Credit Opinion: Volkswagen Bank GmbH

Transcription

1 Credit Opinion: Volkswagen Bank GmbH Global Credit Research - 25 Nov 2015 Brunswick, Germany Ratings Category Moody's Rating Outlook Developing(m) Bank Deposits A1/P-1 Baseline Credit Assessment baa2 Adjusted Baseline Credit Assessment a3 Counterparty Risk Assessment Aa3(cr)/P- 1(cr) Senior Unsecured -Dom Curr A1 Subordinate -Dom Curr Baa1 Commercial Paper -Dom Curr Other Short Term -Dom Curr P-1 (P)P-1 Ult Parent: Volkswagen Aktiengesellschaft Outlook Issuer Rating Negative A3 Senior Unsecured MTN -Dom Curr Commercial Paper -Dom Curr (P)A3 P-2 Parent: Volkswagen Financial Services AG Outlook Negative Counterparty Risk Assessment Aa3(cr)/P- 1(cr) Senior Unsecured -Dom Curr A1 Commercial Paper -Dom Curr P-1 Contacts Analyst Phone Bernhard Held/Frankfurt am Main Katharina Barten/Frankfurt am Main Carola Schuler/Frankfurt am Main Christina Gerner/Frankfurt am Main Key Indicators Volkswagen Bank GmbH (Consolidated Financials)[1] [2]6-15 [2]12-14 [3]12-13 [3]12-12 [3]12-11 Avg. Total Assets (EUR billion) [4]4.4 Total Assets (USD billion) [4]0.5 Tangible Common Equity (EUR billion) [4]-2.3 Tangible Common Equity (USD billion) [4]-5.9 Problem Loans / Gross Loans (%) [5]3.9 Tangible Common Equity / Risk Weighted Assets (%) [6]12.8 Problem Loans / (Tangible Common Equity + Loan Loss [5]24.6 Reserve) (%) Net Interest Margin (%) [5]3.1 PPI / Average RWA (%) [6]1.9

2 Net Income / Tangible Assets (%) [5]0.9 Cost / Income Ratio (%) [5]56.8 Market Funds / Tangible Banking Assets (%) [5]26.0 Liquid Banking Assets / Tangible Banking Assets (%) [5]9.2 Gross loans / Due to customers (%) [5]152.4 Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] 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 Opinion SUMMARY RATING RATIONALE On 6 November, we downgraded the long-term debt and deposit ratings of Volkswagen Bank GmbH (VW Bank) to A1 from Aa3, and kept the rating outlooks for the bank's long-term debt at negative and for its deposits at developing. We also downgraded the bank's subordinated debt ratings to Baa1 from A3 and its long-term Counterparty Risk Assessment (CR Assessment) to Aa3(cr) from Aa2(cr). The bank's Prime-1 short-term debt and deposit ratings and its short-term CR Assessment of Prime-1(cr) were affirmed. The downgrade of VW Bank's long-term debt and deposit ratings reflects (1) the affirmation of the bank's baa2 Baseline Credit Assessment (BCA), (2) the downgrade of VW Bank's adjusted BCA to a3 from a2, following the downgrade to A3 from A2 of the long-term issuer rating of its ultimate parent Volkswagen AG (Volkswagen), (3) the unchanged two notch uplift resulting from our Advanced Loss Given Failure (LGF) analysis and (4) unchanged government support assumptions for VW Bank, which continue to result no ratings uplift. The affirmation of the bank's baa2 BCA reflects its flexibility to offset current headwinds for wholesale market funding by less confidence-sensitive funding channels, including deposits and asset-backed securities in its funding mix. We believe Volkswagen will remain committed to protecting its captive finance subsidiaries from the financial fallout stemming from irregularities in the company's automotive business, helping to mitigate 1) future asset risks related to dealer financing and residual car values and 2) profitability pressure on Volkswagen's bank and leasing operations. Even so, a prolonged increase in funding spreads may weigh on the captives' earnings in The baa2 BCA also reflects that we view the serious internal controls and governance issues at Volkswagen to be contained within the manufacturing business of Volkswagen, with only limited spill-over effect on the company's finance captives. Rating Drivers - Asset quality ratios may deteriorate as a result of reputational damage to the Volkswagen brand and slowing sales - The bank's adequate risk-adjusted profitability relies on net interest income related to Volkswagen's car sales - Capital levels remain satisfactory despite pressure from steady loan growth - VW Bank's liquidity profile benefits from a strong retail-oriented deposit base and good funding diversification - Senior creditors benefit from the large volume of outstanding debt within the bank's direct parent Volkswagen Financial Services AG (VW FS AG) resolution perimeter in the unlikely event of resolution Rating Outlook The outlook on the long-term senior unsecured debt rating is negative and follows the negative outlook on Volkswagen's A3 long-term issuer rating. In addition, it reflects the potential for long-term debt ratings of VW Bank to be downgraded by one notch in case the share of the senior unsecured debt outstanding within the VW FS AG resolution perimeter declines. The developing outlook on VW Bank's A1 long-term deposit ratings reflects the simultaneous presence of both

