Fitch: Deutsche Bank's Improved Underlying 3Q Profit Mitigates Further Legal Costs
Stripping out goodwill and intangible impairment write-downs and litigation costs in this quarter and in the third quarters of previous years, and assuming no one-off positive profit contributions, the EUR 1.6bn for 3Q15 was DB's best third quarter in three years, amid challenging market conditions for peers. Improving underlying profitability in 2015 is a key driver for DB's Issuer Default Rating (IDR) to remain at 'A'.
DB announced that it expects to report a third quarter pre-tax loss of approximately EUR6bn and a net loss of EUR6.2bn, mainly because of impairments of goodwill and certain intangibles in corporate banking & securities (CB&S) and private & business clients (PBC) of approximately EUR5.8bn. In addition, it includes an impairment of the carrying value of DB's stake in the Chinese Hua Xia Bank Co. Ltd. of around EUR0.6bn as well as litigation provisions of approximately EUR1.2 bn.
Fitch deducts goodwill from its analysis of bank capital and similarly ignores any goodwill impairment in its immediate earnings evaluations. Importantly, DB expects to report a fully-loaded CRR/CRD4 Common Equity Tier 1 ratio (CET1) as at end-September of approximately 11%, which includes the impact of the European Banking Authority's Regulatory Technical Standards (prudential valuation) that were adopted in the quarter, somewhat later than peers in other countries. This would mean a reduction of 0.4% from DB's CET1 at 1H15 which was within the range Fitch had expected.
No announcement was made yesterday about the development of the leverage ratio, but we do not expect the leverage ratio to fall much, if at all, from its end-1H15 fully-loaded CRDIV level of 3.6%. Any adverse deviation from this level in the official results release may trigger a rating review. Also, any major setbacks to meeting its 5% target would not be commensurate with DB's current rating level.
Litigation costs were high again in 3Q and are a rating focus. It is difficult to predict when incremental charges will stop mounting, given that certain major settlements are still outstanding and the general level of regulatory fines continues to increase. We view a likely dividend reduction for 2015 positively as this will help mitigate the additional litigation charge announced yesterday.
The Negative Outlook on DB's Long-term IDR reflects our view that implementation of the revised strategy entails considerable execution risks, not least because DB has a mixed track record of executing against stated financial targets. Details expected in the full 3Q15 results release and strategy communication on 29 October should provide additional transparency around plans to implement the new strategy, which are important to our assessment of whether the risks involved in refining DB's business and financial profiles remain commensurate with an 'A' IDR.
DB's 3Q15 loss would not make a significant difference to distributable items required to ensure payment of coupons on additional tier 1 securities (AT1). The distributable items referenced for these securities are calculated under German GAAP for the parent bank, so are not affected by the write-downs of goodwill and intangibles.