Bausparkasse Mainz AG

Transcription

1 CREDIT OPINION 29 May 217 Update Bausparkasse Mainz AG Semiannual Update Summary Rating Rationale We assign A2/P-1 deposit ratings to Bausparkasse Mainz AG (BKM). We also assign a Baseline Credit Assessment (BCA) and adjusted BCA to BKM, as well as an A2(cr)/P-1(cr) Counterparty Risk Assessment (CR Assessment). Analyst Contacts Bernhard Held, CFA VP Senior Analyst bernhard.held@moodys.com Alexander Hendricks, CFA Associate Managing Director - Banking alexander.hendricks@moodys.com Carola Schuler Managing Director Banking carola.schuler@moodys.com BKM's deposit ratings reflect (1) BKM's BCA of ; (2) our assessment that the probability of BKM benefitting from external support is low, leading to no rating uplift; and () the results of our Advanced Loss Given Failure (LGF) analysis, which provides three notches of uplift for deposits above BKM's BCA. The BCA reflects (1) the continued pressure from the low interest rate environment on BKM's profitability; (2) the bank's business model being essentially restricted to a single core product; and () a potential rise in risk charges under an adverse economic scenario, which could exert pressure on BKM's capital adequacy. BKM's BCA also reflects (1) BKM's adequate capital ratios which are conservatively calculated under the standardised approach; (2) its good funding and liquidity management framework with access to and ample usage of alternative funding options which provides diversification to the relatively costly Bauspardeposit that form the backbone of the building and loan associations' sector funding; and () its highly collateralised and granular loan book, predominantly invested in German residential mortgages supplemented by a securities portfolio focused on issuers from comparably strong macroeconomic environments. Exhibit 1 Rating Scorecard - Key Financial Ratios Source: Moody's Financial Metrics

2 Credit Strengths» Sound asset quality given highly granular and collateralised loan book» Good liquidity in conjunction with a diversified and less confidence-sensitive funding profile Credit Challenges» Profitability expected to remain subdued» Capital ratios are adequate, but weak earnings outlook inhibits absolute capital growth Rating Outlook BKM's long-term deposit ratings carry a negative outlook. This reflects the downward pressure exerted by the low interest-rate environment on BKM's BCA. Factors that Could Lead to an Upgrade We see limited upside potential for BKM's BCA and long-term deposit ratings. Last year's improvement in the bank's macro profile from Strong+ to Very Strong- has added some support for BKM's BCA, helping to alleviate the continued pressure on the BCA in relation to the challenges to its core business exerted by the low rates environment. However, any upward pressure on the BCA would be conditional on a material strengthening of the group's capital volume to achieve a significant increase in the bank's Tangible Common Equity (TCE) leverage ratio, a significant improvement of the bank's profitability based on strategic measures to offset challenges for the business model that relate to the prolonged low interest rate environment, without compromising the bank's sound asset quality. Factors that Could Lead to a Downgrade As indicated by the negative outlook on the bank's long-term deposit ratings, BKM's BCA, which is currently positioned at the high end of the scorecard range, could be downgraded unless the bank's solvency metrics improve. In particular, downward pressure may intensify if 1) the bank's TCE leverage ratio declined; or 2) if the bank reduced its cushion of unencumbered liquid assets without reducing market funds in parallel; or ) if persistently low interest rates exert additional pressure on BKM's low profitability, resulting in sustained negative net income and undue strain on capital. A downgrade of the BCA will translate into downward pressure on the bank's long- and short-term deposit ratings. In addition to a lowering of the BCA, downward pressure on BKM's A2 long-term deposit rating may also originate from a stronger than currently anticipated reduction in the amount of senior and subordinated debt outstanding relative to BKM's total banking assets. 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 May 217

