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Deutsche Bank's U.S. Unit Clears Second Round of Stress Test

Zacks Equity Research

Beleaguered by litigation issues, dismal performance and regulatory probes over the past few months, Deutsche Bank DB got a boost from the Federal Reserve’s approval to its capital plan. The bank’s U.S. subsidiary, DB USA Corporation (“DBUSA”), cleared the second level of the Fed’s stress test 2019, which allowed the German lender to increase investors’ payouts.

Deutsche Bank’s clearance of the annual stress test conducted by the Fed to determine that the banking giants are adequately capitalized to survive under a tremendously difficult economic scenario and a subsequent capital plan approval lend a ray of hope to the CEO Christian Sewing in implementing its turnaround strategies. However, the plans got delayed due to the rising concerns over the health of the bank’s U.S. operations.

"This is excellent news," Sewing told employees in a memo published late Thursday. "Achieving success here was one of the key goals we set a year ago. And it is a huge step forward for our business in the US and globally. A strong operating platform in the Americas is essential to our clients."

The Fed concluded that even in an adverse economic condition, DBUSA’s Common Equity Tier 1 capital would remain above the minimum requirement of 4.5% and would not fall below 14.8% over the nine-quarter planning horizon.

Notably, DBUSA’s capital scheme was rejected by the Fed last year on account of “widespread and critical deficiencies” in its capital planning. Also, the reviewer found weakness in data capabilities and controls that contributed to DBUSA’s capital planning process.

The stress test results bear a testimony to Deutsche Bank’s status. Meanwhile, shares of the company have declined around 29% on the NYSE in the past year, due to a number of factors including worries over balance sheet, business operations, costs-control measures and failed merger talks with Commerzbank AG.



Therefore, continuing with its overhauling moves for reviving profitability, the bank’s plan includes detailed restructuring efforts as Sewing enforced "tough cutbacks" to shareholders following futile merger talks with Commerzbank. Per the plan, the German bank is anticipated to decrease its risk-weighted assets by 20-25% over the next 3-5 years.

Notably, other initiatives reflect cutbacks in the U.S. equities trading business including the prime brokerage and equity derivatives. The financial institution would create a ‘bad bank’, a measure used by the failed U.K. banks post the 2008 financial crisis.

The newly-formed unit will hold innumerable Euros of assets worth around €50 billion as Sewing is trimming its investment banking division. This includes Sewing’s plans to shrink or shut down the equity and rates trading businesses outside continental Europe completely and focus on the core transaction banking and private wealth management operation.

Further, the strength of employees to be affected by these endeavors is currently uncertain. The bank will likely reduce the headcount to below 90,000 from the existing 91,463.

Nonetheless, these revamping steps are anticipated to postpone some of the bank's targets including the goal of achieving a return on the tangible equity of 4% in 2019.

Deutsche Bank faces immense pressure to slash its investment banking division following the collapse of its merger talks with the domestic rival Commerzbank. Though the bank’s restructuring attempts including cost-saving measures look encouraging, it is difficult to determine how much it will gain, considering the prevalent headwinds. Nevertheless, Fed’s approval to its capital plan is likely to raise investors’ optimism on the stock.

Deutsche Bank currently carries a Zacks Rank #3 (Hold).

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