OREANDA-NEWS. Fitch Ratings has affirmed Deutsche Bank AG's (DB) Viability Rating (VR) at 'a'. At the same time, the agency has placed Deutsche Postbank AG's (Postbank) Long-term Issuer Default Rating (IDR) of 'A+' and its Short-term IDR of 'F1+' on Rating Watch Negative (RWN). DB's IDRs, which are driven by Fitch's view of the likelihood of sovereign support and are on Negative Outlook, are unaffected by this rating action. A full list of rating actions is available at the end of this commentary.

The rating actions follow DB's announcement on 24 April that, after a comprehensive strategic review, DB has decided to deconsolidate Postbank. DB will prepare the 96.8%-owned subsidiary for an IPO to be launched by end-2016.In addition, DB announced that it plans to reduce gross leverage exposure in its Corporate Banking & Securities (CB&S) business segment by around 20% by end-2018 with the aim of achieving a Basel III Tier 1 leverage ratio of at least 5% by end-2020 (3.4% at end-1Q15), significantly higher than its previous 3.5% target.

DB also announced that it aims to reduce gross operating expenses by a further EUR3.5bn annually (on top of its "2015+" strategy) and that it now targets a cost/income ratio of 65% and a newly calibrated return on tangible equity (RoTE) of above 10%, also by end-2020. Its targeted pay-out ratio (both through dividends and share buy-backs) will be at a minimum of 50%. DB's management intends to provide further detail on its revised strategy within 90 days.

Implementation of the revised strategy entails considerable execution risks, not least because DB has a mixed track record of executing against stated financial targets. Therefore, Fitch believes there is a high chance that the bank will not be able to demonstrate successful progress with execution in the next one to two years, which would result in a downgrade of the VR. Areas of focus for Fitch include maintaining profitability while booking "costs to achieve" in the short term and demonstrating clear progress with deleveraging targeted CB&S assets and with preparing Postbank for sale by end of 2016.

As a result of its revised business strategy, DB's financial metrics, especially capitalisation, leverage and efficiency should improve in the medium term. Profitability, excluding transactions and execution costs ("cost to achieve"), should also improve in the short-to-medium term, largely as a result of a positive development at its more stable businesses, Private & Business Clients (PBC, which includes Postbank), Deutsche Asset and Wealth Management (DAWM) and Global Transaction Banking (GTB). By 2017, the divestment of Postbank, which has reported modest but improving profitability, should also support underlying profitability in the medium term. Postbank's low-risk but high volume asset base means that it would not achieve returns on a leverage-based equity allocation in line with the rest of the group without increasing risk.

DB's profitability will increasingly rely on its CB&S division; CB&S's balance sheet will shrink but risk density will increase as a result of management's focus on disposing of activities that generate considerable leverage exposure but not necessarily risk-weighted assets.

DB's 1Q15 financial results, reported on 27 April, show very strong revenues, supported by all core businesses, especially CB&S and DAWM, and solid pre-tax earnings, despite a hefty increase in expenses, including EUR1.5bn in litigation charges and the full-year charge for the European bank levy of EUR0.5bn.

RATING DRIVERS - DEUTSCHE BANK'S VR
The affirmation of DB's VR reflects Fitch's view that the strategic change makes sense for the bank at this time, given the heightening regulatory requirements it faces by remaining a global universal bank with a leading sales and trading franchise. The high leverage ratio requirements for businesses that will be held under its intermediate holding company in the US will be among the most demanding of these. However, given that DB is taking five years to execute on its plan, Fitch sees a high risk that obstacles will prevent it from achieving its targets.

DB's 'a' VR reflects the bank's strong, diversified franchise by product and geography, even after the planned sale of Postbank and asset disposals, but a complex organisational structure. After the Postbank spin-off, DB will combine an entrenched franchise in domestic and European corporate banking with a leading global securities presence, particularly in global fixed income, and an improving global wealth and asset management franchise. DB's retail banking franchise in Germany and Europe will be focused on higher-end, affluent customers. However, Fitch considers DB's relatively large share of earnings from its sales and trading and markets-driven businesses to be more volatile than commercial banking earnings, which constrains its VR.

