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Moody's Downgrades Deutsche Bank From Aa1/B To Aa3/C+
Barely had we finished bashing Deutsche Bank in our prior post, that we noticed that Moody's had just notched Deustche Banknot once, but twice, from Aa1 to Aa3. Now where the hell are those pesky shorts who are #*$!ing up the grand German uberplan of trying to mimic the US in its don't ask/don't tell plan of financial gayness.
Without further ado, here's Moody's:
London, 04 March 2010 -- Moody's Investors Service has today downgraded Deutsche Bank AG's long-term deposit and senior debt ratings to Aa3 from Aa1, and its bank financial strength rating (BFSR) to C+ from B. At the same time, the long-term debt ratings of its rated branches and most of its subsidiaries were also downgraded. Additionally, the ratings on the bank's senior subordinated debt were downgraded to A1 from Aa2, and as a result of Moody's revised Guidelines for Rating Bank Hybrids and Subordinated Debt, the bank's trust preferred debt was downgraded to Baa1 from Aa3 (for cumulative instruments) and to Baa2 from Aa3 (for non-cumulative instruments). The Prime-1 short-term ratings for the bank and its rated subsidiaries and branches were affirmed. The rating outlook for all ratings is now stable. Today's rating action concludes the review for downgrade that Moody's had initiated on 19 November 2009.
According to Moody's, the downgrade of Deutsche Bank's ratings primarily reflects a combination of three factors:
1.) The continuing preponderance of capital market activities and the ensuing challenges for risk management which potentially expose the bank to earnings volatility that would be inconsistent with the bank's previous ratings.
2.) The delay in the acquisition of Deutsche Postbank AG (rated D+/A1) is set to defer the possible benefits of this acquisition beyond what was initially anticipated at the time when the rating agency changed the outlook to negative in December 2008.
3.) Deutsche Bank's other businesses, which had been expected to provide a more stable earnings anchor, have shown a greater degree of earnings volatility than Moody's had previously expected.
However, Moody's notes that the resulting Aa3 rating is well positioned given Deutsche Bank's strong franchise, market position and resilience against any further major transition risk in its ratings, as reflected in the stable outlook.
RELIANCE ON CAPITAL MARKET ACTIVITIES AND RISK MANAGEMENT CHALLENGES
The 2007-2008 credit crisis exposed vulnerabilities in the wholesale investment banking business model at a number of banks, and intensified Moody's view of the riskiness of this business. Such vulnerabilities include risk management weaknesses, high leverage, confidence sensitivity, excessive concentrations and opacity of risk. Deutsche Bank has a large capital markets franchise in its Corporate and Banking and Securities business to which it allocates more than half of its capital. The bank has some additional exposures to capital markets through its Corporate Investments business.
For many firms that commit substantial capital to such businesses, apart from some limited additional disclosure on legacy positions, there remains limited transparency regarding their risk profile or the trajectory of risk-taking, especially regarding exposure to extreme events, or "tail risk." David Fanger, Moody's Senior Vice President and lead analyst for Deutsche Bank, explained: "This opacity, especially when combined with high leverage, risk concentrations and reliance on wholesale funding, is difficult to reconcile with BFSRs that translate into high investment-grade ratings on a stand-alone basis."
Exposure to tail risk is both difficult to measure and to manage; as such, successful risk management at such highly complex firms is enormously challenging. In this context, the importance of effective risk management becomes paramount. Such effective risk management depends on a deep understanding of the firms' risk profile and a strong discipline in risk-taking to ensure that their risk profile remains within the stated risk appetite. Moody's believes that Deutsche Bank has managed credit risk well, especially in its banking book. However, with regard to market risk management, as well as the areas in which market risk and credit risk intersect, the track record has not been as successful. Although Deutsche Bank has taken a number of steps to enhance its market risk management, including the coordination between analytical and functional risk teams, Moody's believes the current efforts will take more time to succeed.
During 2007, 2008 and 2009, Deutsche Bank took substantial charges in its capital markets businesses, through a combination of write-downs, trading losses and credit provisions on assets reclassified from trading to the loan portfolio. In response to the losses suffered, Deutsche Bank has taken steps to reduce its risk profile by exiting certain proprietary trading activities, adopting additional internal risk limits and measures, and reducing its leverage from what had been, in hindsight, very high levels. In the first half of 2009, lower risk-taking did not hurt revenues as Deutsche Bank, along with many of its capital markets peers, benefited from unusually wide trading margins, thereby helping to absorb charges from "legacy" positions while still adding to capital.
