Deutsche Bank (DB) Ratings Affirmed by S&P Amid Regulatory Scrutiny

October 7, 2016 11:49 AM EDT
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S&P Global Ratings said today that it affirmed its 'BBB+/A-2' counterparty credit ratings on Deutsche Bank AG (NYSE: DB). The outlook is negative.

At the same time, we affirmed the ratings on Deutsche Bank's debt issues and affirmed the counterparty credit ratings on certain related entities.

The rating affirmation reflects our assessment of the amount that Deutsche Bank is likely to pay to settle civil claims brought by the U.S. Department of Justice (DoJ) related to issuance and underwriting of residential mortgage-backed securities (RMBS) in 2005-2007. Deutsche Bank announced on Sept. 15, 2016 that the DoJ's opening position in the settlement negotiations was a $14 billion demand, and added that the DoJ had invited the bank to submit a counter proposal (see "Bulletin: Deutsche Bank AG Ratings Not Immediately Affected By U.S. Litigation Settlement Negotiations," published on zept. 16, 2016).

Deutsche Bank reported €5.5 billion of litigation provisions on June 30, 2016, and identified a further €1.7 billion unreserved contingent litigation liability. The latter is defined as obligations that can be estimated and where a loss is considered less than probable, but more than remote. Our existing capital and earnings projections assume the provisions are fully used, the contingent liability fully crystallizes, and there are additional charges on top (see "Deutsche Bank AG," published on Aug. 5, 2016).

Deutsche Bank did not disclose the proportion of its litigation provisions and contingent liability that relate to the RMBS case. We assume in our capital and earnings projections that Deutsche Bank's RMBS settlement will be materially smaller than the DoJ's $14 billion initial negotiating position. This assumption takes account of penalties and consumer relief paid by peers to settle similar litigation cases with the DoJ. Our projections also consider other outstanding litigation cases, which include U.K. and U.S. investigations into suspicious trades in Russian equities and investigations regarding compliance with U.S. sanctions and embargoes. In addition, we reflect completion of the agreed disposals of the Hua Xia Bank stake and Abbey Life.

On this basis, we project that our risk-adjusted capital (RAC) ratio, which was 8.6% at year-end 2015, will remain consistent with our current assessment that Deutsche Bank's capital and earnings are adequate. The other bank-specific rating factors are also unchanged, including our view of Deutsche Bank's average funding profile and adequate liquidity. We note, for example, Deutsche Bank's statement on Sept. 30, 2016 that its liquidity reserves amounted to more than €215 billion, little changed from the €223 billion it reported as at June 30, 2016. We assess the bank's risk position as
moderate partly due to its elevated litigation risks and the inherent complexity of its capital markets business. We believe the bank is strengthening its risk management and culture to address the historic governance failures highlighted by the litigation cases.

We have affirmed the issue ratings on Deutsche Bank's rated debt, including the 'B+' ratings on its Additional Tier 1 (AT1) securities. Among other factors, payments on the AT1s depend on Deutsche Bank maintaining sufficient unconsolidated Available Distributable Items (ADIs) under German accounting standards (see "Deutsche Bank Tier 1 Issue Ratings Lowered To 'B+' From 'BB-' On Narrow Definition Of Available Distributable Items," published on Feb. 11, 2016). Our central expectation is that Deutsche Bank will maintain sufficient ADIs to support continued servicing of the AT1s, but we could lower the ratings on these issues if outsize litigation charges or other factors further weaken its payment capacity.

We remain of the view that Deutsche Bank's main challenge is the restructuring of its business model to achieve stronger earnings and capital. We believe that it was historically less decisive than peers in adjusting its strategy and balance sheet to the changed regulatory and market environment, and it is now looking to catch up. Under its five-year plan known as Strategy 2020, Deutsche Bank's priorities include cost cutting, deleveraging, and simplifying its operations. It describes 2016 as the peak restructuring year in which it aims to set the foundations for future progress. The volatility surrounding Deutsche Bank in the past three weeks is clearly unhelpful to the execution of its strategy, in our view.

The negative outlook reflects the possibility that we may downgrade Deutsche Bank if it is unable to demonstrate a clearer path to stronger stand-alone creditworthiness. We intend to focus on its earnings and capital prospects over our two-year rating horizon, its performance relative to similarly rated peers, and its ability to defend its market position in its core businesses amid adverse market sentiment. We will also assess the impact on capital as it resolves outstanding litigation.

If Deutsche Bank responds to the challenging operating environment by revising the actions and targets previously set out under Strategy 2020, we would assess the extent to which its new objectives accelerate the achievement of a stronger, more stable credit profile.

We could lower the long-term issuer credit and senior unsecured issue ratings if we consider that Deutsche Bank's current underperformance is likely to persist in 2017. In that scenario, we would likely remove the one-notch positive adjustment that we currently include in the 'BBB+' long-term rating. The issue ratings on AT1 and Tier 2 regulatory capital instruments would be unaffected if the stand-alone credit profile (the starting point for these ratings) remains 'bbb'. Higher-than-expected litigation charges or losses on disposal of non-core businesses could also lead to a downgrade if they materially erode the bank's capital or franchise, with no mitigating actions.

We could revise the outlook to stable if Deutsche Bank makes substantial progress toward a stronger business position and more robust earnings and capital metrics.

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