DB's 1Q15 results are evidence of the strength of its franchise. Strong revenues and adjusted pre-tax earnings (excluding litigation charges of EUR1.5bn) in 1Q15 were driven by strong results from the CB&S business segment, which increased 15% and 37.9% yoy, respectively, comparing well with Global Trading and Universal Bank (GTUB) peers. In addition, all core business segments showed an improved performance yoy. Total revenues for DB were up by 24% yoy and adjusted pre-tax earnings were up 34.6% yoy to EUR3.5bn. Revenue growth was also supported by favourable foreign exchange movements (reflected in higher costs, however).

We view positively that DB's PBC and GTB segments reported modest revenue and earnings improvement in a difficult interest rate environment, and that DAWM achieved strong revenue (+29%) and earnings (+75%) growth supported by an increase of its assets under management to EUR1.2 trn as of end-1Q15, an increase of EUR120bn from end-2014 of which net inflows contributed EUR17bn.

DB's announced revised strategy, if executed well, should improve the lagging profitability and efficiency of its core bank in the medium term. In addition, while risk-weighted capitalisation will remain broadly unchanged mainly due to increased regulatory weightings (DB targets a fully-loaded CET1 ratio of 11%; 11.1% at end-1Q15), progress towards its 5% leverage ratio target should position DB well compared especially with European GTUB peers. DB's risk-weighted capitalisation was considerably strengthened during 2014 by a EUR8.5bn capital increase and issuance of additional Tier 1 instruments, which is positive for the VR.

However, DB's 1Q15 results also illustrate challenges to strengthening its financial metrics. Extraordinarily high costs, including litigation charges of EUR1.5bn, resulted in a drop in reported pre-tax income to EUR1.5bn compared with EUR1.7bn for 1Q14 and net income of EUR0.6bn, a 45% decline yoy. Operating expenses amounted to EUR8.7bn in 1Q15, up EUR2.2bn or 34% compared with 1Q14. The increase was mainly driven by higher litigation costs, foreign exchange movements and bank levy costs (which increased by EUR0.5bn yoy, reflecting both the increase in size and the recognition of the full-year impact of the levy in the first quarter). Operating expenses were also negatively affected by higher regulatory induced expenses. However, even on an adjusted basis (excluding litigation charges, "cost to achieve" and other one-off items), DB's cost base increased by 11.8% yoy, highlighting DB's difficulties to anticipate and balance regulatory headwinds.

Fitch will closely monitor how DB implements its revised EUR3.5bn cost savings programme, particularly since it entails considerable "costs to achieve" (around EUR5bn), including EUR0.8bn in existing costs from deleveraging in CB&S and EUR2.5bn of investments in digitalisation and GTB by 2020.

DB's VR takes into account our view that the bank's exposure to litigation and conduct risk will remain elevated in the short- to medium-term. In this context, DB not only increased its litigation reserves in 1Q15 by EUR1.5bn but also its identified contingent liabilities to EUR3.2bn from EUR1.9bn at end-2014. Out of EUR1.5bn litigation charges only EUR1bn related to the joint settlement DB reached with the Department of Justice (DOJ), Commodity Futures Trading Commission (CFTC) and New York State Department of Financial Services (NYDFS) in the US and Financial Conduct Authority (FCA) in the UK as part of an industry-wide investigation into past submissions for interbank offered rates benchmarks on 23 April 2015.

DB's decision to deconsolidate Postbank and shrink its CB&S business is on balance neutral for the bank's VR. Fitch believes that the shrinkage of DB's C&BS business of net EUR130bn-150bn is a defensive reaction in light of market and regulatory headwinds. Several other European peers have taken similar steps, but DB plans to retain a more substantial presence and better market shares across global securities markets than its European peers and remains the only committed European challenger to the global US-based brokerage houses.

