Commerzbank Finance & Covered Bond S.A.

Transcription

1 CREDIT OPINION Update Commerzbank Finance & Covered Bond S.A. Semi-annual update Summary Rating Rationale We assign a Baa long-term issuer rating as well as a Baa2(cr)/P-2(cr) Counterparty Risk Assessment to Commerzbank Finance & Covered Bond S.A. (CFCB). Analyst Contacts Michael Rohr VP-Senior Credit Officer michael.rohr@moodys.com Alexander Hendricks, CFA Associate Managing Director - Banking alexander.hendricks@moodys.com Carola Schuler Managing Director Banking carola.schuler@moodys.com CFCB's long-term issuer rating reflects (1) the bank's b2 baseline credit assessment (BCA) and its ba2 Adjusted BCA, which incorporates very high support from its parent Commerzbank AG (A2 stable/baa1 stable, baa1); (2) the results of our Advanced Loss Given Failure (LGF) analysis, which takes into account the severity of loss faced by the different liability classes in resolution, and which results in two notches of rating uplift for CFCB's issuer rating; and () our 'low' government support assumption, which results in no additional rating uplift. The bank's b2 BCA reflects (1) CFCB's high, albeit improving, balance-sheet leverage; (2) the bank's very low earnings generation capacity, partly as a result of the winding-down of certain legacy portfolios; and () CFCB's high dependence on market funding despite a large part of its funding being derived from its parent Commerzbank, as well as its relatively high asset encumbrance. Its ba2 Adjusted BCA reflects our assessment of a very high probability of support from its parent, resulting in three notches of affiliate support uplift from the bank's b2 BCA. Our assessment of continued parental commitment takes into account the Letter of Comfort provided to CFCB by its parent as well as several Service Level Agreements between Commerzbank and CFCB, supporting the bank's operational stability. Exhibit 1 Key Financial Ratios Source: Moody's Financial Metrics

2 Credit Strengths Modest liquidity risk owing to refinancing support from Commerzbank AG Solid, albeit recently declining, capital ratios are a credit strength, despite high leverage Credit Challenges Manage run-down of legacy public finance portfolios without meaningful impact on capital and thereby reduce high balance-sheet leverage Maintain profitability at break-even, despite challenging market environment Monoline nature of business constrains the bank's BCA Rating Outlook The outlook on CFCB's issuer rating is stable, reflecting the absence of any directional pressure on its fundamental credit metrics nor on the results of our Advanced LGF analysis. Factors that Could Lead to an Upgrade An upgrade of CFCB's long-term ratings would be likely if we (1) upgraded the bank's BCA and/or Adjusted BCA; and/or (2) increased the rating uplift resulting from our Advanced LGF analysis. Upward pressure on the bank's BCA could be exerted if (1) CFCB manages the orderly wind-down of its legacy public finance portfolios without a meaningful impact on profitability and/or capital; and (2) CFCB strengthens its earnings-generation capacity in order to better protect its capital base against adverse developments potentially arising from its large exposure to public sector entities. CFCB's Adjusted BCA is insensitive to mild positive changes in Commerzbank's fundamental credit strength, provided our affiliate support assumptions remain unchanged. Our Advanced LGF analysis could result in higher notches of rating uplift if CFCB issues significant volumes of bail-inable subordinated debt. Factors that Could Lead to a Downgrade A downgrade of CFCB's long-term ratings could be triggered if we (1) downgraded the bank's BCA and/or Adjusted BCA; and/or (2) reduced the rating uplift resulting from our Advanced LGF analysis. Downward pressure on the bank's BCA could result from (1) higher-than-expected losses arising from the bank's large public sector portfolio and/or a significant worsening of the credit quality of the bank's more critical exposures to local authorities in the United States (US), and regional creditors in Italy and Spain; (2) a significant further reduction of CFCB's capital adequacy metrics, either as a result of larger unexpected losses and/or upstreaming of capital to its parent Commerzbank; and/or () an increase of its already high, albeit recently improving, balance-sheet leverage. Downward pressure on the bank's Adjusted BCA could arise from lower support assumptions that may result from (1) Commerzbank no longer being committed to orderly unwinding CFCB's legacy portfolios; and/or (2) Commerzbank withdrawing the Letter of Comfort and/or existing Service Level Agreements with CFCB. Our Advanced LGF analysis could result in fewer notches of rating uplift if the volume of senior unsecured debt considered bailinable fell significantly, specifically if this results from a meaningful withdrawal of parental funding. 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 on for the most updated credit rating action information and rating history. 2

