Commentaries

The electric car is a technological cul-de-sac

The End Is Nigh is always an arresting headline, the end which is nigh now is the Age of Oil, following the deep thoughts of the boffins at Deutsche Bank.

They are forecasting a “game change” as a result of – wait for it – the electric car. Their thoughts are “unburdened by the conflicting forecasting agendas of government agencies, oil companies or auto makers”, so can roam the intellectual highways and byways.

They postulate a price spike to 175 dollars around 2016, followed by an “equilibrium” price around 100 dollars by 2030. The shock will be enough for the electric car to displace the conventional automobile, and OPEC will eventually be reduced to cutting prices to maintain its market share.

These projections are far enough into the future to ensure that nobody will remind Paul Sankey and his fellow authors of their words if they turn out to be hideously wrong.

Even at hundred-dollar oil, the electric car is a technological dead-end, and the battery is the roadblock. The technology is improving, but there is no sign of the “breakthrough” that might put energy storage capacity within an order of magnitude of the petrol tank. Nor is there a solution to the question of charging times – and the faster a battery is charged, the less efficient the process becomes.

The size of the problem can be simply illustrated: if a dozen cars are filling up simultaneously, the energy transfer (of fuel into the tanks) is equivalent to the output of a medium-sized power station.

Then there is the question of the cost of the exotic materials needed to squeeze more from batteries and electric motors. Rare earth elements, with unpronounceable names and mostly found in China, are crucial to modern technology, but electric and hybrid cars eat them wholesale.

Rates rush may end in tears

Investment banks have made out like bandits over the first half of this year, largely from so-called “flow” businesses, like rates and foreign exchange (FX) that have been unlikely beneficiaries of the credit crisis. This has tempted several other investment banks to enter or expand in those businesses.

However, the volatility and lack of competition that widened bid-offer spreads are disappearing fast. The underlying business is commoditised and requires massive scale. Only a handful of players will make money, and even then they may not make very much.

Before the crisis, FX and rates — the collective term for trading government bonds and interest rate derivatives — were, like cash equities, something of Cinderella businesses. Trading currencies and government bonds — and even the associated derivatives — was seen as an unglamorous business, but one that investment banks had to be in in order to be taken seriously.

During the credit boom, the rates business became steadily less appealing. It gradually shifted from being one in which clients called a few brokers to get a price to one where the majority of transactions were done electronically. These new platforms blew away the brokers’ mystique because clients could see prices for themselves.

Banks had to have an electronic platform if they wanted to remain in the business because clients were demanding cheap and efficient trade execution. This represented a huge investment, mostly in information technology. The combination of higher costs and lower revenues squeezed profits.

All this changed during the crisis. Some banks disappeared or withdrew from the business. In chaotic and volatile markets, the old-fashioned broker’s skills came to the fore again. Bid-offer spreads — the means by which dealers make money in both FX and rates — ballooned to some three to five times pre-crisis levels.

The extraordinary profits made from such flow businesses have been behind investment banks’ recovery and the strong resurgence in their share prices.

Kraft moving ahead with financing

Why let a little rejection stand in your way? Kraft is proceeding with the financing it would need to buy Cadbury, even though the U.K. confectioner spurned the initial offer. It looks like it’s financing plans are  above what had been initially expected, which could mean slightly more new cash could  be added to a revised bid.

Credit Suisse had put the new debt at $6.667 billion. Bloomberg reports it looks more like $8 billion.

Kraft Foods Inc., the world’s second-largest foodmaker, is in talks to arrange about $8 billion of financing for its bid to buy candy maker Cadbury Plc, according to two people with knowledge of the matter.

Citigroup Inc. and Deutsche Bank AG are working on setting up debt financing to cover about half of the 9.77 billion-pound ($16 billion) offer to buy Cadbury, said the people, who declined to be identified because the talks aren’t public. The financing would consist of a bridge loan to be repaid with the proceeds of an investment-grade bond offering, one of the people said. Officials from the two banks declined to comment.

They could also be using the new debt to refinance some of Cadbury’s outstanding debt of $2.4 billion.

The key remains that the financing is based on an investment-grade rating. The added financing isn’t likely to pressure the company’s ratings enough to make a junk rating more likely.

Moody’s Investors Service warned Tuesday that it could downgrade Kraft’s ratings if the deal goes through, but most likely would limit it to a one notch drop.

A rally to remember

Deutsche Bank has published some interesting research putting the recent equity market rally over the past six months in historical context, showing that the only comparable six-month gains occured during the 1930s. During the last six months the S&P 500 has risen 51 percent, while BBB corporate bond spreads have rallied 228 basis points, both one in 200 events, according to Deutsche

The analysts also make some good points on current equity market valuations:

The interesting point to note is that on a Shiller P/E valuation method (ie using real adjusted 10-year rolling average earnings to adjust for the business cycle), the 1933 rallies started with a P/E of between 5-8 and ended the 6-month period between 12-14. This rally started with a Shiller P/E ratio of 12 (the highest in the study) and we now stand at around 18.