Similarly, Fitch views the divestment of Postbank as neutral, despite the potential positive medium-term impact on DB's profitability, capitalisation and leverage ratios. In Fitch's view, DB's failure to create a more profitable retail banking franchise in Germany after the acquisition of Postbank in 2011, which would have helped to achieve a more balanced business model, highlights some weaknesses in DB's execution capabilities that will need to be addressed to retain the VR at its current level.

Fitch considers DB's risk controls sound, which underpin the VR, as the bank has sizeable exposures to credit and market risk. The bank remains exposed to non-core assets, which it is both actively reducing and allowing to run-off. Reduction of non-core assets has slowed down, and Fitch expects it will take some years to run down the remainder.

RATING SENSITIVITIES - VR DEUTSCHE BANK
Upside to DB's VR is limited in the medium term given its business model and challenges to implement its strategic plan. To maintain the VR at its current level and avoid a downgrade of likely one notch, we need to see tangible signs of progress with the bank's new strategic plan during the next one-to-two years. In particular, for 2015 as a whole and 1Q16, we would need to see an improvement in the underlying operating cost base, a net improvement in the CRDIV leverage ratio from the end-1Q15 level of 3.5%, and evidence of progress made with preparing Postbank for sale or IPO by end of 2016.
DB's VR factors in our expectation that underlying earnings will improve during 2015 and reported earnings will improve in 2016. Failure to improve underlying and reported profitability in line with these expectations would put pressure on DB's VR, including any conduct fines or settlement costs whose incremental costs absorb more than two quarters of earnings.

DB's VR is also sensitive to delays in improving its leverage ratio. Should we come to the conclusion that DB starts lagging its stated leverage ratio target or that leverage exposure reduction will have a more significant impact on DB's revenue base or franchise than planned, then this would be negative for the VR.

KEY RATING DRIVERS - DB SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by DB and its subsidiaries are all notched down from DB's VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.

RATING SENSITIVITIES - DB's SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of subordinated debt and other hybrid capital issued by DB and its subsidiaries, excluding Postbank, are primarily sensitive to a change in its VR. The securities' ratings are also sensitive to a change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance relative to the risk captured in the issuer's VR. This might reflect a change in capital management in the bank or an unexpected shift in regulatory buffer requirements, for example.

RATING DRIVERS - POSTBANK'S IDRS, SENIOR DEBT AND SR
Postbank's IDRs are equalised with DB's. The RWNs on Postbank's IDRs reflect the planned sale of Postbank and a low likelihood in Fitch's view that a new owner would have the ability and propensity to support Postbank at an 'A+' level. Fitch will likely downgrade Postbank's Long-term IDRs to below DB's during the next few weeks to reflect the parent's plan to deconsolidate its subsidiary. However, given that no sale is planned before 2017, we will likely continue to factor support from DB into the ratings in the interim period. DB owns 96.8% of Postbank as at end-1Q15 and plans to squeeze out the remaining shareholders by end-2015. In our view, there is an extremely high likelihood that DB would support Postbank if needed as long as it remains majority owner. Support is underpinned by a control and profit and loss transfer agreement between Postbank and DB Finanz-Holding GmbH (not rated, the wholly-owned subsidiary of DB that holds the shares in Postbank). Postbank's Support Rating (SR) also reflects this backing from DB.

If there is a general market sale of Postbank, its Long-term IDR would be downgraded to the level reflecting its own financial strength and stand-alone creditworthiness. Following DB's announced intention to deconsolidate Postbank and unwind its back-office links to the subsidiary, Fitch will assess Postbank's stand-alone creditworthiness during the next few months once more information is available. At this stage, we expect that the bank's VR would likely be in the 'bbb' category, based on its overall low risk profile, stable franchise and funding, as well as modest profitability and capitalisation.

