DBRS Initiates Coverage of Deutsche Bank – Senior Long-Term Debt at A (high), Stable Trend

DBRS, Inc. (DBRS) has today initiated ratings coverage of Deutsche Bank AG (Deutsche Bank, DB, or the Bank). DBRS has assigned a Senior Unsecured Long-Term Debt & Deposit rating of A (high) and a Short-Term Instruments rating of R-1 (middle). The trend on all ratings is Stable. The Bank’s intrinsic assessment (IA) is “A”. Reflecting DBRS’s view that DB is a systemically important banking organization (SIB) with an SA-2 support assessment, the Bank’s final ratings are positioned one notch above its IA at A (high).

Underpinning Deutsche Bank’s IA of “A” is the resilience of its diversified global franchise with strong revenue generation across its core businesses, while also considering headwinds related to profitability and strategic execution challenges. Key strengths of the franchise include DB’s capital markets franchise, where the Bank maintains top-tier league table rankings across diverse asset classes with trading businesses that extend across products, markets and client segments. This, combined with its retail and corporate bank that maintains solid market positioning in Germany and across Europe and its other businesses, such as transaction banking and asset & wealth management, add diversity and depth to DB’s global franchise. A solid funding and liquidity profile, which is supported by sizable deposit base, combined with much improved capitalisation levels, also support the current rating level. Also factored into the rating level are the significant headwinds still faced by Deutsche Bank in its earnings generation ability, most notably from persistently elevated expense levels, driving a high cost/income ratio, and resulting in a more limited ability to generate capital internally. This raises some concerns regarding potentially elevated litigation settlements that could negatively impact capital. Furthermore, DBRS views DB as facing a number of execution challenges with regards to meeting its Strategy 2015+ targets.

The Stable trend indicates DBRS’s view that the ratings are well-placed at the current level. The Corporate Banking & Securities (CB&S) franchise appears to be gaining market share in EMEA with the restructuring/retrenchment of European capital markets peers, which DBRS views as a key opportunity for the Bank over the medium-term. DB’s other businesses contribute to revenue diversity and stability including Private & Business Clients (PBC), which provides banking and other financial services to retail and SME customers in Germany, across Europe and in Asia, including a 19.99% stake in Hua Xia Bank in China, and Global Transaction Banking (GTB), where DB facilitates global trade finance and cash management services, as well as trust and securities services to corporates and financial institutions. Deutsche Asset & Wealth Management (DeAWM) is a leading asset and wealth manager that is demonstrating success following the reorganisation of the business in 2012.

DB generates a high level of relatively consistent revenues, averaging EUR 31 billion per annum over the past six years, despite the challenging operating environment characterized by an uneven economic recovery, particularly in EMEA where the Bank has strong market shares. The ratings also consider DB’s effective risk management capabilities, supported by the Bank’s risk culture initiative, which is reinforcing a more conservative culture across the organisation. While DB maintains extensive risk systems that continue to be enhanced and harmonised globally, the Bank’s involvement in wide ranging capital markets activities and diverse market risk requires it to maintain advanced systems and technology.

Deutsche Bank continues to face significant headwinds in its earnings generation ability, most notably from persistently elevated expense levels resulting from numerous factors, including i) systems enhancements/integrations; ii) regulatory-related spend; iii) litigation-related expenses; and iv) the continued drag from the Non-Core Operations Unit (NCOU). As a result, DBRS views Deutsche Bank’s internal capital generation as limited. Furthermore, DBRS views DB as facing a number of execution challenges with regards meeting its Strategy 2015+ targets. With management expected to provide an update on strategic plans in 2Q15, some adjustments to strategic businesses could be announced, along with the possibility for restating targets or extending its completion timeline; all of which have the potential to impact the franchise and future revenue generation.

DBRS views Deutsche Bank as having strong underlying fundamentals, and notes that the Bank is taking actions to address its challenges, although this is taking longer than expected and more progress needs to be made. Important progress so far includes much improved capital levels, with a fully-loaded Common Equity Tier 1 ratio (CET1) of 11.7% at end-2014, up significantly from 9.5% at 1Q14. DB achieved this via a significant EUR 8.5 billion equity raise in June 2014 and additional tier 1 (AT1) issuances in May 2014 (EUR 3.5 billion) and November 2014 (USD 1.5 billion). Leverage ratios have also improved somewhat with capital increases and leverage exposure reductions, though a fully-loaded leverage ratio of 3.5% remains at the low end of DB’s global peer group. While capitalization has been improved through these various actions, DBRS views DB as being somewhat limited in its ability to further increase capital over the near-term, if needed.

The Bank has also significantly de-risked is NCOU portfolio, with legacy exposures (ex-litigation) generally far less material than in the past. Total assets in the NCOU portfolio are down more than 70% from peak levels, which should contribute to a lower drag on overall results in future quarters. In this portfolio, pre-tax losses remain elevated with losses of EUR 2.9 billion in 2014, EUR 3.4 billion in 2013 and EUR 2.9 billion in 2012, mainly driven by elevated litigation costs. DBRS notes that continued progress in the NCOU reduction remains an important element in improving the Bank’s position.

DBRS views DB as challenged to meet its current targets with regard business initiatives, and cost reductions as laid out in its Strategy 2015+ plan. If the Bank’s adjusted strategic plan, to be announced in 2Q15, is not considered attainable, DBRS would view this as a significant shortcoming of current management. This would likely negatively pressure the ratings. Additionally, further substantial litigation or reputational issues could also result in negative rating action, especially if DBRS perceived these to be causing damage to the Bank’s core businesses, or if sizable settlements were to have a negative impact on capital.

Upward pressure on the ratings could arise once DB’s adjusted strategic plan has been announced, if DBRS views this plan as having the potential to enhance the franchise and details an attainable path to generating acceptable returns. Furthermore, DBRS would need to have a high degree of confidence in Deutsche Bank having the ability to execute on this plan, given execution challenges with the current plan. In combination, if DB were also to proceed with various settlements that put its material legacy litigation issues in the past, this could also add upward ratings pressure if the settlements were not deemed to be outsized or damaging to the franchise. DBRS would view this as eliminating a significant distraction, enabling management to more fully concentrate on its core businesses.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015). These can be found at: http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Lisa Kwasnowski
Rating Committee Chair: Alan G. Reid
Initial Rating Date: February 27, 2015
Most Recent Rating Update: February 27, 2015

For additional information on this rating, please refer to the linking document under Related Research.