3 Key Indicators Exhibit 2 Bausparkasse Mainz AG (Consolidated Financials) [1] Total Assets (EUR billion) Total Assets (USD billion) Tangible Common Equity (EUR billion) Tangible Common Equity (USD billion) 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 (%) CAGR/Avg [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; LOCAL GAAP [] Basel II; LOCAL GAAP [4] May include rounding differences due to scale of reported amounts [5] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime [6] Simple average of periods presented for the latest accounting regime. [7] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed Rating Considerations Profitability expected to remain subdued The provisions of the special banking act for German building and loan associations (Bausparkassengesetz) narrowly delimit the allowed business activities of BKM; we therefore classify BKM as a monoline institution that is vulnerable to potential changes in market dynamics which - in an adverse scenario - could be sudden and unforeseen with no offsetting earnings stream. The classification as a monoline entity leads to a full notch qualitative deduction from BKM's BCA in our scorecard. We expect the overhaul of the special banking act for the German Bausparkassen introduced in 215 to allow BKM to gradually offset pressure on its net interest margin through greater funding and asset flexibility, foremost through the selective increase in the maximum loan-to-value ratio beyond the former statutory 8% limit and the issuance of mortgage covered bonds. If successful, these initiatives will in our view translate into higher profits rather in the medium- than in the short-term. The low interest rate environment has accentuated the mismatch between BKM's Bauspar- and term deposit base and its opportunities to lend to Bauspar-clients. In our view, this exposes the Bausparkassen sector and BKM to additional interest rate margin pressure and asset-liability management (ALM) risks that bear significant earnings risks in a prolonged low interest rate environment. As a result, we assign a Profitability score of only b to BKM, one notch below the score suggested by our scorecard. BKM's earnings generation is poor, reducing its ability to strengthen and expand its existing franchise, and to withstand the negative impact of competitive challenges and the risks intrinsic to its business model. BKM's funding mix is less burdened than the overall Bausparkassen-sector by legacy high-coupon Bauspar deposits. However, BKM's profitability has been under pressure from costly interest-rate macro hedges, which as of year-end 215 had a negative market value of 1 million (214: - 19 million). In addition, BKM has had to adjust downward interest rate assumptions used for estimating its pension funding gap. For 215, BKM reported a pre-tax profit of.8 million, up from a 9.1 million pre-tax loss in 214 (21: million). According to BKM, which will publish its 216 annual report in June 217, the bank's 216 net income of 1.5 million slightly exceeded its 215 results. The bank has a relatively high cost base given its small size and lack of economies of scale. The bank has initiated several measures in 214 to lower earnings pressures in future years, which in conjunction with the ongoing savings program give management some flexibility to offset the ongoing earnings pressure in the low rates environment. 29 May 217

4 Good liquidity in conjunction with a diversified and less confidence-sensitive funding profile We believe BKM's funding profile, which includes a mix of retail deposits - both under Bauspar contracts and regular term deposits and institutional funds, is a relative strength of the entity compared to the typically highly Bauspar-deposit centered funding profile of the broader building and loan associations sector. Although we regard the internet deposits and promissory notes issued by BKM less sticky than traditional Bauspar deposits, these funds have offered the bank greater flexibility to adapt to the low interest rate environment and protect net intrest margins. Over the past years, BKM has been successful in building up a retail-based funding franchise by offering money-market and termdeposits to private customers at competitive rates via the Internet. Although we regard these deposits as inherently more confidencesensitive and thus less "sticky" (stable) than traditional retail deposits, we highlight that the retail deposit base (including Bauspar deposits) now represents 1.8 billion or 69% of total assets as of year-end 215 and has significantly diversified BKM's previously wholesale-dominated funding profile. In turn, the bank's funding dependence on fixed-rate Bauspar-deposits is considerably lower-than-average for the sector. In the low interest rate environment, this gives BKM some flexibility to maintain its net interest margin at adequate levels compared to other Bausparkassen that rely more heavily on traditional Bauspar-deposit funding. In addition, BKM exhibits increased volume flexibility compared to its direct competitors as result of the shorter-term nature of money-market and term-deposits. Interbank financing accounts for 557 million or 22% of total assets. Although interbank funding is more credit-sensitive, particularly as it is largely sourced via brokers, we view favourably that it is largely long term, relates to promissory notes (Schuldscheindarlehen, 18 million as of year-end-215 compared to 21.5 million as of year-end 214) primarily sourced from the German savings and co-operative banks sector, and also encompasses minor funding sources related to promotional lending. In addition, BKM's securities portfolio contains sufficient central bank eligible assets to counter unexpected liquidity outflows. Thus, we regard BKM's overall liquidity profile as good. Capital ratios are adequate, but weak earnings outlook inhibits absolute capital growth Because of weak internal capital generation as result of BKM's poor profitability, we expect the bank's capital volume to remain rather stable over the coming years, thereby limiting BKM's growth potential when assuming unchanged leverage. Nevertheless, BKM's capitalisation levels are mitigated by the institution's moderate risk profile because of its focus on highly granular residential real-estate lending. BKM's Common Equity Tier 1 (CET1) ratio increased to 12.18% as of December 215, up from 11.6% at end-214. For 216, BKM preannounced that its CET1 ratio improved to 12.7% (including retained 216 earnings) whereas its total capital ratio rose to 15.7% (from 15.1% as of December 215). In contrast to the risk-based capital ratios, BKM's TCE leverage ratio stood at a satisfactory 4.% as of year-end 215, leading to a one notch negative adjustment of the assigned capital score to a. Under the standardized approach employed by BKM to measure its risk-weighted assets (RWAs), the risk weight assigned to mortgage loans declined in 214 to 5% from 5% under Basel II. We expect BKM with its highly-collateralised loan book to be less exposed to upward pressure on its risk-weighted assets upon future tighter regulatory risk-measurement requirements, because the bank does not employ an internal model-based approach to measure its risks for regulatory purposes. Sound asset quality given highly granular and collateralised loan book The credit risk of BKM's loan book is low, as reflected by the institution's focus on residential mortgage lending (accounting for 69% of total assets) and the inherent high portfolio granularity. In addition, risks to asset quality are mitigated by the fact that borrowers under most mortgage loans granted by BKM need to build deposits at a speed above typical German mortgage loan amortisation schedules. For loans subject to the Bausparkassengesetz, the maximum loan-to-value (LTV) ratio has thus far been capped at 8%. In December 215, a revision of this law increased the maximum LTV ratio for owner-occupied residences to 1%. Overall, the proposal is designed to alleviate business model problems related to the prolonged low interest rate environment. Traditional mortgage loans sourced from Bauspar contracts only accounted for 8% of BKM's total customer loans as of year-end 215 whereas bridge loans (conventional mortgage loans granted in connection with Bauspar arrangements) accounted for the bulk of client lending May 217