And add:

Most of the prior rallies found valuations still historically low at the end of the 6-month period. On a Shiller P/E basis this rally leaves us historically on the expensive side now.

Retail no answer for bank capital dearth

How does a bank raise capital when institutional investors are steering clear of hybrid debt? The dilemma may be particularly acute for Deutsche Bank, which is still in bad odour with some fund managers for not repaying some subordinated debt at the first opportunity this year as expected.

Deutsche has come up with an answer — bypass the institutional investors and flog some of your capital to the rich man in the street instead. The bank is marketing more than 300 million euros in fixed rate perpetual notes, yielding nearly 10 percent, primarily to retail investors.

If that yield sounds like a lot, it isn’t enough to tempt many asset managers who previously bought tier 1 debt securities. They are still nervous of the asset class because the European Commission is starting to demand banks spread the pain of bailouts with creditors by forcing them to defer coupons and not call debt.

Investors have also twigged that banks won’t always repay the bonds at the earliest opportunity just to please bondholders, as Deutsche illustrated this year. Some fund managers are now so sick of subordinated bank debt they want to have the bonds excluded from investment-grade bond indexes, as Reuters reported yesterday.

Retail investors may be less discerning. Perhaps they care less about the bank choosing to delay repayment and are less sensitive to the price volatility these instruments have displayed in recent months. The fear, however, is that they are simply being bamboozled by the yield, which may look juicy compared to paltry deposit rates but won’t mean much if the bank has to stop paying interest.

To be fair to Deutsche, it isn’t the first bank to issue retail tier 1 bonds so far this year and the rates are not scandalously low when compared to yields in the secondary market of about 9 percent or less.

It certainly won’t be the last bank to launch a retail offering. However, private investors alone will not solve the problem: 300 million euros is equivalent to less than 1 percent of Deutsche’s total Tier 1 capital.

For Sale: Investment Bank, one troubled owner

So Deutsche Bank has written a large cheque to bail out Sal. Oppenheim — allowing the German private bank’s investors to subscribe to a 300 million euro share issue  which raises its equity capital to around 2.1 billion euros.

This is just part of the story though. The next step is apparently for Deutsche to take a stake in the 220-year-old private bank and for Sal. Oppenheim to sell off its investment banking business.

Sal. Oppenheim and Deutsche are giving little away — although the private bank says on its website that shareholders made the injection, which was financed by Deutsche and is the first step in a process of establishing a “strategic partnership” with the German lender.

A source tells Reuters that “interested parties” are already knocking on the door to buy Sal. Oppenheim’s investment banking business, which made a loss in 2008 — largely because of share trading losses.

The investment bank had been Sal. Oppenheim’s main money machine in recent years but in 2008 dragged its parent nearly 120 million euros into the red — its first annual loss since the Second World War.

Sal. Oppenheim’s 450-strong investment banking team not only sells M&A advice but also trades.

The challenge now is for the investment banking wing — led by partner Dieter Pfundt — to regain its magic touch and secure a decent price for its own business.

from Margaret Doyle:

Deutsche deal shows Oppenheim weakness

How are the mighty fallen! Sal Oppenheim may be have been banker to Germany's elite for 220 years. However, a few rash investments over the past couple of them appear to have forced it into the hands of Deutsche Bank, the 800 pound gorilla of German banking. However, Oppenheim's clients may be less than delighted at the change of ownership.

The two admitted to being in talks enabling Deutsche to acquire a minority stake on Wednesday, though sources suggest that this could lead to a majority holding.

Oppenheim likes to boast that it is Europe's biggest 100 percent independent private bank. It rejected the idea that it might need a boost in capital from the state just a few weeks ago as its financial woes mounted. The private bank -- headquartered in Luxembourg since 2007 -- made its first loss since the World War Two (of 117 million euros) in 2008 on the back of a few spectacularly badly chosen deals. It invested in IKB, the subprime casualty, Arcandor, Germany's largest post-war insolvency, and Continental,  the tyremaker which was taken over by Schaeffler the ball-bearings maker in 2008, in an expensive and ill-timed deal.

The bank's owners -- some 40 or so shareholders from the Ullmann, Oppenheim and Pferdemenges families -- had to plug in 200 million euros last December to shore up its capital base. Partners at the private bank include aristocrats like Baron Christopher von Oppenheim and Count Matthias von Krockow.

However, with the further troubles among its industrial clientele this year, it looks like a further capital injection would have proven necessary in the absence of a deal.

Given the collapse of other, bigger, banks, its customers may well have started to get twitchy about Oppenheim's solidity. The deal would give Deutsche an "in" into Germany's wealthy aristocratic families and its industrious Mittelstand that it has so far lacked. Despite its small size, Oppenheim has been an adviser to some of the biggest players in Deutschland AG -- it had a hand in the Daimler's 1998 takeover of Chrysler and in Allianz's similarly poor acquisition of Dresdner in 2001.

