Deutsche Bank risks higher capital bar for leveraged loans

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(Bloomberg) – Deutsche Bank AG will face higher capital requirements from its supreme regulator if it does not slow down lending to heavily indebted clients, making it difficult for CEO Christian Sewing to accelerate growth and profitability.

After months of behind-the-scenes discussions, the European Central Bank told Deutsche Bank that people familiar with the matter said it may have to hold more capital to account for the risks it takes on leveraged lending. The lender could dodge a higher capital bar if it mitigates those risks before the ECB sets 2022 requirements by the end of this year, people said, asking not to be named when discussing private information.

The profitable business has been a key driver for the investment banking division, and it has taken on even more importance this year as the trade boom that has so far driven Deutsche Bank’s recovery begins to fade. After seizing market share from competitors, he is now coming under more scrutiny from his regulator, which has urged companies to exercise caution in leveraged financing even before the pandemic raised the likelihood of a wave of corporate defaults.

“Leveraged loans are important business for the economy and many banks, including Deutsche Bank,” said a spokesman for the German lender. “We have extensive business experience and take a prudent approach to managing risk in accordance with regulatory requirements. We don’t comment on the dialogue with our regulators in principle. ”

An ECB spokeswoman declined to comment.

The ECB has given “clear expectations” for leveraged loans to banks under its purview, Supervisory Board Chair Andrea Henria said at a conference last week. However, “we did not see sufficient promptness,” he said, without naming the creditor.

Deutsche Bank shares continued their decline in trading in Frankfurt, falling 1.6%. They are up about 22% this year amid a broader rally in banking stocks.

The lender is the largest provider of leveraged loans among banks located in the European Union, and this business has received special attention from regulators in the past. Last year, the ECB recommended that the lender suspend some operations after identifying deficiencies in risk management. Deutsche Bank took remedial action but did not comply with the ECB’s request to suspend high-risk transactions until the problem is resolved, an acquaintance said at the time.

The garment business needs a lending business to meet its primary goal of increasing profitability during the final phase of its four-year recovery effort, which will last until the end of next year. The CEO said the investment bank’s revenue will be stable this year, although trading profits are expected to decline, which means other divisions will have to step up their efforts.

The leveraged lending business generated more than $ 300 million in revenue in 2020, aided by leading roles in some of the year’s biggest deals, including $ 23 billion in T-Mobile loans to acquire rival Sprint, according to data compiled by Bloomberg. The data shows Deutsche Bank is the seventh largest lending institution in the United States, up from 10th last year. In Europe, the Middle East and Africa, it is ranked third after reaching one level.

The German lender said the business was a key driver of a 5% increase in leveraged revenue in the first quarter from a year earlier.

Deutsche Bank prides itself on its credit risk management system and is saving less money for bad loans after increasing reserves last year at the start of the pandemic. He was also one of the few lenders to Archegos Capital Management to walk away unharmed after the family office collapsed earlier this year.

At the same time, the bank had to face a number of new regulatory challenges. German regulator BaFin expanded its anti-money laundering watchdog powers at Deutsche Bank in April, while the Federal Reserve warned the lender of continuing violations. Spain is undergoing an internal investigation into alleged misappropriation of derivatives, and Chief Risk Officer Stuart Lewis is facing an investigation into his role in the dividend arbitrage deal known as Cum-Ex.

Sewing has made building relationships with regulators a top priority after a decade of deteriorating relations, but the ECB’s focus on leveraged loans creates a new dilemma. If he chooses to meet the risk mitigation requirement, he will rein in the profitable unit he needs to meet his goals.

If he doesn’t, sewing will send a signal of confrontation to an influential stakeholder, and doing business can become significantly more costly. The ECB could order Deutsche Bank to apply a capital premium specifically tied to the leveraged leverage unit, or impose higher overall capital requirements for Deutsche Bank to account for the risk it takes, the sources said.

(Updates with shares in the seventh paragraph, earnings for the first quarter in the 11th)

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