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NewsMarch 9 2010

Ratings agency gets tough on Deutsche risk management

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Moody’s downgrade of German bank is a rare decision based on qualitative factors

International ratings agency Moody’s downgraded Deutsche Bank (DB) by two notches, to Aa3 from Aa1, citing a wide range of concerns about the group’s future earnings prospects.

Moody’s analyst David Fanger noted that Deutsche Bank’s management appear to be hesitating about acquiring a majority stake in Deutsche Postbank, which could also delay the expected benefits of that acquisition in terms of more stable earnings and deposit funding for DB.

However, Moody’s also sounded concerns about market risk management in DB’s large capital markets division that accounts for more than half of its capital allocation. This is striking, given that ratings agencies tend to feel most comfortable downgrading on easily demonstrated quantitative measures, rather than qualitative factors.

According to Mr Fanger, “Deutsche Bank has managed credit risk well, especially in its banking book. However, with regard to market risk management, as well as the areas in which market risk and credit risk intersect, the track record has not been as successful,” and may take more time to improve. He is also concerned that falling margins as investment banking competition intensifies again will encourage even greater risk-taking.

Hank Calenti, banking analyst at RBC Capital Markets in London, says: “We note that the potential impact of poor credit risk is miniscule at DB relative to the potential impact of poor market risk. As such, we ignore this credit risk comment and surmise that it was inserted to placate Moody’s fee payer.”

Mr Calenti says the risk profile of DB and other investment banks remains opaque, a point noted by Moody’s itself. Consequently, he believes the downgrade reflects a general belief that the capital required for market risk-exposed investment banks – not only from regulators, but also from ratings agencies – is still rising in the wake of the financial crisis.

“[This] could make return on equity goals of many banks difficult to achieve. As the equity markets react to this new banking reality, debt markets may react to an increased cost of equity,” says Mr Calenti.

For more on bank capital, see CoCo Bonds: Mixed reception

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