3 downward and upward pressure on VW Bank's deposit rating. The negative pressure on VW Bank's debt ratings resulting from the negative outlook on Volkswagen's long-term issuer rating applies equally to VW Bank's deposit rating. At the same time, the revision to the German insolvency ranking continues to exert upward pressure on VW Bank's deposit ratings. What Could Change the Rating - Up Due to the intrinsic interlinkages of VW Bank with its automotive parent, the bank's ratings are highly dependent on the creditworthiness of Volkswagen, whose ratings have a negative outlook. As a result, we currently see no upward pressure on VW Bank's debt ratings. A stabilization of Volkswagen's outlook could occur if there is evidence that the effects of the emissions issue are contained with manageable effects on Volkswagen's brand image, pricing power, earnings and cash position. The change in insolvency legislation in Germany that subordinates senior unsecured debt to deposits in resolution from January 2017 onwards places upward pressure on VW Bank's long-term deposit ratings, if Volkswagen's creditworthiness does not deteriorate further. There is currently limited upward pressure on the standalone BCA rating, which is positioned at the higher end of the scorecard range. An upgrade of the standalone BCA would require a significant strengthening of the bank's solvency through clearly improving asset quality and capitalization combined with a material improvement of the bank's liquidity profile through a boost in the bank's available liquid banking assets, which we consider unlikely at present. What Could Change the Rating - Down A downgrade of Volkswagen would result in a similar rating action on VW Bank's adjusted BCA, which would, in turn, likely lead to a downgrade of the bank's long-term debt ratings. In addition, VW Bank's debt ratings could be downgraded if debt volumes at the level of the VW FS AG resolution perimeter decreased significantly relative to tangible banking assets. This could result in fewer notches of uplift resulting from our LGF analysis. A downgrade of VW Bank's standalone BCA could be triggered by one, or a combination of the following factors: (1) our view that the current rating levels may not adequately reflect the pressure points should the operating environment weaken; (2) asset quality deterioration, especially considering the bank's large exposure to car dealers and the resulting burden that this may exert on both profitability and capitalisation, even though VW Bank's conservative risk provisioning provides the bank with some buffers: (3) a prolonged increase in funding spreads which would weigh on VW Bank's earnings and (4) any signs that the serious internal controls and governance issues at Volkswagen were not contained within the manufacturing business of Volkswagen. DETAILED RATING CONSIDERATIONS ASSET QUALITY RATIOS MAY DETERIORATE AS A RESULT OF REPUTATIONAL DAMAGE TO THE VOLKSWAGEN BRAND The bank's large exposure to car dealers of EUR9.9 billion (or 26% of its loan book as of June 2015) may result in undue strain on its profitability and thus capital ratios in an adverse scenario, which we would not rule out to result from the consequences of environmental standard breach allegations against Volkswagen. We consider that these exposures - albeit well-diversified by borrowers - represent aggregate risks due to their inherent correlation, given that the performance of the dealer loan book is to a large extent related to the well-being of the related car manufacturer and its brands. The common risks shared by the dealers foremost relate to declining car sales and lower used car values, which could result on the side of the dealers in higher working-capital financing needs and in losses from rising balloon loan contract termination rates. We adjust VW Bank's Asset Quality score down by one notch due to the dynamic loan growth in recent years, which may add to asset quality concerns in a less benign operating environment for VW Bank. In addition, the strong focus of VW Bank's business profile on auto loans and lending to borrowers related to the automobile industry leads us to apply a full notch negative qualitative adjustment to the bank's BCA.VW Bank displays a significant level of intercompany loans to other entities within VW FS AG, which represented about 100% of Tier 1 capital as of year-end 2014 (EUR4.3 billion). As of December 2014, VW Bank's non-performing loan (NPL) ratio stood at 3.0%, an improvement from the 3.8% three-year average NPL ratio. In 2014, new provisions were stable in comparison to 2013, leading to an improvement in the coverage of the declining amount of non-performing loans reported. In preparation for higher