3 Key Indicators Exhibit 2 Commerzbank Finance & Covered Bond S.A. (Consolidated Financials) [1] Total Assets (EUR million) Total Assets (USD million) Tangible Common Equity (EUR million) Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross loans / Due to customers (%) Avg [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [] Basel II; IFRS [4] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used for average calculation Source: Moody's Financial Metrics Detailed Rating Considerations CFCB continues its significant realignment and repositioning within Commerzbank group Since 15 February 2016, Commerzbank Finance & Covered Bond S.A. (CFCB) is the new name of Erste Europäische Pfandbrief- und Kommunalkreditbank Aktiengesellschaft in Luxemburg S.A. (EEPK). CFCB, as a fully-owned subsidiary of Commerzbank, plans to extend its business within the remits of a covered bond bank in Luxembourg, also offering syndicated loans and fiduciary notes. CFCB resulted from the merger of two Luxembourg-based Commerzbank subsidiaries: former EEPK, which held a portfolio of publicsector loans, and Hypothekenbank Frankfurt International S.A. (HFI; unrated), a wind-down entity that used to be a subsidiary of Hypothekenbank Frankfurt AG (unrated), containing HF's international public finance portfolio in Luxembourg. Both entities used Lettres de Gage (covered bonds) to refinance a large portfolio of public-sector loans. On 4 July 2016, Julius Baer Group Ltd. (JBG, issuer rating A negative) acquired selected parts of Commerzbank's Luxembourg private banking and wealth management business (former Commerzbank International S.A. (CISAL), renamed Bank Julius Baer Luxembourg S.A., unrated). As part of the deal, some of former CISAL's asset and liabilities as well as certain businesses from Commerzbank's Luxembourg branch were transferred to CFCB. We will assess the full impact of these transactions on CFCB's credit profile, particularly with regards to capital and profitability, upon release of its half-year report that we expect to be published by late August CFCB's asset quality is moderate and contains considerable tail risk in the public finance portfolio Large tail risks stem from public sector exposures to the US, United Kingdom (UK), Italy and Spain, which is reflected in our negative adjustment of the bank's Asset Risk score to b1. As of 1 December 2015, CFCB managed a public-finance portfolio with a nominal value of 1.0 billion, down 15% or 2. billion year-over-year. As of end-2015, the portfolio mainly comprised exposures to public sector entities in the US ( 5.7 billion or 44% of the total), the UK ( 2.5 billion or 19%), Italy ( 1.5 billion or 12%) and Spain ( 1.2 billion or 9%). Unrealised losses on CFCB's public sector portfolio amounted to 1.7 billion as of year-end 2015, or 225% of its balance-sheet equity. This constitutes significant tail risks for the bank's solvency metrics if the portfolio wind-down cannot be performed in a value-preserving manner.

