CLIENT SERVICES Deutsche Bank AG · the bank will merge Global Markets, Corporate Finance and Transaction businesses into one division. Streamlining and re-focusing these businesses

FINANCIAL INSTITUTIONS

ISSUER IN-DEPTH6 March 2017

Analyst Contacts

Peter E. Nerby, CFA 212-553-3782Senior Vice [email protected]

Ross J Hampson 44-20-7772-1440Associate [email protected]

Laurie Mayers 44-20-7772-5582Associate [email protected]

Robert Young [email protected]

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Deutsche Bank AGCapital Raise, Strategic Course Corrections Are Credit Positive

On 5 March, Deutsche Bank AG (DB, A3/Baa2 stable, ba1)1 announced an €8 billion fullyunderwritten raise of common equity and some major course corrections to its 2020strategic plan. These measures, on top of the firm’s progress in de-risking its balance sheet,are positive for DB’s bondholders. Most importantly, the capital raise gives DB more time andfinancial leeway to achieve the revised 2020 plan, though sustainable improvement to thebank’s credit strength, and ratings, will depend on the success of its ongoing reengineering.

The fully underwritten equity capital raise buys time and leeway for managementand should also bolster customer and counterparty confidence. The capital raise willincrease DB’s fully loaded common equity Tier 1 ratio by about 200 basis points to over 14%pro-forma, as of year-end 2016, providing a significant financial cushion for managementto continue to execute its ambitious plan to reengineer the firm, now five years in themaking. The capital raise will also allow the bank to pursue business and revenue growthmore assertively, following losses in 2016 that hindered efforts to strengthen and stabilizeprofitability and led to some customer and counterparty attrition. DB’s announcement ofa settlement with the US Department of Justice in late 2016 has helped alleviate concerns,and momentum has picked up in many businesses in early 2017 along with improved marketconditions. The capital raise is a powerful response to the challenges DB faced in 2016 and islikely to amplify the positive trends since the DOJ settlement.

Course corrections to strategic plan will help DB build on progress in de-risking.DB can use its increased financial flexibility to recalibrate the plan. A major strategicreversal is the decision to retain, rather than dispose of, Deutsche Postbank AG, whichmanagement will integrate into its existing German private and commercial banking andwealth management businesses in the hopes of building a source of more stable earningsin 2020 and beyond, although strengthening earnings for this segment remains a majorexecution challenge. The bank plans to IPO a stake in its asset management division. Finally,the bank will merge Global Markets, Corporate Finance and Transaction businesses intoone division. Streamlining and re-focusing these businesses will help DB build leaner, moreprofitable franchises that more closely match with its long-term strategic goal to simplifyand de-risk the bank while revitalizing its operating platform and processes.

With plenty still to do, capital and liquidity protections and strong strategicexecution will continue to drive DB’s creditworthiness in 2017. The capital raise andannouncement of other actions are credit positive, but upward rating pressure will onlydevelop if the bank makes steady progress toward the 2020 targets while investing tostrengthen the technology platform and control infrastructure of the bank. Our currentstable rating outlook assumes modest profitability levels in 2017.

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Deutsche Bank RecalibratesSunday’s announcement represents the second major recalibration of a strategic plan first announced in 2012 (with an originalambition to complete by 2015). Many of the strategic goals remain bondholder friendly and, if achieved, would result in a morebalanced business mix and a stronger control environment for the bank. DB would also operate with lower leverage, a simpler balancesheet and more conservative return on equity targets. This remains a developing credit story, and the effectiveness of strategicexecution will continue to drive changes in Deutsche Bank’s creditworthiness.

There are six key components to the latest recalibration:

1. The €8 billion, fully underwritten equity capital raise, significantly strengthening DB’s balance sheet and raising the fully loadedCET1 ratio to 14.1%, and a Supplementary Leverage Ratio of 4.1% on a pro-forma basis for 31 December 2016.

2. The decision to retain (rather than dispose of) Postbank and to plan to merge it with DB’s domestic operations, thereby eliminatingthe Postbank ring-fencing, which would make retail liquidity more fungible and increase the potential for cost efficiencies.

3. The plan to IPO a minority stake in Deutsche Asset Management to provide a new share currency that can be used for retentionand recruitment of investment management talent as well as for potential expansion.

4. The reconfiguration of the existing Global Markets, Corporate Finance and Transaction Banking businesses into a single Corporateand Investment Banking (CIB) division to generate additional cost savings and pursue a strategy more focused on cross-selling toreal economy corporate clients.

