DBRS Downgrades Deutsche Bank to A (low), Trend Now Stable

DBRS, Inc. (DBRS) has today downgraded the ratings of Deutsche Bank AG (DB or the Bank), including its Senior Unsecured Debt & Deposits rating to A (low) from ‘A’, and its Long-Term Critical Obligations Rating (COR) to A (high) from AA (low). At the same time, DBRS has confirmed DB’s short-term ratings, including its Short-Term Debt & Deposits ratings at R-1 (low) and Short-Term COR at R-1 (middle). The trend on all ratings is now Stable. This concludes the review that was initiated on April 1, 2016. At the same time, DB’s Intrinsic Assessment (IA) has been lowered to A (low) from ‘A’. Related subsidiary ratings have also been impacted by these actions.

The downgrade considers the notable challenges DB faces in generating solid, sustainable returns, at a time when the Bank’s regulatory capital levels have fallen to the low end of the global peer group. While DB has made progress against its Strategy 2020 initiatives, DBRS considers that the Bank requires a longer track record of successful execution in order to become a stronger, more balanced and more efficient bank. DBRS also expects the Bank’s earnings generation to remain constrained over the medium-term, driven both by the scale of the restructuring task, which includes significant expenditure on technology and systems enhancements, and the difficult operating environment, which will likely challenge revenue growth. When assessing DB’s underlying fundamentals and comparing across a global peer group, DBRS views the Bank’s IA as more appropriately placed at the A (low) rating level.

The Stable trend reflects DBRS’s view that the ratings are now well-placed at the current level and its franchise remains unimpaired. Supporting the current rating level is the continued resilience of DB’s global franchise, with solid revenue generation across core business in 2015 and 1Q16, despite ongoing headwinds. Key strengths of DB’s franchise include its top-tier investment banking and capital markets franchises, most notably in EMEA and APAC, solid retail and corporate banking capabilities within Germany and Europe, and sizeable wealth and asset management franchises, with invested assets of approximately EUR 1.2 trillion at end-1Q16.

DB has been affected by a number of significant litigation and conduct-related expenses, with EUR 5.2 billion of charges taken in 2015. Although DB has built up litigation reserves of EUR 5.4 billion, a number of legacy litigation items remain outstanding which could lead to further charges. In particular, the final US RMBS settlement could be substantial, although DBRS notes that DB has sizeable provisions booked relating to this case. DBRS remains concerned about the Bank’s operational risk controls, but recognises that the current litigation and conduct-related issues faced by the Bank have arisen under the previous management team. With a new management team in place, DBRS will continue to monitor the Bank’s progress in introducing and enforcing a conservative culture across its organization which should reduce the likelihood of major mis-steps occurring in the future on the scale and range of past events.

DBRS notes that DB has made progress in its restructuring plans, deleveraging the Non-Core Operations Unit (NCOU) Risk-Weighted Assets (RWA) by 46% since end-2014, to EUR 31 billion at end-1Q16. The impact on the Bank’s earnings has, however, been significant, with NCOU recording a loss before tax of EUR 2.3 billion in 2015, and EUR 533 million in 1Q16. With DB targeting an accelerated run-down of NCOU, the drag on earnings is expected to continue over the near-term.

DB benefits from a funding and liquidity profile that has proven to be resilient despite challenging market conditions. The Bank reported a loan-to-deposit ratio of 76%, liquidity reserves of EUR 213 billion, and a Liquidity Coverage ratio of 119% at end-1Q16. The Bank has made considerable efforts to reduce its short-term funding exposures, most notably by reducing its overnight repo activity which can be susceptible to disruption in times of stress. DBRS will continue to assess DB’s progress in moving away from shorter-term wholesale funding sources toward longer-term funding. DBRS notes that any notable reversal of this progress could add pressure to the rating.

Although DB’s capital base has increased significantly in recent years, with a 23% increase in equity since 2011, regulatory ratios remain at the low end of the global peer group. At end-1Q16, DB reported a fully-loaded CRDIV Common Equity Tier 1 (CET1) ratio of 10.7%, and a leverage ratio of 3.4%. DB has committed to meet CET1 and leverage ratio targets of 12.5% and 4.5% respectively by 2018. Given ongoing developments in regulatory capital requirements and RWAs, and with internal capital generation expected to be limited over the near-term, it is imperative for the Bank to successfully execute the accelerated run-down of NCOU, as well as the planned sale of Hua Xia, which are expected to be positive for capital ratios.

RATING DRIVERS
Upward pressure on the rating is unlikely in the near-to-medium-term, as DBRS expects that it will take time for the Bank to execute on its strategic initiatives and return to solid, sustainable earnings. Over the longer-term, positive rating pressure could arise if DB demonstrates continued progress in successfully executing on its strategic initiatives, by meeting targets related to cost reductions and internal capital generation.

Negative pressure could be driven by Deutsche Bank’s inability to meet targets, or any indication that the restructuring task is negatively impacting the overall strength of the Bank’s franchise. Further substantial litigation/reputational issues or sizeable settlements beyond current expectations could also result in negative rating action, especially if they were to be significantly detrimental to the Bank’s capital position. A material change in the funding profile from stable, term funding towards shorter-term could also add negative pressure.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and Critical Obligation Rating Criteria (February 2016). These can be found can be found at: http://www.dbrs.com/about/methodologies

The 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: William Schwartz
Initial Rating Date: February 27, 2015
Most Recent Rating Update: April 1, 2016

The rated entity or its related entities did participate in the rating process. DBRS did have access to the accounts and other relevant internal documents of the rated entity or its related entities.