However, Moody's expects that, as competition in the capital markets business re-intensifies, it will be more difficult for Deutsche Bank to meet its ambitious earnings objectives. Moody's is therefore concerned that the bank could choose to add more leverage and risk to counter these pressures, thereby potentially putting creditors at greater risk. Identifying such increases in risk-taking, and in particular tail risks, in a timely manner may be difficult given the opacity constraints described above.
Despite these risks, Moody's recognizes that Deutsche Bank has taken significant steps to improve its capital position. Deutsche Bank boosted its Tier 1 ratio to 12.6% at the end of 2009 from 8.6% at the end of 2007, although the bank's core Tier 1 ratio increased more modestly to 8.7% from 6.9%. However, from a crude leverage perspective (including the deduction of derivative replacement costs from total assets for IFRS reporters), at FYE 2009 Deutsche Bank showed a higher exposure than most of its capital markets peers, with an estimated adjusted tangible common equity leverage ratio of 3.1% compared to a peer median of 3.8%. "Moreover, Deutsche Bank remains exposed to additional potential losses on its legacy assets," Mr. Fanger noted, "most notably in commercial real estate, leveraged finance and financial guarantor receivables. Under a more severe stress scenario, Moody's believes that the bank would have sufficient earnings and capital to absorb those incremental losses -- but such a scenario would nonetheless have an impact on the bank's capital ratios."
Furthermore, the rating agency believes that Deutsche Bank's capital ratios are likely to face further pressure from pending acquisitions, potential increases in loan-loss provisions and higher regulatory capital charges. With regard to the latter, Moody's notes that the amendments to the market risk framework -- to be implemented at the end of 2010 -- should facilitate a better alignment of capital and the risks undertaken in certain capital markets activities. However, Moody's also believes that higher capital requirements could pressure Deutsche Bank's management to add incremental risk in other areas in order to satisfy shareholder objectives.
DELAY IN ACQUISITION OF DEUTSCHE POSTBANK
In September 2008, Deutsche Bank announced an agreement to acquire a minority stake in Deutsche Postbank AG, along with an option to acquire additional shares at a later date, and a put option to sell shares. At the time, Moody's indicated that the acquisition of Postbank, if funded so as to preserve Deutsche Bank's capital ratios, could be a positive for bondholders. In December 2008, when Moody's changed its outlook on Deutsche Bank's ratings to negative, the rating agency highlighted the planned acquisition of Postbank as an important, positive strategic step supporting the ratings. This reflected to potential for a Postbank acquisition to significantly increase the proportion of stable earnings at Deutsche Bank, and at the same time provide the bank with additional retail deposits, thus strengthening its funding profile.
However, Postbank itself is facing considerable challenges from the crisis due to its sizable exposures to structured assets and commercial real estate. This was reflected in Moody's recent downgrade of Postbank's ratings to D+ BFSR and A1 for deposits. Moody's believes that these challenges have caused Deutsche Bank's management to be more cautious with regard to any eventual acquisition of a controlling stake in Postbank. This could in turn delay the timing and the extent of any integration with Postbank, and thus increases the uncertainty regarding the potential realization of benefits for bondholders from any such
acquisition. In this context, Moody's believes that, for the time being, it is no longer appropriate for Deutsche Bank's ratings to incorporate any such potential benefit.
VOLATILITY OF REMAINING BUSINESSES
Moody's also noted that the earnings stability in Deutsche Bank's own retail banking business has proven to be less reliable than previously anticipated. The earnings volatility in this segment reflects the heavy reliance this segment had prior to 2008 on revenues from the sale of retail investment products and investment certificates with embedded derivatives. The decline in capital markets led to a sharp drop-off in revenues from such sales activity, and only a portion of the lost revenue has been offset through loan and deposit growth and higher loan margins. In response, the bank has undertaken a significant restructuring
initiative, which in the short-term has led to additional operating costs. However, Moody's notes that, over the longer term, this initiative could help return pre-provision profitability to previous levels.
In addition, similar to many of Deutsche Bank's peers, earnings in the bank's asset wealth management business have also come under greater pressure due to lower asset management fees, reflecting lower market values on assets under management. These results were compounded by losses on sizeable seed capital positions, most notably in commercial real estate. Similar to the steps taken in retail banking, Deutsche Bank has also incurred significant restructuring charges in this business in an attempt to restore profitability.