4 In addition, exposures to US student loans ( 2.9 billion as of 1 December 2014) and long dated interest-only loans to British local authorities with maturities of years (so-called Lobo loans) of 2.4 billion, also as of 1 December 2014, were acquired from HFI, adding to CFCB's risk profile. High leverage remains a rating constraint The bank's common equity Tier 1 (CET1) ratio of 17.8% declined by 90 basis points year-over-year, largely as a result of higher credit risk-weighted assets (RWA). The increase in credit risk was largely owing to the debt moratorium imposed on Heta Asset Resolution AG (Heta, Ca review for upgrade2; CFCB nominal exposure 7 million) and other negative rating migrations resulting from smaller defaults. For large parts of its public-sector portfolio, CFCB continues to benefit from a zero risk-weight for public-sector exposures in the European Economic Area. We further consider CFCB's substantial, albeit improving, leverage (equity as a percentage of total assets was.8% as of year-end 2015) a further rating constraint. Overall, and additionally taking into account CFCB's limited access to capital, we have assigned a Capital score of ba2. Profitability is set to remain weak, owing to the continued portfolio run-down For 2015, CFCB reported a net profit of 79.4 million (2014: net loss of 67.5 million), largely driven by non-recurring one-off gains from the buyback of 2.2 billion of own bonds ( 18 million positive effect) as well as write-backs on provisions ( 51 million positive effect). Given the further run-down of selected portfolio parts and the recent asset and liability transfers within Commerzbank's Luxembourg operations, it will be difficult to assess the bank's future earnings-generation capacity. We have captured the potential for a net result below break-even in 2016 and potentially beyond by assigning a Capital score of caa1, in-line with the historic average of caa1, taking into account management's guidance of a pre-tax loss in In preceding years, CFCB reported net losses resulting from the value-destructive unwinding process of CFCB's legacy portfolios. We believe pressures have not meaningfully eased, as displayed by the aforementioned high unrealised losses exceeding the bank's equity by a wide margin. Moreover, pressure for further write-downs on CFCB's exposures and from additional provisioning needs may be exerted if the economic recovery in Europe comes to a halt following the UK's referendum vote to leave the EU. This may have adverse effects on bond spreads in the bank's public-sector portfolio and widen the gap between equity and unrealised losses further. In addition, lower government bond ratings, e.g. on CFCB's large exposures to the UK, may increase credit RWA and thus pressure the bank's capital adequacy metrics. Modest liquidity risk owing to refinancing support from Commerzbank The bank ceased its funding with 'Lettres de Gage' in October 2015 due to changes in the Capital Requirements Directive (CRD IV) that excludes 'Lettres de Gage' from the European Central Bank's repo program. Instead, CFCB aims to reduce funding needs by further reducing its asset base and fill any potential gaps by tapping senior funding from Commerzbank going forward. The 10.5 billion liabilities towards Commerzbank at year-end 2015 (2014: 7.2 billion) stand against 1. billion of related intragroup assets (2014: 1.5 billion), unveiling the close integration of CFCB into Commerzbank's group treasury, thereby benefitting from its parent's now lower funding costs, as funds are passed through on to CFCB on favourable terms. We have captured the reliance of CFCB on confidence-sensitive market funding sources as well as its intragroup exposures together with the high asset encumbrance by assigning a Combined Liquidity score of b2. Monoline adjustment captures the bank's limited revenue and earnings diversity outside of the public finance sector In addition to the pure subfactor score adjustments, we have qualitatively reduced the bank's overall Financial Profile score by one full notch, leading to a b2 BCA. This adjustment reflects CFCB's low revenue and income diversity outside of the public finance lending businesses. As a result, we classify CFCB as a monoline bank according to our approach for business diversification. 4