4 default risks due to weak economic conditions in countries particularly struck by the euro zone crisis, VW Bank increased its stock of portfolio-based loan loss provisions by EUR115 million in This increases the bank's specific & portfolio-based loan loss reserves to EUR1,118 million (2013: EUR1,028 million). Actual write-offs for retail car financing have remained consistently low, with the bulk of asset quality issues arising from dealer financing. Direct residual value risk is mainly incurred through VW Bank's contracts in France, Italy, Portugal, and Ireland. Outside these countries, residual value risks incurred through a specific balloon auto loan product are moderate and mostly of indirect nature, as this risk is typically absorbed by car dealerships in the first place. On 23 October, VW Bank's direct parent VW FS AG announced that Volkswagen "will bear the financial impact of the consequences relating to vehicles with Type EA189 engines". THE BANK'S ADEQUATE RISK-ADJUSTED PROFITABILITY RELIES ON NET INTEREST INCOME RELATED TO VOLKSWAGEN'S CAR SALES VW Bank lacks income-stream diversification, and is highly dependent on its automotive parent's sales volume, as evidenced by its reliance on net interest income from car-financing activities. Although VW Bank has developed related services that gradually translate into rising fee income - such as loan payment insurance, vehicle maintenance contracts and car insurance products - its monoline franchise limits its ability to generate recurring earnings in case of a severe stress on Volkswagen's car sales globally. In addition, higher risk provisions to compensate for a deterioration in the creditworthiness of related car dealers may pressure profitability further. VW Bank reported a pre-tax profit of EUR308 million in the first half of 2015 (full year 2014: EUR464 million; 2013: EUR459 million). As a result of higher lending volumes, net income from lending and leasing before risk charges slightly increased by 2.0% in comparison to the first six months of 2014 (2014: EUR1,204 million; 2013: EUR1,188 million), while net interest margin pressure was mitigated by significantly lower funding costs for deposits and debt instruments. VW Bank's risk-adjusted profitability has been resilient over the past three years, having maintained recurring preprovision income of around 2% (measured against average risk-weighted assets, 2013: 2.4%). CAPITAL LEVELS REMAIN SATISFACTORY DESPITE PRESSURE FROM STEADY LOAN GROWTH Whereas we expect retail loan growth to moderate going forward against the background of potentially weaker than anticipated car sales volumes, we also see a risk of the dealer finance book expanding at a faster pace, given a possible rise in working capital needs of these clients. Going forward, we expect regulatory capital ratios to remain in the range of current levels. As minimum capital requirements gradually increase, this will translate into a declining, yet still adequate buffer, reflective of a less conservative capital management under the Basel III regulatory framework. A further decrease of capital ratios closer to the regulatory minima would put pressure on the currently assigned capital score of a3, which is applicable to Tangible Common Equity ratios in a range between 12% and 13%. As of June 2015, VW Bank reported a Tier 1 capital ratio of 12.5% under Basel III (2014: 13.2% Basel III; 2013: 14.0% Basel II). We regard VW Bank's capitalisation as strong enough to mitigate potential volatility of the underlying automotive industry cycle. We also take comfort from the sound quality of the bank's capital which does not contain any hybrid capital. VW BANK'S LIQUIDITY PROFILE BENEFITS FROM A STRONG RETAIL-ORIENTED DEPOSIT BASE AND GOOD FUNDING DIVERSIFICATION VW Bank's good access to a range of funding tools has allowed the bank to efficiently manage its liquid resources. We consider the strong reputation of the Driver Auto ABS program and VW Bank's stable deposit base important strengths of the bank's funding profile. Nonetheless, as a result of VW Bank's partial market-funding reliance, which - prior to adjusting for maturity-matched asset-backed securities funding - represents 28.0% of tangible banking assets as of December 2014, limited challenges may arise in case of reduced availability of wholesalemarket funding, potentially resulting in higher funding costs. VW Bank's EUR25.1 billion deposit base as of June 2015 is its main financing source, accounting for 56% of total assets. These are sourced primarily from individual customers in Germany. This deposit base has proven reasonably stable even during market turmoil, in spite of it largely being invested in overnight deposits and collection of deposits through the internet potentially entailing some volatility. VW Bank's liquidity profile is limited by asset encumbrance and a 8.5% Liquid Banking Assets ratio in 2014.

