It's Not Over Yet - Moody's Put Deutsche Bank On Review For Downgrades

In a worryingly coincidentally timed move, Moody's has put Desutche Bank on review for downgrade, citing "execution challenges" in its new strategic plan. The worrying aspect comes from the fact the timing is entirely fitting with the ratings downgrade that started the last and most painful down-leg in Lehman's collapse...

Full Moody's statement:

Moody's reviews for downgrade Deutsche Bank's ratings (senior debt at Baa1)

 

New York, March 21, 2016 -- Moody's Investors Service has placed on review for possible downgrade the ratings of Deutsche Bank AG ("Deutsche Bank") and affiliates, including the bank's long-term deposit rating of A2, its senior unsecured debt rating of Baa1, its standalone baseline credit assessment ("BCA") of baa3, its counterparty risk assessment of A2(cr), as well as its short term ratings and short term counterparty risk assessment of Prime-1 and Prime-1(cr), respectively.

 

Also placed on review for downgrade were the long-term ratings of US-based Deutsche Bank Trust Corporation and its trust company affiliates, considering the close linkages of the franchise value of these operations to those of the parent Deutsche Bank. Principal ratings affected include the long-term deposit ratings of A1, issuer ratings of Baa1, the standalone baseline credit assessments of a3, and the counterparty risk assessments of A2(cr) and Prime-1(cr). The Prime-1 short-term deposit ratings of the trust companies were affirmed.

 

For Deutsche Bank's subsidiary Deutsche Postbank AG, Moody's placed the entity's main ratings on review for downgrade, with the exception of the bank's ba1 BCA which was unaffected by today's rating action. The Postbank ratings placed on review for downgrade include the bank's A2 long-term deposits ratings, its (P)Baa1 senior unsecured programme rating, the bank's Prime-1 short-term debt and deposits ratings and the A2(cr)/P-1(cr) counterparty risk assessment. Each of these ratings benefit from one notch of affiliate support, based on the BCA of Deutsche Bank.

 

RATINGS RATIONALE

 

The review for downgrade is prompted by the rising execution hurdles facing Deutsche Bank in its efforts to strengthen and stabilize profitability over the next three years. The firm recently indicated weak performance within its capital markets operations in the first two months of 2016 (typically the strongest quarter in the year for this business), and this follows on a weak fourth quarter 2015 performance. "Deutsche Bank's diminished performance in the most recent two periods is a function of both environmental and firm-specific factors" said Peter Nerby, a Moody's Senior Vice-President.

 

Since changing leadership last June and recalibrating its strategic plan last November, the operating environment has worsened for Deutsche Bank. This is increasing the already high level of execution challenges the group faces in addressing its structural cost issues and achieving its new strategic plan. Moody's forecasts that revenue and expense headwinds may delay an improvement in profitability and achievement of Deutsche Bank's interim cost-to-income targets (principally a cost-to-income ratio of approximately 70%) for 2018. The scale of the firm's reengineering task, the potential for further weak revenue, and the risk of incremental litigation charges also create uncertainty, further increasing the execution challenge.

 

Despite the near-term earnings challenges, the firm's overall solvency and liquidity profiles support its creditworthiness and provide the firm time and flexibility to adjust the plan as conditions warrant. Deutsche Bank's solvency is supported by a solid overall capital and litigation reserve position, as well as its asset risk profile. Deutsche Bank also maintains a strong liquidity profile. As such, Moody's expects that should there be a downgrade of Deutsche Bank's Baa1 senior debt and A2 deposit ratings, it would be limited to one notch.

 

Furthermore, the ultimate objectives of the new strategic plan are credit positive. The business mix of the bank will be tilted away from more volatile and capital-intensive capital markets activities, with a greater emphasis on more stable, annuity franchises, including transaction banking and asset and wealth management. As a result, Deutsche Bank is committed to having a simpler and more stable business mix, operating with lower leverage and targeting a more conservative return-on-equity. However it is not clear whether the revenue attrition from shrinking the balance sheet and streamlining the client base can be quickly offset by growth in new areas.

 

The review will focus on the details of the execution plan for 2016 and 2017, in particular, and the extent to which it will have to be adapted given challenges in the operating environment. The review also will focus on details and timing of the plan to renew the technological platform of the bank, a key enabler of future revenues and cost efficiencies.

 

Moody's will also review Deutsche Bank's Additional Tier 1 securities (Ba3) to evaluate whether its execution challenges increase the risk of a coupon deferral on them. This could warrant additional, wider notching for these securities and result in up to a two notch downgrade for these securities.

But it's different this time...

May/June 2008 - S&P downgrades major US banks including Merrill, Lehman, and Morgan Stanley (all after the banks raised additional equity capital, sparking the bounce).

It's not over yet.