consumers):

Made for Multimedia

Unlike the G5 and its modular system of third-party hardware add-ons, the LG V20 comes with a built-in quad-DAC made by ESS. LG reps made a swipe at the disappearing headphone jacks on some competitors—like Apple’s rumored iPhone 7 and Motorola’s Moto Z saying that the DAC can be used with high-end headphones to enjoy higher fidelity music. ESS reps in San Francisco informed me that the DAC on the V20 supplies enough power to power high-end headphones that traditionally would require an additional power source. When you load the V20 with uncompressed audio files, plugging a pair of headphones into the smartphone will give you a more high fidelity listening experience with the built-in DAC. For comparison, the modular DAC on LG’s G5 costs roughly $199, but the accessory isn’t even available for sale to date for US customers.

LG also said during its keynote that for a limited time, the V20 will ship with earbuds from Bang & Olufsen.

Better Audio Production

Screen Shot 2016-09-07 at 12.12.34 AM.png

The V20 comes with three high fidelity microphones, which LG claims will record better sounding audio files and better videos. The microphones will help to reduce audio clipping in noisy environments, LG said during its presentation. This means that you can capture clip-free audio from concerts with studio quality-like recordings, according to an LG spokesperson. LG also included its Hi-Fi Audio capture app to allow you better control of your audio recording with more fine-tuned settings.

Below is a Veritaseum Smart Cotnract allowing you to swap Samsung equity exposure (on the Korea Stock Exchange) for LG equity (KS) at 3x leverage (using a digital multiplier). No broker, risk or legacy stock exchange needed. No counterparty or credit risk to deal with.

Short Samsung long LG Veritaseum contract

Following up on Deutsche Bank as Ground Zero?, I'd like to focus on the deteriorating credit metrics at Germany's largest bank. To be absolutely honest, an educatied consumer is the at odds with the bank's other stakeholders in this situation. Educated consumers, particularly those seeking safe, secure bank accounts and lending faciilities should be moving out of Deutshe bank right now. DB is far from safe and secure, particularly in relation to other destiniations. Remember, bank bail-ins are EU law now. European regulatory authorities can force these failing institutions to cancel or severely dilute shareholder equity or to cancel, write-down or convert unsecured liabilities to equity. Such regulatory action is referred to as a “bail-in.” Bank depositors (checking, savings, demand accounts) are investors as well, in the form of unsecured creditors. 

Most depositors still don't realize this (despite Icelandic bank depositors getting smashed). Depositors are the largest, one of the cheapest, and currently the most stable form of bank financing.

DB credit matrix

Most depositors, when they realize they actually are investors, should head to safer pastures. This will leave a gaping whole in Deustche Bank where 312 euros once stood. Let's recent how I described The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs:

... Below is a chart excerpted from our most recent work showing the asset/liability funding mismatch of a bank detailed within the report. The actual name of the bank is not at issue here. What is at issue is what situation this bank has found itself in and why it is in said situation after both Lehman and Bear Stearns collapsed from the EXACT SAME PROBLEM!



... The problem then is the same as the European problem now, leveraging up to buy assets that have dropped precipitously in value and then lying about it until you cannot lie anymore. You see, the lies work on everybody but your counterparties - who actually want to see cash!


... The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors.  In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!


 The research and knowledge subscription module "European Bank Contagion Assessment, Forensic Analysis & Valuation" contains a full report of a very large European Deustche Bank counterparty that faces a full 27% downside from current levels. It appears as if no one suspects a clue. It also contains much, much more (including at least 3 to 5 suspect banks). We can break this apart a la carte, if requested.

As excerpted:

Susceptible Bank 1: Financial Modeling


Friday, 09 September 2016 16:25

Deutsche Bank as Ground Zero?

Wells Fargo was recently fined $185 million for opening over a million fake accounts and credit cards. This got a lot of attention in the media. It is our assention that Deustche Bank's situation is far more worthy of attention.

DB credit woes

We all know how I feel about credit agencies...

Well, as slow as the ratings agencies are to pull the trigger, even they have downgraded DB to "subprime"...

Subscribe to European Bank Contagion Assessment, Forensic Analysis & Valuation to access our research on the Deutsche Bank counterparty that has a 27% potential downside near to medium term. It is one of the most thorough analyses of a bank that you are likely to ever have seen. Remember, we the guys to call Bear, Lehman, Countrywide and WaMu.

We are releasing new information on Deutsche Bank three times per week, with new free content and analysis coming out this weekend. In the meantime, this is what you may have missed:

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