5 However, funding via group companies remains modest and would be available to a larger degree based on a back-up line from VW Group, leading to a liquid resources score of b1. The overall combined liquidity score is ba1. VW BANK'S BCA IS SUPPORTED BY ITS STRONG+ MACRO PROFILE The bank's BCA benefits from its Strong (+) Macro Profile, largely determined by the German environment, with very high economic, institutional and government financial strength and very low susceptibility to event risk. Operating conditions for the German banking system are, however, constrained by high fragmentation in an oversaturated market, low fee income generation and intensifying competition for domestic business. VW Bank`s `Strong+' macro profile also captures the bank's exposures to countries with weaker macro profiles compared to Germany, in particular France and Italy. Notching Considerations AFFILIATE SUPPORT Based on the profit and loss transfer agreement of VW Bank with its parent VW FS AG and based on its important strategic role in Volkswagen Group, we consider VW Bank to be "affiliate backed" by its owners, resulting in an adjusted BCA of a3, aligned with the A3 long-term issuer rating of Volkswagen. LOSS GIVEN FAILURE VW Bank is subject to the EU Bank Resolution and Recovery Directive, which we consider to be an Operational Resolution Regime. In accordance with our methodology, we therefore apply our Advanced LGF analysis, considering the risks faced by the different debt and deposit classes across the liability structure at failure. We assume residual tangible common equity of 3% 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 are in line with our standard assumptions. Our advanced LGF analysis applied at the level of VW FS AG' domestic operations indicates a very low lossgiven-failure for deposits and senior unsecured debt, leading us to position their Preliminary Rating Assessment (PRA) two notches above the Adjusted BCA. As a result, we assigned A1 long term debt and deposit ratings to VW Bank. Our advanced LGF analysis indicates a high loss-given-failure for junior debt classes, leading us to position their PRA one notch below the 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 relatively small size relative to the German banking system, it is not significant market share in the domestic deposit market and its limited degree of systemic interconnectedness, we continue to assign a low government support probability assumption for VW Bank, which does not result in any rating uplift from government support. ABOUT MOODY'S BANK RATINGS About Moody's Bank 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. Rating Factors Volkswagen Bank GmbH Macro Factors

6 Weighted Macro Profile Strong + Financial Profile Factor Historic Ratio Macro Adjusted Score Solvency Asset Risk Problem Loans / Gross Credit Trend Assigned Score 3.8% a3 baa1 Loan growth Loans Capital TCE / RWA 13.0% a3 a3 Profitability Net Income / Tangible Assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets Liquid Resources Liquid Banking Assets / Tangible Banking Assets Combined Liquidity Score 0.9% baa1 baa1 a3 baa1 Key driver #1 Key driver #2 28.0% baa2 baa1 Market funding quality 8.5% ba2 b1 Access to committed facilities baa3 ba1 Financial Profile baa2 Qualitative Adjustments Adjustment Business -1 Diversification Opacity and Complexity 0 Corporate Behavior 0 Total Qualitative Adjustments -1 Asset encumbrance Sovereign or Affiliate constraint Scorecard Calculated BCA range Aaa baa2 - ba1 Assigned BCA baa2 Affiliate Support notching 2 Adjusted BCA a3 Instrument Class Loss Given Failure notching Additional notching Preliminary Rating Assessment Government Support notching Local Currency rating Foreign Currency rating

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