Deutsche Bank's profit could be hit by up to 1.7 billion euros ($2.4 billion) due to loans that have dwindled in value as a result of the credit market crisis, sources familiar with the situation said.
Chief Executive Josef Ackermann last week acknowledged the bank was heading for a rocky third quarter, flagging an upcoming revaluation of 29 billion euros of credit it had promised to clients.
Deutsche would normally farm these loans out to other banks, but it has become harder to sell on such debt in the wake of a credit squeeze that began with a wave of mortgage defaults in the U.S., and the bank now faces having to write down the value of these loans to reflect this.
One source familiar with the situation said the bank estimates that the credit is now worth between 4 and 6 percent less than face value.
That would hit profit by up to 1.7 billion euros booked in the third quarter. In the same period a year ago, Deutsche made a net profit of 1.2 billion.
Deutsche, one of the world's biggest M&A banks, is now trying to get clients to renegotiate credit terms or drop deals to shrink the size of the fallout. The loss could also shrink if credit market conditions improve.
The bank declined to comment.
At 8:06 a.m. EDT Deutsche Bank's shares were down 2.1 percent at 89.91 euros, underperforming the DJ Stoxx European banking sector index and Germany's blue-chip DAX index.
"It's all a black box at the moment," said DZ Bank analyst Andreas Weese. "I wouldn't exclude a 1.7 billion-euro hit and that certainly would be a negative scenario," he said.
WestLB analyst Georg Kanders said Deutsche's share price was being driven entirely by irrational investor fear.
"Deutsche Bank's low valuation makes it extremely attractive and the dividend is not in danger," said Kanders, who has a "buy" rating on the stock.
The potential loss is bigger than the estimates made by many analysts, some of whom are expecting as little as 500 million euros. Merrill Lynch has predicted up to $1 billion.
Many analysts privately admit, however, that making a forecast is difficult.
Deutsche is hoping that some customers, which include private equity investors as well as big companies carrying out M&A transactions, will either accept new terms for the credit or in some cases drop the deals.
The bank can use its muscle to renegotiate the terms of the credit, which in turn makes it easier for them to sell to other banks and reduces the need for writedowns.
Big banks can sometimes call in such favors from customers because of their lending clout.
"If you take a private equity buyer, the bank provides them with leveraged finance to do their deals," said one banker active in the market. "So it's in their interest to keep the relationship good."
Deutsche's Ackermann has acknowledged his bank made "mistakes" during the recent market turmoil and publicly called for "transparency", demanding banks should come clean quickly about the full impact of the credit crunch on the bottom line.
But he also told Germany's Spiegel magazine in Monday's edition he saw "initial encouraging signs" that financial markets were returning to normal.
Last week, investment bank Bear Stearns saw its profit plunge almost two thirds as the value of investments in risky subprime mortgages dipped.
Goldman Sachs and Lehman Brothers surprised investors, however, with unexpectedly good results.