5. Some senior management changes, including the creation of two Deputy CEOs

6. Board approval of upcoming AT1 coupons and an intention to reinstate the common dividend at a rate of €0.11 per share in May2017.

Management indicated further restructuring costs-to-achieve of approximately €2 billion through 2020 and a plan to establish a legacyportfolio of approximately €46 billion of risk-weighted assets (RWA), mostly in the form of legacy rates and credit positions and othernon-core assets. The updated financial targets are outlined in the table below.

Exhibit 1

Strategy 2020 – Current and Revised Targets

Source: Company Data

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 6 March 2017 Deutsche Bank AG: Capital Raise, Strategic Course Corrections Are Credit Positive


At Substantial Cost, Balance Sheet Risk Is DownSince arriving in June 2015, DB’s new management team has engaged in a more purposeful and urgent execution of the strategicplan to rationalize the bank’s geographic footprint, shed non-core assets and resolve litigation. However, it has also had to deal withperiodic outbreaks of customer and counterparty concern. The €8 billion equity raise greatly enhances management’s flexibility tocontinue to de-risk the bank at its own pace and simultaneously pursue selected growth opportunities without having to rely asextensively on balance sheet reduction.

Some 2016 milestones in DB’s simplification and de-risking included:

» A $7.2 billion settlement with the US Department of Justice (DOJ) RMBS Working Group

» Closing operations in Scandinavia, Central & South America and Russia to reduce risks

» A 76% reduction in Non-Core Operating Unit (NCOU) RWA since year-end 2015 and subsequent closure of the division (Exhibit2). Of the €9 billion in remaining RWA, €5.7 billion will be transferred back into the new Corporate and Investment Banking (CIB)division.

Exhibit 2

Steady Run-Down of Non-Core Assets, but at a Cost…Non-core RWAs (left) and non-core pre-tax profit/losses (right)


In Q4 2016 DB resolved some major outstanding litigation, cutting the bank’s tail risk. It settled with the US DOJ for $7.2 billionregarding civil claims in connection with the bank’s issuance and underwriting of residential mortgage-backed securities (RMBS) andrelated securitization activities between 2005 and 2007. The bank paid a monetary penalty of $3.1 billion in January 2017 and willprovide $4.1 billion in consumer relief to be delivered over a multi-year period. DB also announced settlements with both the NewYork Department of Financial Services (DFS) and the UK Financial Conduct Authority (FCA) for a total of $630 million in relation tothe Russian ‘mirror’ trading investigation. This settlement was fully covered by existing provisions; however, there remain outstandingenquiries into the mirror trades by criminal authorities, which are not yet resolved, and the reasonably possible contingent liability was€2.2 billion at year end, and roughly €2.8 billion of remaining reserves (Exhibit 3).



Exhibit 3

Significant Settlements in Late 2016 Have Cut Deutsche Bank’s Tail RiskQ4 litigation reserve and settlements

Source: Moody’s Investors Service on Company Data

In addition, the market risk profile of the bank has fallen to a historic low since 2012 (Exhibit 4), likely reflecting planned business exitsand higher regulatory charges on certain trading activities, as well as secular declines in the industry pool.

Exhibit 4

Deutsche Bank’s Market Risk Profile Is at a Historic LowQuarterly VAR/Tangible Common Equity


Asset quality in DB’s core operations remains quite strong, dominated by the high-quality mortgage book – 93% of mortgages hada loan to value (LTV) below 90% at 30 September 2016. Asset quality measures remained stable during 2016, with a modest 1%decrease in impaired loans to €7.4 billion, largely the result of the de-risking, offset by a modest increase in impairments to theShipping, Metals & Mining and Oil & Gas sectors during the year. Reserve coverage remained stable in 2016, ending the year at 61%.



Capitalization and Liquidity Are StrongerWhen a bank is re-engineering to this extent, its capital adequacy and liquidity profile take on paramount importance to bondholders.As Exhibit 5 shows, DB was able to minimize erosion of its key capital ratios through an aggressive program of balance sheet reductionand sale of non-core assets (i.e., Hua Xia and Abbey Life). The €8 billion equity raise bolsters two key capital ratios for DB, providingmore time and financial leeway to continue the balance sheet and business restructuring. Management noted it would revise the CET1target to a comfortable level above 13% (up from the original 2020 target of 12.5%), with a leverage ratio target of 4.5%.

Exhibit 5

Key Capital Ratios Have Held Up Well, Considering Large Reengineering CostsCET1 and Tier 1 Leverage ratios


The announced €8 billion equity raise has significantly improved DB’s capital position (Exhibit 6, blue bars) compared with its closestglobal investment bank (GIB) peers, especially considering the reduction in tail risk resulting from the DOJ settlement.