5 Notching Considerations Affiliate Support CFCB's Adjusted BCA benefits from our assessment of a very high probability of support from its parent Commerzbank, resulting in three notches of affiliate support uplift from the bank's b2 BCA, to ba2. This assessment also takes into account a remote tailrisk of a future break-up between Commerzbank and CFCB, leading to a positioning of CFCB's ba2 adjusted BCA two notches below Commerzbank's baa BCA. Loss Given Failure CFCB is subject to the EU Bank Recovery and Resolution Directive, which we consider to be an Operational Resolution Regime. We therefore apply our Advanced LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure should the bank enter resolution. We assume residual tangible common equity of % and losses post-failure of 8% of tangible banking assets, a 25% run-off in junior wholesale deposits, a 5% run-off in preferred deposits, and assign a 25% probability to deposits being preferred to senior unsecured debt. These ratios are in line with our standard assumptions. CFCB is funded by Lettres de Gage public issues as well as by secured and unsecured lendings from Commerzbank. We consider Commerzbank's funding to be bail-in-able before any third party debt. Under our Advanced LGF analysis, CFCB's long-term issuer ratings therefore display a very low loss-given-failure, resulting in two notches of rating uplift from CFBC's ba2 adjusted BCA, from which the ratings are notched. Government Support The ratings of CFCB do not incorporate additional rating uplift from government support, reflecting our view that the Luxembourg authorities are unlikely to extend any systemic support to CFCB in case of need. Ratings Exhibit Category COMMERZBANK FINANCE & COVERED BOND S.A. Outlook Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating -Dom Curr Moody's Rating Stable b2 ba2 Baa2(cr)/P-2(cr) Baa PARENT: COMMERZBANK AG Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating Senior Unsecured Subordinate Commercial Paper -Dom Curr Other Short Term Stable A2/P-1 baa baa A2(cr)/P-1(cr) Baa1 Baa1 Ba1 P-1 (P)P-1 Source: Moody's Investors Service 5

6 Rating Methodology and Scorecard Factors Exhibit 4 Commerzbank Finance & Covered Bond S.A. Macro Factors Weighted Macro Profile Strong + Financial Profile Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver #2 Solvency Asset Risk Problem Loans / Gross Loans 2.6% a2 b1 Sector concentration Collateral and provisioning coverage Capital TCE / RWA 21.5% aa1 ba2 Access to capital Nominal leverage Profitability Net Income / Tangible Assets -0.2% caa1 caa1 Return on assets Expected trend Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 75.9% caa Liquid Resources Liquid Banking Assets / Tangible Banking Assets 15.5% baa2 Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA Balance Sheet Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Junior subordinated bank debt Preference shares (bank) Senior unsecured holding company debt Dated subordinated holding company debt Junior subordinated holding company debt Preference shares (holding company) Equity Total Tangible Banking Assets 6 100% a b1 b2 b Market funding quality b1 Asset encumbrance b2 b Aaa b1-b b2 ba2 in-scope (EUR) 10,504 % in-scope 5.4% at-failure (EUR) 10,504 % at-failure 5.4% 8, % 0.1% 8, % 0.1% ,676.0% 100% ,676.0% 100%

7 Debt class Counterparty Risk Assessment Instrument Class Counterparty Risk Assessment De jure waterfall De facto waterfall Notching LGF Assigned Additional Preliminary LGF notching Rating Instrument Sub- Instrument SubDe jure De facto notching guidance notching Assessment volume + ordination volume + ordination versus subordination subordination BCA 46.6% 46.6% 46.6% 46.6% 0 baa2 (cr) Loss Given Failure notching Additional Preliminary Rating notching Assessment 0 baa2 (cr) Government Local Currency rating Foreign Support notching Currency rating 0 Baa2 (cr) -- Source: Moody's Financial Metrics 7

8 Endnotes 1 Unless indicated otherwise, the ratings shown in this report are the banks' deposit rating and senior unsecured debt rating together with their corresponding outlooks, as well as the banks' baseline credit assessment (BCA). 2 The rating shown is the entity's Carinthian (Carinthia; B developing) state-guaranteed senior unsecured debt rating and outlook. The scorecard shown above does not display Issuer Ratings. Instead, the Counterparty Risk Assessment and its LGF notching is displayed. Please consult our Bank Rating Methodology for more details on our Advanced LGF notching approach. 8

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10 10 Contributors CLIENT SERVICES Mira Carey Associate Analyst Americas Asia Pacific Japan EMEA