Taken together, these results highlight a higher degree of correlation than previously anticipated between the earnings of Deutsche Bank's primary capital markets businesses and those of its more stable businesses. In light of this, Moody's believes the benefits to bondholders from this diversification may be lower than previously thought.
RATING OUTLOOK IS STABLE
The stable outlook reflects Moody's view that, notwithstanding the concerns highlighted above, Deutsche Bank benefits from a strong and geographically diversified market presence in many of its businesses, as well as an improved capital position, as also noted above. The stable outlook also reflects Moody's expectation that profitability is likely to improve in Private Clients and Asset Management segments over the near to medium term, as the benefits of the bank's restructuring initiatives take hold. Profitability is likely to be further augmented by higher profits from the Global Transaction Banking segment as interest rates rise from their current low levels.
The rating agency explains that upward pressure on Deutsche Bank's ratings could result from a reduced reliance on capital markets activities; clearer evidence that market risk management and the business line are working together effectively; or improved structural liquidity through a combination of a higher proportion of liquid assets and a reduced reliance on short-term wholesale funding.
Alternatively, downward pressure on the ratings could result from an increase in the bank's risk appetite, as evidenced by increased leverage or increased market risk, which in turn is indicated by Value at Risk (VaR), economic capital, or stress test results.
RATINGS ON HYBRID CAPITAL INSTRUMENTS ALSO DOWNGRADED
As a part of today's rating action, Moody's has also downgraded its ratings of Deutsche Bank's hybrid securities in line with its revised Guidelines for Rating Bank Hybrids and Subordinated Debt, published in November 2009. Prior to the global financial crisis, Moody's had incorporated into its ratings an assumption that support provided by national governments and central banks to shore up a troubled bank would, to some extent, benefit the hybrid debt holders as well as the senior creditors. However, Moody's has found that the systemic support for these instruments has not been forthcoming in many cases. The revised
methodology largely removes previous assumptions of systemic support. In addition, based on the instrument's features, the revised methodology generally widens the notching on a hybrid's rating. Moody's rating action removes systemic support from Deutsche Bank's hybrids and, for instruments with non-cumulative coupon payments, widens the gap to the bank's standalone ratings by an additional notch.
The starting point in Moody's revised approach to rating hybrid securities is the Adjusted Baseline Credit Assessment (Adjusted BCA). The Adjusted BCA reflects the bank's standalone credit strength, including parental and/or cooperative support, if applicable. The Adjusted BCA excludes systemic support. Following the downgrade of the BFSR, the Adjusted BCA for Deutsche Bank AG is A2 -- the same as the BCA, since parental and/or cooperative support does not apply.
The rating on Deutsche Bank's upper Tier 2 trust preferred security, issued by Deutsche Bank Capital Finance Trust I, was downgraded to Baa1, i.e. two notches below the Adjusted BCA, from Aa3. This security has a junior subordinated claim in liquidation, and its coupon payments are cumulative except when a coupon skip is mandated by the bank's regulator. The two-notch downgrade reflects the removal of systemic support, and thus also reflects the downgrade of the BFSR.
The ratings on Deutsche Bank's Tier 1 and contingent Tier 1 trust preferred securities were downgraded to Baa2, i.e. three notches below the Adjusted BCA, from Aa3. These securities have a preferred stock claim in liquidation and their coupon payments are non-cumulative (coupons on the contingent Tier 1 securities were cumulative, but were converted to non-cumulative in 2008 when Deutsche Bank exercised its conversion option in order to qualify as Tier 1). A coupon skip is optional for the issuer, and there is no mandatory trigger tied to a net loss at the bank, although there is a mandatory trigger in the case of a balance sheet loss or a net loss at the trust. The two-notch downgrade reflects the removal of systemic support as well as the downgrade of the BFSR, and Moody's added an additional notch to the downgrade to reflect the non-cumulative
coupon payments.
The ratings on the Tier III tranches of Deutsche Bank's MTN programmes were downgraded to A1 from Aa2, one notch below the bank deposit rating, due to its senior subordinated claim and weak deferral triggers which are breached only when regulatory capital ratios are at or below the minimum.
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financial gayness.
that term could have some serious legs and go viral.
Beat me to it.
Holy crap, is that funny.
Moody's, HA! Zero credibility.
DB up 1% on the"news". Talk about a perfect market-pricing mechanism! lol
that's why it is called financial gayness!
Moodys should knock WFC down 2 or 3 notches to get it up over that $30 mark.....
It is a perfect pricing mechanism - for "them". Nothing but up.
It certainly is a queer market...
Deep Shah.
greek style.
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