5 Loans subject to specific loan loss reserves accounted for 1.5% of gross loans as of year-end 215, further improving from 2.1% as of year-end 214. The reported problem loan metric is low compared with banking peers in Germany; however, we note that the published problem loans under local GAAP (the German Commercial Code or HGB) may understate downside risk as they do include only amounts where loan loss provisions have been built ('past due and impaired'). Our assigned asset risk score of a is three notches lower than the aa macro-adjusted score, reflecting foremost interest rate risk and that unimpaired 9 days past due loans are not captured in the historic problem loan ratio. Absent of loan growth, BKM invested excess liquidity in a securities portfolio representing a significant 65 million or 25.5% of total assets as of year-end 215. The portfolio mostly comprises highly rated financial institutions, corporate exposures and euro-area sovereigns, within the conservative investment limits set by the Bausparkassengesetz and by BKM's investment policy. BKM's ratings are supported by its macro profile of Very StrongGerman banks benefit from operating in an environment with very high economic, institutional and government financial strength and very low susceptibility to event risk. Low and declining private-sector debt and a stable house price cycle support credit conditions. Funding conditions benefit from a strong domestic deposit base and good wholesale market access. However, operating conditions for the German banking system are constrained by high fragmentation in an over-saturated market, low fee income generation and intensifying competition for domestic business. Around three quarters of BKM's assets are in Germany and the remainder is predominantly invested in the Euro area as well as in countries such as the US that exhibit comparably strong macro profiles as BKM's domestic market, resulting in a weighted macro score of `Very Strong-' (VS-). Notching Considerations Loss Given Failure BKM is subject to the EU Bank Recovery and Resolution Directive (BRRD), which we consider an Operational Resolution Regime. We apply our advanced Loss Given Failure (LGF) analysis to BKM's liabilities, considering the risks faced by the different debt and deposit classes across its liability structure at failure. 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. These are in line with our standard assumptions. In line with the new German insolvency legislation that will effectively subordinate senior bonds and notes to deposits in resolution from January 217, we base our calculation on the assumption that deposits are preferred to most senior unsecured debt instruments. For deposits, our LGF analysis indicates an extremely low loss-given-failure, leading to a three-notch uplift from the bank's Adjusted BCA. Government Support Following the introduction of the BRRD, we have lowered our expectations about the degree of support that the government might provide to a bank in Germany in the event of need. Because of its small size relative to the German banking system and its limited degree of systemic interconnectedness, we continue to assign a low systemic support probability assumption for BKM, which does not result in any rating uplift from government support May 217

6 Rating Methodology and Scorecard Factors Exhibit Bausparkasse Mainz AG Macro Factors Weighted Macro Profile Very Strong - Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver #2 Collateral and provisioning coverage Solvency Asset Risk Problem Loans / Gross Loans 1.9% aa a Interest rate risk Capital TCE / RWA 12.4% a2 a Nominal leverage % b2 b Earnings quality Profitability Net Income / Tangible Assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 21.8% Liquid Resources Liquid Banking Assets / Tangible Banking Assets a 27.% baa1 baa1 Market funding quality a2 Asset encumbrance 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 a Balance Sheet in-scope (EUR million) 454 1,724 1, ,552 Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Equity Total Tangible Banking Assets 6 1% 29 May 217 baa Aaa -ba1 % in-scope 17.8% 67.6% 6.8% 6.8% 1.6% 1.%.% 1% at-failure (EUR million) 575 1,6 1, ,552 % at-failure 22.5% 62.8% 57.8% 5.1% 1.6% 1.%.% 1%

7 Debt class Counterparty Risk Assessment Deposits Instrument class Counterparty Risk Assessment Deposits 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 a2 (cr) 4.% 14.6% 2 a2 Loss Given Failure notching Additional Preliminary Rating Notching Assessment a2 (cr) a2 Government Support notching Local Currency Rating A2 (cr) A2 Foreign Currency Rating -A2 Source: Moody's Financial Metrics Ratings Exhibit 4 Category BAUSPARKASSE MAINZ AG Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Moody's Rating Negative A2/P-1 A2(cr)/P-1(cr) Source: Moody's Investors Service Output of the Baseline Credit Assessment Scorecard Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read in conjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecard may materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strong divergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity May 217

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9 Analyst Contacts Bernhard Held, CFA VP-Senior Analyst 9 29 May 217 CLIENT SERVICES Christina Gerner Associate Analyst Americas Asia Pacific Japan EMEA