Deutsche Bank Faces Headwinds from US-Based Credit Ratings Agency…….

Moody’s Investors Service – the US-based credit ratings agency officially slashed Deutsche Bank’s debt rating to Baa2, from Baa1. This marks the second such cut for Deutsche Bank by Moody’s in 2016. The reason for the credit cut is linked to what Moody’s perceives to be increased challenges within Deutsche Bank’s turnaround strategy. At its current level of Baa2, Deutsche Bank’s unsecured senior debt is essentially 2 rungs above junk status rating. Of equal importance was the downgrade to Deutsche Bank long-term deposit rating to A3 from A2. In late 2015, Deutsche Bank embarked upon a 5-year strategic plan which was geared towards increasing profitability and the company’s capital position. This was brought about by several years of lacklustre performance, and exorbitant legal costs faced by the bank. According to the strategic blueprint, Deutsche Bank is committed to exiting multiple countries, cutting 9,000 positions, as well as reducing nonessential costs and underperforming business assets.

Moody’s is of the opinion that until such time as substantive progress has been made by Deutsche Bank in achieving strategic objectives, the risk profile would remain in effect. Moody’s Investors Service is seeking conservative leverage at Deutsche Bank, balanced earnings and a stable outlook. The ratings cut was announced on Monday, May 23, and it is significant as Deutsche Bank AG is one of the major players in the European capital markets. The ratings cut will impact not only Deutsche Bank AG but also all of its affiliates. These include its standalone baseline credit assessment, otherwise known as BCA which gets the chop from baa3 to ba1. Additionally, Deutsche Bank AG’s counterparty risk assessment will get cut from A2(cr) to A3(cr).Moody’s Investors Service also moved swiftly to downgrade Deutsche Bank Trust Corporation (a US-based entity) as well as its trust company affiliates. Their long-term credit ratings received a downgrade score of A2, from a prior rating of A1. Deutsche Bank AG has a 5-year strategic plan which Moody’s Investors Service perceives as stable off to the downgrades. Provided the plan can be put into effect through 2020, and the bank is able to retain liquidity levels and preserve its capital assets, the restructuring will likely go off unhindered.

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Why did Moody’s downgrade Deutsche Bank?

Simply put, Deutsche Bank has a high risk profile and the credit ratings agency did not see the German bank as capable of making good on its strategic objectives given its profile. Presently, Deutsche Bank AG is working hard to bolster its balance sheet and bring about a stabilization in its earnings potential. However, the banking conglomerate remains locked in cost-cutting initiatives that are proving difficult to implement and time consuming at the same time. The bank has to contend with other negative factors on a macroeconomic basis, namely ultralow interest rates in the EU. This is hurting profitability in a big way, and given the state of the euro zone, and the sentiments of the ECB, this is unlikely to change. Moody’s Investors Service believes that this cornucopia of economic factors paints a bearish picture for the bank, given its ambitious objectives.

In 2015, Deutsche Bank performed poorly with a reported loss of €6.8 billion. There is also concern that the overall economic reality that Deutsche Bank and other European banks operate in will bring about reduced customer volumes across multiple facets of Deutsche Bank’s operational activities. Of primary concern to Moody’s is Deutsche Bank’s ability to tackle important credit challenges namely internal capital generation within two years and an improvement of its weak profitability figures. As it stands, Deutsche Bank AG has a new management team on board, but the challenges facing the bank of making it difficult to operate in a flexible manner. However, from their perspective, Deutsche Bank and its chief financial officer (CFO) Mr. Schenck is not concerned about the downgrade since all investment -related components of the bank remain in A territory.

Why Ratings Matter?

There are only a handful of highly reputable international credit ratings services in the world, including Moody’s Investors Service, Standard & Poor’s and Finch. A rating is simply an opinion of the creditworthiness of an individual business entity or an individual to repay debt. Ratings are however not to be considered as buy/sell recommendations as they are incapable of guaranteeing that default will not take place. For its part, Moody’s gathers data to evaluate the risks to investors relative to a specific entity. Moody’s will then come to a conclusion by a committee to provide the right credit rating and ongoing monitoring of that credit rating will be undertaken. Once a decision has been taken vis-à-vis credit ratings, Moody’s publishes this for the market to see. In terms of investment-grade ratings the highest rating that can be awarded by Moody’s is AAA. This is followed by high-grade rating such as Aa1, Aa2, and Aa3. Upper-medium grade ratings are listed as Baa1, Baa2 and Baa3. The better the rating, the more likely investors will feel secure in the financial entity.