However, Oppenheim may simply be swapping one set of problems for another. True, a small independent bank lacks the deep pockets of a huge, listed one. However, being the client of a huge investment banking group is not much happier, as UBS customers found out to their cost. Deutsche has been trying to build up its private bank for years. Presumably Oppenheim's clients had good reasons for not making the switch.

Ackermann makes half-baked case for reform

In the debate about the future of financial regulation, most senior bank executives have been notable by their silence, preferring to lobby behind the scenes rather than argue their case in public.

So we should welcome Josef Ackermann’s effort to publicly put the case for big banks. In a long screed published in today’s FT, the chief executive of Deutsche Bank makes the argument that cross-border financial institutions are important for the success of the global economy, and that cutting them back to size would be a mistake.

It would be easy to dismiss Ackermann’s views as self-serving. After all, he runs a global investment bank that has much to lose from increased regulation, and is chairman of the Institute for International Finance, the talking shop for big banks. 

His argument is thoughtful and deserves a more measured response. Nevertheless it has a couple of significant flaws.

from Neil Unmack:

Finance’s 80s experiment shows cracks

We may never see mullet hairstyles or other weird fashions again, but in finance, there is a 1980s revival.     The International Accounting Standards Board has gone back to the future, allowing banks to reclassify assets they previously had to mark to market as loans and receivables, valued at amortized cost. That effectively allowed them to avoid the embarrassment of mark-to-market and return to the historic cost accounting of a quarter-century ago.     The reasons are plausible enough: many asset classes were quoted at nominal, distressed sale prices only. But you ignore market prices at your peril: problems loans are left to fester, exposing investors to the cost of loan managers (understandably) taking a rosy view of advances they may have approved.     Many European banks took advantage of the IASB's lenience to whip doubtful assets off their trading books -- not just plain debt, but collateralized loan obligations, leveraged loans and other doubtful exotica. Now Deutsche Bank <DBKGn.DE> has indicated how this stuff is doing, and the answer is: badly.     Deutsche's pretty figures would have been quite spoiled had it taken a further 1.4 billion euros of unrealized losses on the 37 billion euros of assets it reclassified since last October.     The discrepancy between the carrying value and fair value shouldn't be a surprise -- that was the whole point of the changes. Unfortunately, the market is proving to have been right in pricing some of these assets as junk, because the losses in the reclassified book are starting to show.     More than half of Deutsche's 1 billion euro provisions for credit losses in the second quarter derived from these reclassified assets. Some 2 billion euros of the 3.2 billion euro rise in problem loans had previously been reclassified.     Deutsche is not alone. RBS' <RBS.L> impairment losses on reclassified assets rose to 747 million pounds in the first three months of the year, up from 466 million at the end of last year. UBS is carrying assets reclassified last year at 24.7 billion Swiss francs, versus the fair value of 20.6 billion.     The accounting changes are not designed to bamboozle investors, even though that is frequently the result. Losses may have been deferred, but they will happen. The question for banks is whether they can generate profits quickly enough to offset them. Market prices that seemed ridiculous in the depths of the panic may turn out not to have been the equivalent of the mullet after all.

Deutsche Bank walks bad loan tightrope

    Deutsche Bank’s Josef Ackermann has bet that income from investment banking will more than cover bad debts buried in his balance sheet.     Ackermann is as usual putting a brave face on things, but looking at the hefty charges Deutsche is taking to provision against credit losses, it’s going to be a close call.     At the height of the financial crisis, Deutsche shifted assets from its trading to its banking book, thus avoiding mark-to-market write-downs and the need to raise more capital.     But dodgy loans catch up with you even if you hold to maturity — the losses just take longer to work their way through the pipe as loans become impaired.     Like Barclays in the UK, Deutsche’s sleight of hand may have helped it wriggle out of needing government help. But the Q2 charges have understandably rattled investors, with its shares down some 9 percent on Tuesday.     The big fear is that these charges are only the beginning and there are other skeletons in Deutsche’s cupboard.     But even if there is more bad news to come — and Ackermann is not overly optimistic in his outlook — the question is whether Deutsche can earn its way out. At first glance, it has successfully done this in the second quarter, beating estimates with a net profit of 1.1 billion euros ($1.57 billion) — helped by a lower tax bill — despite charges of 1.4 billion euros.     There are a few serious caveats other than the rise in bad debt provisions. Deutsche’s profit before tax was actually lower than some estimates, as were the revenue figures for some businesses including investment banking. Costs rose 9 percent.     Given that conditions for sales and trading and other investment banking activities could not get much better than they were in Q2, Deutsche is going to be closely watched.     Deutsche can’t do much more about its previous lending decisions. By focusing on avoiding past mistakes and growing its profits it might still squeeze through with no need to raise new capital, a move Ackermann has staked his reputation on doing without.     Deutsche has done well to bolster its capital ratios and cut risk weighted assets. But on the basis of these results, it’s going to be tight.