It has been a while since investors focused their attention on the world’s “most systematically risky” bank, Deutsche Bank. Moments ago, S&P made sure to remind us that nothing is fixed, when it released a report saying that “Operating Conditions May Challenge Strategy Execution” but keeping the bank at a BBB+ rating.
The full report below:
Deutsche Bank Outlook Revised To Negative As Operating Conditions May Challenge Strategy Execution; Ratings Affirmed
- We believe the difficult operating environment may challenge Deutsche Bank as it undertakes a material restructuring of its business model and balance sheet.
- We are revising our outlook on Deutsche Bank to negative from stable.
- We are affirming our ‘BBB+/A-2’ issuer credit ratings on Deutsche Bank.
- The negative outlook reflects the possibility that we may lower the long-term issuer credit rating if market conditions challenge Deutsche Bank’s ability to preserve its capital and maintain its franchise while implementing its restructuring plans.
LONDON (S&P Global Ratings) July 19, 2016–S&P Global Ratings said today that it revised the outlook on Germany-based Deutsche Bank AG to negative from stable. The ‘BBB+/A-2’ global scale, ‘cnA+’ Greater China regional scale, and ‘trAAA/trA-1’ Turkey national scale issuer credit ratings were affirmed.
At the same time, we revised the outlook on certain Deutsche Bank branches and subsidiaries to negative from stable (see rating list for details). The ratings on these entities were affirmed.
In addition, we affirmed the issue ratings on Deutsche Bank AG’s long-term senior unsecured debt at ‘BBB+’, short-term senior unsecured debt at ‘A-2’, dated nondeferrable Tier 2 regulatory capital instruments at ‘BB+’, and perpetual Tier 1 instruments at ‘B+’.
The outlook revision reflects our view that the unfavorable operating environment poses particular challenges to Deutsche Bank as it implements its 2016-2020 strategic plan (known as Strategy 2020). Although market conditions may recover somewhat from the weak first quarter of 2016, ultra-low interest rates and generally subdued client trading activity may persist for the foreseeable future. These pressures affect the entire sector but we believe they are particularly unhelpful for Deutsche Bank as it seeks to strengthen capital and maintain its franchise while fundamentally restructuring its business model and balance sheet. We note that Deutsche Bank is still in the early stages of its plan and we expected from the outset that 2016 would be the peak restructuring year. Where possible, we expect it will seek to accelerate planned cuts in costs and regulatory risk-weighted assets (RWAs) to mitigate lower revenues. Nevertheless, although it is not our current base-case scenario, we see a risk that the achievement of Deutsche Bank’s targets under Strategy 2020 may be challenged if operating conditions remain adverse.
More specifically, the negative outlook reflects the potential removal of the one-notch positive adjustment that we currently include in the ‘BBB+’ long-term issuer credit rating. This adjustment reflects our view that, if it executes Strategy 2020 well, Deutsche Bank would transition toward improved stand-alone creditworthiness over the medium term if it achieves a more stable and predictable operating model. Key elements of Strategy 2020 include significant reductions in RWAs and leverage exposure; a far-reaching cost cutting program; and exits from unprofitable countries, products, and markets. These initiatives are intended to strengthen the fully-loaded Common Equity Tier 1 (CET1) and leverage ratios to at least 12.5% and 4.5%, respectively, in 2018 and beyond. We could remove the one-notch positive adjustment from the rating if we believe Deutsche Bank appears likely to fall short of these objectives. If the Strategy 2020 measures prove insufficient, we believe it would be difficult for Deutsche Bank to extend cost and RWA cuts without harming its core businesses. The bank has already cancelled equity dividends in respect of the 2015-2016 financial years, which reduces flexibility to respond to unexpected capital events.
We have affirmed the ratings because, in addition to the one-notch positive adjustment, the anchor and bank-specific factors are also unchanged. Our risk-adjusted capital ratio was 8.6% at year-end 2015 and we expect it to be in the 8.5%-9.0% range at year-end 2017. This projection assumes relatively weak earnings in the near term, a significant reduction in RWAs, and further material litigation charges. We consider that the bank’s principal capital constraint will occur in 2019-2020 when the Basel Committee’s RWA reforms are due to be implemented and Deutsche Bank’s minimum regulatory requirement will be a 12.25% fully-loaded CET1 ratio. The bank expects to meet this hurdle by steadily strengthening retained earnings in the coming years as its restructuring measures take effect and litigation charges ease. The scope and timing of the RWA reforms remain highly uncertain and an easing of the ultimate requirements would benefit Deutsche Bank’s transition process.
The U.K.’s recent vote to leave the EU (Brexit) is a consideration in the outlook revision, but not a prominent one. We consider that Deutsche Bank should not be materially affected if the U.K. were to lose access to the EU financial services passporting arrangement, although it may need to relocate some activities from its large London branch. We assume Deutsche Bank’s trading revenues received a boost from Brexit-related market volatility but, in the longer term, we see Brexit as a factor that may prolong the current period of ultra-low global interest rates and depressed business volumes.
The negative outlook reflects our view of the execution challenges facing Deutsche Bank over our two-year rating horizon as it restructures its business model and balance sheet. We regard 2016-2017 as the most demanding phase of Strategy 2020 and we see a risk that generally unfavorable operating conditions could challenge the achievement of its goals. In assessing Deutsche Bank’s progress, we intend to focus on its capital generation prospects for 2017 and beyond, its performance versus peers, and its ability to defend its market position in its core businesses.
We could lower the long-term issuer credit and senior unsecured issue ratings if we consider that Deutsche Bank is falling behind its announced schedule for strengthening its business position and risk position. In that scenario, we would likely remove the one-notch positive adjustment that we currently include in the ‘BBB+’ long-term rating. Higher-than-expected litigation charges or material losses on disposal of non-core businesses could also lead to a downgrade if they materially erode capital.
If we were to lower the long-term rating to ‘BBB’, we would likely maintain the short-term rating at ‘A-2’ due to Deutsche Bank’s satisfactory liquidity profile. The issue ratings on Additional Tier 1 and Tier 2 regulatory capital instruments would be unaffected if the stand-alone credit profile (the starting point for these ratings) remains ‘bbb’.
We could revise the outlook to stable if Deutsche Bank executes Strategy 2020 well, maintains a resilient business position, and demonstrates progress toward its balance sheet targets.
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