RATING SENSITIVITIES - POSTBANK'S IDRS, SENIOR DEBT AND SR
Postbank's ratings are primarily sensitive to the conclusion of its sale, at which point its IDRs and senior debt ratings will reflect the higher of its stand-alone creditworthiness, most likely indicated in a VR, or the ability and propensity of any new owner to provide institutional support in case of need. The SR could be downgraded to as low as '5' depending on the new owner and Fitch's assessment of its ability and propensity to provide support in case of need.

RATING DRIVERS - POSTBANK'S HYBRID SECURITIES
Hybrid capital issued by Postbank's issuing vehicles are all notched down from DB's VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. As a result of DB's announcement to divest Postbank, Fitch has placed Postbank's hybrid instruments on RWN. These instruments will be likely be downgraded when Fitch concludes its review of interim support from DB for Postbank and again on the sale of Postbank, or possibly before if there are changes to the control and profit and loss transfer agreement between Postbank and DB Finanz-Holding GmbH. They will likely be notched from Postbank's future VR.

RATING SENSITIVITIES - POSTBANK'S HYBRID SECURITIES
The hybrid capital securities issued by Postbank's issuing vehicles are primarily sensitive to the sale of the bank by DB. Prior to that the securities' ratings are also sensitive to a change in their notching from DB's VR when Fitch concludes its assessment of support available from DB to Postbank in the interim period prior to sale. Additional notching could arise in the interim period if Fitch assesses the probability of the securities' non-performance relative to the risk captured in DB's VR to have increased as a result of changes to capital management within DB before Postbank is sold. These could include, for example, a change to the control and profit and loss transfer agreement, or an unexpected shift in regulatory buffer requirements, for example.

RATING DRIVERS AND SENSITIVITIES - POSTBANK'S LEGACY UNSECURED GUARANTEED DEBT RATINGS ISSUED BY DSL
The ratings of the legacy guaranteed debt issued by DSL, which was acquired by Postbank in 1999, reflect the grandfathered deficiency guarantee on these notes from the Federal Republic of Germany (AAA/Stable), which relate to its sovereign ownership and policy role prior to privatisation. The ratings are sensitive to any change to Germany's IDR or to any change in Fitch's assessment of the likelihood that Germany will honour the guarantee.

The rating actions are as follows:
DB
Viability Rating, affirmed at 'a'
Subordinated market-linked securities: affirmed at 'A-emr'
Subordinated Lower Tier II debt: affirmed at 'A-'
Additional Tier 1 Notes: affirmed at 'BB+'

DBTrust Corporation
Subordinated debt: affirmed at 'A-'
DBCapital Funding Trust VII: affirmed at 'BBB-'
DBCapital Funding Trust VIII: affirmed at 'BBB-'
DBContingent Capital Trust II: affirmed at 'BBB-'
DBContingent Capital Trust III: affirmed at 'BBB-'
DBContingent Capital Trust IV: affirmed at 'BBB-'
DBContingent Capital Trust V: affirmed at 'BBB-'

Other ratings are unaffected

Postbank
Long-term IDR: 'A+' placed on RWN
Short-term IDR: 'F1+' placed on RWN
Support Rating: affirmed at '1' Senior debt, including programme ratings: 'A+'/'F1+' placed on RWN
Unsecured guaranteed bonds issued by former DSL Bank: affirmed at 'AA''

PB Finance (Delaware); Inc:
Commercial paper: 'F1+' placed on RWN

Deutsche Postbank Funding Trust I (Germany): 'BBB-' placed on RWN
Deutsche Postbank Funding Trust II (Germany 'BBB-' placed on RWN
Deutsche Postbank Funding Trust III (Germany): 'BBB-' placed on RWN
Deutsche Postbank Funding Trust IV (Germany): 'BBB-' placed on RWN
ProSecure Funding Limited Partnership (LP Jersey): 'BBB' placed on RWN