Exhibit 6

DB’s Equity Raise Significantly Strengthens Its Capital Position Compared with PeersFully loaded CET1 and Tier 1 Leverage ratios for GIB peer group as of year-end 2016

Note: *BIS definition CET1 ratio and Leverage ratio on a look-through/fully-loaded basis.Source: Company Data



DB has also maintained strong liquidity throughout its reengineering (Exhibit 7). This is in part a natural consequence of divesting assetsand retaining the liquidity rather than retiring debt. The firm significantly deepened its liquidity pool in the fourth quarter, bringingtotal liquidity reserves up by €18 billion to €218 billion at 31 December 2016, following a liquidity outflow earlier in the year.

Exhibit 7

Liquidity Has Stayed Strong Throughout ReengineeringLiquidity pool & Liquidity Coverage Ratio


Plenty of Re-engineering Still to DoOne of the long-standing goals of DB’s strategy has been to grow earnings from less capital-intensive businesses and diversify thebusiness mix, reducing reliance on capital markets earnings. Earnings from less capital-intensive activities can serve as a “shockabsorber” to protect bondholders from the volatility of capital markets results over the cycle. As Exhibit 8 shows, DB has a thinnershock absorber than many of its peers with extensive capital markets operations.

Exhibit 8

Shock Absorption Capacity Varies Widely Amongst Global Investment Banks

Note: Capital markets earnings based on firm LOB disclosures including sales/trading and investment banking (origination and advisory) but excluding other corporate banking activitieswhere possible. Where disclosed, legacy unit losses from capital markets have been allocated to capital markets segment. Corporate overhead segments are included in non-capitalmarkets segment. Earnings are adjusted for own credit gains/losses (DVAs). HSBC’s baseline credit assessment shown (a1) represents the intrinsic standalone financial strength of the group(HSBC Holdings plc) and is currently on negative outlook. RBS (ba1) is currently on positive outlook, BCS (baa2) is currently on negative outlook. Societe Generale’s GIB Pre-tax Incomealso includes Securities Services and Financial & Advisory, Barclays’ GIB Pre-Tax Income also includes Corporate Lending and Transactional Banking. DB’s GIB pre-tax income also includesTrade Finance and Cash Management services and other Loan products.Source: Moody's Investors Service on Company Reports



With much of its balance sheet clean-up completed, structural profitability is DB’s greatest management challenge. Long-standingissues limit the profitability of German retail banking, and will be difficult to overcome strictly through cost cutting. DB must alsocontend with the rising expense of maintaining a global capital markets footprint. The dilemma has been exacerbated by a low-interest-rate environment and extended periods of low volatility, which reduce trading revenue. Furthermore, DB faced some name-specific headwinds during 2016, although management observed that these abated somewhat after the DOJ settlement. Results in thefirst two months of 2017 are ahead of 2016 levels (which was an unusually slow period).

Restructuring, legacy and litigation costs have consumed the majority of DB’s pretax profit from core businesses since its restructuringbegan in earnest in 2012 (Exhibit 9). The burden of such costs may again be above normal this fiscal year, with management indicatingthat a further €2 billion of restructuring costs will be incurred, with 70% of that amount incurred over the next two years. Our stableoutlook incorporates the possibility of only modest profitability during 2017.

Exhibit 9

Litigation and Legacy Costs Have Placed a Heavy Burden on Pretax ProfitabilitySources and uses of pretax profitability 2012-16


Annualized core profitability has been volatile and declining since the first half of 2015, when the new management arrived (Exhibit 10).Some of the decline is due to decisions to exit riskier businesses and client relationships, some is due to turbulent market conditionsand some is due to DB-specific headwinds.

Exhibit 10

Core Returns on Risk-Weighted Assets Have Been Volatile and Declining…Annualized quarterly pre-tax profits/RWA – 2015 & 2016

Note: Core Pre-tax earnings excluding; Hua Xia revenues, Abbey Life pre-tax income, restructuring and severance, litigation and goodwill impairmentsSource: Moody’s Investors Service on Company Data



As Exhibit 11 shows, much of the decline in core profitability has been due to the volatility of the global markets franchise, whichis not surprising given the inherent unpredictability of the business and the fluid nature of many client relationships. Exhibit 11also demonstrates the strategic need for Deutsche Bank to increase more dependable less capital-intensive earnings streams. Themanagement changes and line of business reorganizations announced yesterday are intended to facilitate that by realizing digitalsavings and synergies within the combined Private Wealth & Commercial Clients/Postbank operations, and by recalibrating on realeconomy clients within the reorganized Corporate and Investment Bank segment.

