Moody's Downgrades Deutsche Bank's Debt Two Notches Above Junk

While not quite on the level of last week's Berenberg downgrade (to Sell) which warned that DB's problems are now "insurmountable", shortly after the close Moody's surprised the market with a downgrade that may have substantial repercussions on the funding costs (and perhaps viability) of the largest German, and European, lender.

Shortly after the market close, the rating agency decided to pile some more pain on the misery that has befallen Germany's largest lender (who just today admitted it had rigged stocks in addition to seeing yet another MBS probe unveiled against it), when it downgraded the bank's credit ratings across the board as follows: Senior debt to Baa2, or just two notches above junk, Long term deposits to A3 and counterparty risk assessment to A3.

Moody's also downgraded Deutsche Bank's short-term ratings and short-term counterparty risk assessments were also downgraded to Prime-2 from Prime-1 and to Prime-2(cr) and Prime-1(cr).

Moody's downgrades Deutsche Bank's ratings (senior debt to Baa2, long term deposits to A3 and counterparty risk assessment to A3(cr)); outlook stable

The full release:

Moody's Investors Service has today downgraded the ratings of Deutsche Bank AG and affiliates, including the bank's long-term deposit rating, to A3 from A2, its senior unsecured debt rating to Baa2 from Baa1, its standalone baseline credit assessment (BCA) to ba1 from baa3, and its counterparty risk assessment to A3(cr) from A2(cr). Deutsche Bank's short-term ratings and short-term counterparty risk assessments were also downgraded to Prime-2 from Prime-1 and to Prime-2(cr) and Prime-1(cr), respectively. Today's rating action reflects the increased execution challenges Deutsche Bank faces in achieving its strategic plan.

Moody's also downgraded the ratings of US--based Deutsche Bank Trust Corporation and its trust company affiliates. These trust companies'
long-term deposit ratings were downgraded to A2 from A1, their long-term issuer ratings were downgraded to Baa2 from Baa1, their standalone baseline credit assessment was downgraded to baa1 from a3; their long-term and short-term counterparty risk assessments were downgraded to A3(cr) from A2(cr) and to Prime-2(cr) and Prime-1(cr) respectively. The Prime-1 short-term deposit ratings of these trust companies were affirmed.

The outlook on the ratings is now stable, reflecting the potential long-term benefits to creditors of Deutsche Bank's five-year strategy plan through 2020 once achieved. It also reflects actions taken by the management team to preserve capital and liquidity during the restructuring process. This rating action concludes Moody's review for downgrade of Deutsche Bank and its subsidiaries which began on 21 March 2016.

RATIONALE FOR RATINGS DOWNGRADE

Deutsche Bank is engaged in a multi-year undertaking to simplify its businesses, fortify its controls, strengthen its balance sheet and stabilize its earnings. Once substantial progress has been made, Deutsche Bank will have a reduced risk profile, more balanced earnings and operate with more conservative levels of leverage. Accomplishing these objectives will be positive for Deutsche Bank's creditors, and the newly appointed management team is diligently attempting to execute this plan.

However, the rating downgrade reflects increased risks to Deutsche Bank's ability to successfully execute this ambitious, creditor-friendly plan. Deutsche Bank's performance over the last several quarters has been weak, and substantial operating headwinds, including continuing low interest rates and macroeconomic uncertainty, will challenge the firm. These forces will likely result in periods of subdued customer volumes and revenues within Deutsche Bank's retail, asset management and institutional franchises, in Moody's view. Moody's expects that such revenue weakness could hinder or delay Deutsche Bank's ability to make progress on its plan, as this would be contingent on the firm's ability to balance the impact of plan-related expenses on its internal capital generation against the firm's growing regulatory capital requirements.

"Deutsche Bank's new management team is executing in a disciplined way, but the headwinds have stiffened, reducing the firm's operating flexibility", said Peter Nerby, a Moody's Senior Vice President.

These challenges have been evident in revenue pressures facing Deutsche Bank over the past two quarters. Looking ahead, continuing headwinds could limit management's ability to address one of the bank's key credit challenges - to improve its structurally weak profitability and internal capital generation by 2018. Moody's estimates that the firm is unlikely to achieve its targeted profitability improvements unless there is a material and sustained improvement in the operating environment.

RATIONALE FOR STABLE OUTLOOK

At the same time, the outlooks on Deutsche Bank's ratings are stable, reflecting the potential long-term benefits to creditors of the five-year plan through 2020. Deutsche Bank maintains a sound liquidity position which is supportive of the bank's credit fundamentals while management is deploying many operating and financial tools to execute this multi-faceted re-engineering. Recent actions include the implementation of a more comprehensive account opening process, the decommissioning of many legacy systems and the closure of onshore
operations in Russia.

The stable outlooks also reflect actions taken by the management team to preserve capital and liquidity during the restructuring process, such as suspending the dividend on its common stock and accelerating asset sales. These are important actions to maintain prudent cushions above regulatory minimums, if profit generation is limited in 2016 and 2017.

The downgrades to Deutsche Bank Trust Corporation and its trust company affiliates reflect the close linkages of the franchise value and client base of these operations to those of the parent Deutsche Bank. At the same time, the baa1 baseline credit assessments of the trust companies remain three notches above those of Deutsche Bank, reflecting strong regulatory ring-fencing, which preserves the capital and liquidity position of these entities as well as a lower risk profile focused on operational and wealth management services within these entities.

What Could Change the Rating - Up?

Steady progress toward improving profitability and reducing tail risks in the form of outstanding litigation and the run-off of legacy
positions as well as material progress in rebuilding the information technology environment of the bank, could lead to a rating upgrade.

What Could Change the Rating - Down?

The current ratings incorporate the possibility for a modest loss and substantial litigation costs in 2016 and the potential for limited profitability in 2017. Further downward pressure could occur if capital ratios weaken substantially or if liquidity declines sharply.

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Remember that Deutsche Bank - Lehman analog?

With every additional downgrade by the likes of Berenberg or Moody's, the two lines will converge ever closer.