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RAOUL PAL: 'It's not a big storm yet, but the clouds are everywhere'

A rising full moon is seen over the distinctive twin towers of Germany’s Deutsche Bank headquarters in Frankfurt. REUTERS/Kai Pfaffenbach

Shares of Deutsche Bank have been clobbered over concerns the German lender needs to raise capital to pay a $14 billion fine from the US Department of Justice to settle probes over toxic mortgages it packaged leading up to the financial crisis.

But this is just a “canary in a coal mine” signalling a much bigger problem in the European banking system, according to former macro hedge fund manager Raoul Pal.

“Deutsche Bank was just one of the warning signs out there for the banks. It just looks the worst based on the shear size,” Pal told Yahoo Finance in an interview. “It’s one of the canaries in the coal mine telling something really bad is going on in the European banks overall.”

Pal, who previously co-managed GLG’s Global Macro Fund, is the publisher of The Global Macro Investor, a research letter read by top hedge fund managers. He’s also the co-founder of Real Vision Television, an online subscription investing video service.

Raoul Pal

In a presentation he gave on Real Vision in February, Pal said the European banks were “the black swan nobody was looking at,” referring to a hard-to-predict event.  It’s something he’s been writing about in The Global Macro Investor for almost two years.

Across the board, European bank stocks have gotten slaughtered this year. Deutsche Bank (DB) has collapsed more than 50% this year. Credit Suisse (CS) has plummeted more than 40%, while UBS (UBS) has fallen 31%. Royal Bank of Scotland (RBS) has fallen 48% and Barclays (BCS) has slumped more than 33%. Shares of Spanish banks Banco Popular and Bankia have also been pummeled.

In an interview with Yahoo Finance, Pal highlighted five key issues that are creating storm clouds in the banking system.

1. The banks are still a mess. The European Central Bank has been trying to tackle the issue of non-performing loans (NPLs). The ECB has taken a massive amount of low quality collateral off the banks’ balance sheets, especially from banks in Greece and Cyprus. The banking system is still not functioning properly. There are still a ton of bad loans. There’s also concern that the banks don’t have enough capital.

2. Meanwhile, the yield curve has been getting flatter and yields have been turning negative. This is bad for the banking business since banks borrow at the short end and lend at the long end. When the yield curve is steep they can make money from the difference in the spread. Right now, spreads are very little and banks can’t make money.

3. Regulations have been getting tighter. In addition to massive new collateral needs driven by the Basel III agreement, the European Union established rules designed to prevent taxpayer bailouts. Germany can’t bail out Deutsche Bank. If it did, the fear is that Greece, Italy or Cyprus might insist that their bank bail-ins were inappropriate if those rules didn’t apply to Germany. This sets the EU up for huge legal issues or even some countries wanting out of the EU altogether.

4. LIBOR (the London interbank offered rate) has become a worrying story for the banking system. Libor, a measure of banks’ borrowing costs, has continued to climb higher, making it more difficult to manage all that borrowing.

5. A lot of foreign companies and banks have, since the crisis, been borrowing in US dollars to invest in projects outside of the US. The BIS suggests these borrowings amount to $10 trillion. Dollars were seen as cheap and stable. As the US dollar moves higher this situation could get really ugly as it becomes more challenging to pay back those loans. The rise in Libor makes it even more concerning.

“It’s not yet a big storm, but the clouds are everywhere,” Pal said.

Pal isn’t alone in his concern.

For months, Pal and other guests on Real Vision Television have sounded the alarm on Deutsche Bank and other European banks. Hedge fund manager Edward Misrahi, the founder and CIO of RONIT Capital, recently said on Real Vision that the “best tail-risk insurance” for any portfolio is buying puts on Deutsche Bank. Top fund managers like Mark Hart of Corriente Advisors, Bernd Ondruch of Astellon Capital Partners, and Lee Robinson of Altana Wealth have also raised concerns.


Julia La Roche is a finance reporter at Yahoo Finance.

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