Exhibit 11

Weak Global Markets Performance Dampens Group Pre-Tax IncomeQuarterly pre-tax profit per line of business - 2015 & 2016

Note: excludes Hua Xia revenues, Abbey Life pre-tax income, restructuring and severance, litigation and goodwill impairmentsSource: Moody's Investors Service on Company Data

DB faced strong revenue headwinds from business exits, the extremely low German rate environment and turbulent market conditionsin 2016. Revenues (excluding NCOU, Hua Xia and Abbey Life) fell 10% overall to €29.4 billion and each business unit was down, exceptfor Postbank. Core revenue yield to RWA has been on a general downward trend in 2015 and 2016 (Exhibit 12).

Exhibit 12

Revenue Yields Have Been FallingQuarterly core revenue/RWA

Note: Group revenues excluding NCOU, Hua Xia and Abbey LifeSource: Moody’s Investors Service on Company Data



In the face of these revenue headwinds, DB’s cost-control efforts have intensified, as can be seen in Exhibit 13. Compensation expensewas reduced in 2016, but the firm maintained its spending on information technology and professional service fees related to its multi-year plan to rebuild the technological platform of the bank.

Exhibit 13

Expense Control Has Offset Some of the Profit DeclineQuarterly compensation costs & other adjusted costs – 2015 & 2016


A Significant Reversal on PostbankThe decision to retain Postbank may have reflected an inability to sell the subsidiary at a reasonable price. Nonetheless, integration ofDB’s German banking operations, if approved by regulators, may eventually bring bondholder benefits in the form of fungible liquidityacross the bank, as well as a greater contribution of earnings from German retail banking, bringing more balance to the business mix.

At this stage, however, we think large cost savings will prove difficult to achieve. In 2016, DB reported a 84% cost-income ratio for thePostbank segment and a 83% cost-income ratio for the Private, Wealth & Commercial Clients segment, highlighting the formidableexecution challenge the bank will face to reach its 65% target. The task is further complicated by the fact that Postbank owns BHW, asavings and loan association, whose business model is particularly challenged by the low-interest rate environment.

DB will undertake this intensive integration in a German banking system that has challenges, but that we see as fundamentally stable.Our stable outlook on the German banking system reflects the economic resilience of Germany (Aaa stable). We expect German realGDP to grow by 1.6% in 2017 and 2018, a slight deceleration from the 1.9% growth registered in 2016. In addition, unemploymentwill remain below 5%, supporting a stable operating environment for German banks. Domestic retail loans will remain sound, owing tostable employment and the country’s economic growth. The main challenges for the banks over the next 12-18 months are the bankingsystem's high cost base, and the very low-yield environment, which together continue to pressure earnings and margins. Therefore,profits only provide a limited cushion for potential economic downside risks.



Moody's Related ResearchCredit Opinions

» Deutsche Bank AG, November 2016 (1049810)

Issuer Comment

» Deutsche Bank AG: Full Year 2016 Results Commentary: Re-Engineering Strengthens Capital Position Despite Significant LitigationProvisions, February 2017 (1057666)

» Potential Litigation Costs Pose a Hurdle for Deutsche Bank’s Reengineering Efforts, October 2016 (192450)

» Deutsche Bank Looks to Settle US Mortgage Legal Exposure at a Reasonable Cost, September 2016 (192220)

Issuer In-Depth

» Barclays, Credit Suisse, Deutsche Bank, Royal Bank of Scotland and UBS: De-risking Will Slow with Heightened Market Uncertainty,October 2016 (1042606)

» Brexit-related Costs and Uncertainties Pose Fresh Challenge to Non-UK GIBS’ Pan European Business Models, July 2016 (1033749)

Rating Action

» Moody's Affirms Baa2 Debt and A3 Deposit Ratings of Deutsche Bank AG. Outlook Stable, March 2017

Banking System Outlook

» Germany, October 2016 (1038523)

Rating Methodology

» Banks, January 2016 (186998)


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https://www.moodys.com/research/Moodys-Affirms-Baa2-Debt-and-A3-Deposit-Ratings-of-Deutsche--PR_363055




Endnotes1 Ratings presented are: long-term deposit, long-term debt and baseline credit assessment.



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CLIENT SERVICES Deutsche Bank AG · the bank will merge Global Markets, Corporate Finance and Transaction businesses into one division. Streamlining and re-focusing these businesses