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It's Possible That Deutsche Bank's IHC May Not Pass CCAR 2018

|Includes: Deutsche Bank Aktiengesellschaft (DB)

Its Deutsche Bank Trust Company (DBTC) entity failed CCAR 2015 and CCAR 2016.

The only reason DBTC passed CCAR 2017 was because it was not subject to the Fed's qualitative assessment.

Deutsche Bank USA (DBUSA), which is the holdco that contains its broker-dealer, DBTC, and other significant entities, is, however, deemed to be a 'large and complex' firm by the Fed.

As a result, DBUSA will be subject to the Fed's qualitative assessment, and will likely lead to its failing CCAR 2018.

The hits are likely to keep coming for Deutsche Bank (DB) this week.

While we learned last week that all participating banks passed the quantitative portion of this year's CCAR, this Thursday will reveal which firms received a non-objection, objection, or a conditional non-objection (i.e. a mulligan) to their capital plans. Given DBTC has failed CCAR for 2015 and 2016, and only passed CCAR 2017 because it was no longer subject to a review of its capital plan (i.e. not subject to the Fed's qualitative criterion), it's not likely that the deficiencies and weaknesses cited by the Fed during those earlier years will have materially been remediated.  With DBTC now under the umbrella of its large and complex DBUSA IHC holdco entity, it's almost assuredly going to receive an objection to its capital plan.

Why did DBTC fail CCAR for 2015 and 2016? According to the Fed's website, it cited broad and substantial weaknesses across its capital planning processes, and insufficient progress being made toward correcting those weaknesses and meeting supervisory expectations around continual improvement.

DBTC dodged a bullet in 2017 by being, for the first time, exempted from CCAR's qualitative requirement (it and other smaller and less non-complex firms were relieved of the qualitative assessment requirement). That is, its capital plan could not be used as a reason to object to its CCAR submission. My understanding is that from now on, and unless the Fed changes its mind, DBTC (along with the other smaller and non-complex firms) is no longer subject to the qualitative assessment for CCAR. Thus, as long as DBTC meets the quantitative requirements for their capital and leverage ratios (see table below), they would be expected pass CCAR.

Upon review of past CCAR exercises, DBTC has handily beat the other banks in terms of the above ratios, mainly arising from a lot of trapped capital it cannot upstream to its holdco DBUSA, or back to its parent in Frankfurt. Certainly not the best and highest use of all that excess capital if one were a shareholder.

However, now that DBUSA (for the first time) is subject to CCAR and is considered by the Fed to be a 'large and complex' firm, it will be subject to the qualitative requirement as well as the quantitative one. Hence, there is no avoiding DBUSA being judged during this year's CCAR as to the quality of its capital planning processes (for which its own smaller trust company entity was assessed as being weak and deficient for two years in a row). 

In my opinion, there's almost no way DBTC would have passed CCAR 2017 and probably not CCAR 2018, had the qualitative assessment of its capital plan still been required of it.  And almost surely, because of the weaknesses cited of DBTC, its holding company entity DBUSA will, in my opinion, also be cited by the Fed as being broadly and substantially weak across its capital planning processes. I say this because it's highly doubtful that enough progress would have been made to fix the problems cited against DTBC during the past 12-18 months, and, by assumption, these same issues would in parallel also be plaguing its larger and more complex holdco, DBUSA. 

The news for DB has not been positive for a relatively long time. And some hedge fund and PE firms have even gone so far as to say that the bank's shares are a practical way to express a view around hedging tail risk (i.e. shorting shares, buying puts).  My educated guess is that the news will not be getting any better for DB after the market close this Thursday afternoon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.