Deutsche Bank : Initiating coverage: Buy Tier 2, Reduce AT1

>Strengths/Opportunities - The EUR8bn capital increase announced by Deutsche Bank (DB) in early March is set to boost the fully-loaded (FL) CET1 ratio by more than 200bp to 14.1% on a pro-forma basis at end-2016, a level far more commensurate with the bank’s risk profile, expected RWA inflation and modest internal capital generation in the medium term. The partial IPO of the asset management subsidiary and asset disposals will also contribute strengthening capital, supporting the bank’s new objective of a FL CET1 FL “comfortably above” 13%. The revision of the 2020 strategy announced alongside the capital increase will consolidate the share of German retail private and commercial banking (PCB) operations in DB business mix as a consequence of the decision to integrate (instead of divesting) Postbank (11% of 2016 revenues).The capital increase should allay the concerns of both customers and employees, boosting DB’s activity in segments sensitive to counterparty confidence and employee motivation.The sharp increase in RWA due to regulatory changes is likely to be staggered over a longer period than initially expected on the credit risk side. This will give DB more time to absorb their impact on its credit ratios.The bank enjoys a healthy funding profile dominated by stable customers resources and has ample liquidity reserves.Weaknesses/Threats - Despite the integration of Postbank, CIB operations, inherently riskier and more volatile activities than PCB, remain dominant in DB’s business mix.The bank needs to demonstrate its ability to execute an ambitious plan, especially on profitability matters, where it will need to generate revenues while slashing costs, an area where it has limited track record.While the announcement of the DoJ RMBS fine and the partial settlements of proceedings relating to Russian transactions have reduced litigation risks, outstanding proceedings could take a toll on the bank’s financial health and customer confidence.The leverage ratio has benefited from the capital increase, but DB needs to strengthen it further to attain the 4.5% target. This will necessitate deleveraging measures, without harming the commercial business.Credit Opinion: Stable - Market Recommendation: Buy Tier 2, Reduce AT1 - The recent strategic announcements and capital increase have stabilised DB's position. We could revise this opinion if there were significant setbacks in the execution of the strategic plan (significant and lasting damage on BFI franchises, cost slippages or litigation fines), which is not our central scenario. Conversely, strong operating performance and the achievement of the profitability and capital targets would lead us to positively review our credit opinion on DB.We initiate the coverage on DB with the following recommendations: 'Neutral' on senior debt securities which trade at 'fair' prices but without prospect of outperformance in our view, 'Buy' on Tier debt securities 2 with yields that we consider attractive (06/2020 1.79% , 02/2025 2.95%) and 'Reduce' on AT1 instruments due to the strong price recovery since the end of December (+17 pp since 01/12/2016 for EUR PerspNC22 6% at 97%), a limited upside potential and volatility that could result from any negative fact/rumor about DB.