Houston, we have a problem. It is Deutsche Bank.

Imagine that you are as a bank accused of dishonest selling of mortgage securities and you have to pay USA 14 billion dollars as a settlement on top of that. To add more to it, it was found out that during the financial crisis you’ve been cheating your accounting when you kept 12 billion USD losses secret. Then there was also a manipulation of the interest rate LIBOR. And there are rumors that you’ve been laundering money of Russian oligarchs who are on the sanctions list. The biggest bank of Germany – Deutsche Bank has to deal with all of that now.

The investors have given up on Deutsche Bank already. The value of bank’s stocks lost 52 % this year only. In last 10 years it dropped almost 87 %! The biggest German financial institute made clean loss of 6.8 billion euros, because of writedowns and additional expenses in last year. When at the end of 2014 it was still showing a profit of 1.7 bn. euros. If nothing else then the expensive lawsuits are draining the bank. The costs of lawsuits were only in fourth quarter of last year 1.2 billion euros. There’s nothing else the bank can do but to try to save money. The head of the bank John Cryan agreed to radical lowering of costs, which for example means closing 188 branches, firing 9000 employees or leaving some of the foreign markets. Will it be enough?

What stinks in Deutsche Banks the most are the derivatives. The Deutsche Bank overdid it in pre-crisis era. The bank kept the derivatives on the underlying nominal value 42 trillion euros at the end of last year. That is almost 14-times the German GDP in current prices! That is where a huge potential risk lies. Data about this underlying nominal value is sort of data of fictitious value, it is not the amount of loss which would have to be covered (in this sense important data is of the so-called derivative position market value, either way nobody but Deutsche Bank is able to find out this number). But the data about the foundational nominal value is so extreme that it is out of touch with conventions of other banks. Ruling of the German government could in extreme situation be hypothetically too short to help the Deutsche Bank out of it derivatives problem. But it’s written nowhere that the government would actually want to help.

The biggest problem is that the economic world is tied together with invisible web. The banks usually don’t go bankrupt separately but the fall of one of them is usually problem of several others. The problems of the biggest German bank must be seen in broader context. We observed drop of investments in last quarters of year in middle-European region. The businesses are starting to be more careful and they are sensing the upcoming crisis. The European economy would need to rely on healthy bank sector more than ever. But to put Deutsche Bank’s problems aside we have here Italian bank sector which is in troubles as well. Plus there is one more giant exclamation mark coming from the financial markets. From the beginning of last crisis the central banks started to cure the banks with cheap money. The result is that cheap money settled in prices of overpriced stocks and bonds. Their prices are still holding on level that’s within eyeshot of historic maximum. Except that the support from central banks won’t be growing on forever. The prices of stocks and bonds will go down sooner or later. That will only enhance the current problems of the banks.

The Deutsche Bank is obligated to pay the fine for selling mortgage securities amounting to 14 billion dollars to the USA immediately. Deutsche Bank did expect the fine but much lower. It put aside 6.2 billion dollars designated to settle the lawsuit in advance. If the Deutsche Bank was forced to pay the fine in full amount, it wouldn’t have enough free resources to pay some of their own bonds. That would equal bankruptcy. The German chancellor Angela Merkel categorically rejected any help from the state. It does her credit since the German elections are coming up and Mrs Merkel is not riding the popular wave so far.

Deutsche Bank will ask USA to lower the fine similarly to other banks which meddled in this affair of selling mortgage securities. The result of the appeal is unsure. Even if the Deutsche Bank got out of the problems of huge fine, it is still hiding many skeletons in its closet. For example the derivative pressure cooker is still heating up.

It is questionable if coming of another crisis will enhance the problems of Deutsche Bank or the problems of Deutsche bank will make the crisis come sooner. Neither is a pleasant picture. Our long-term recommendation doesn’t change even when the Deutsche Bank is in problems. We would put hands away from the “overheated” stocks and bonds. Who is considering leaving mutual funds in nearby future, shouldn’t postpone it too much.